Big is Beautiful?

How big should a company be?

76 years ago Ronald Coase set out to explain why people organize themselves into businesses, firms, and corporations rather than just freely trade goods and services with one another. If Adam Smith’s “invisible hand” is so efficient, why don’t we all organize ourselves independently?

The answer has to do with costs. It’s cheaper to build a firm around one product or service and aggregate the inputs and outputs needed to get the product to market, rather than everyone negotiating every little detail with everyone else. With a large and complex system like a car, there are literally millions of parts, each of which must be built to precise specifications. It would be really inefficient for the billions of transfers to be negotiated independently.

Transactions costs can be lowered dramatically by bringing them into a single firm. When this works, it works beautifully: an engaged workforce creates and produces something the sales-force can market effectively, gathering feedback from customers as they go, funneling this to an R&D group that solves problems imaginatively.

But nothing fails like success. Small firms that “ideate” effectively grow into behemoths that become caricatures of themselves: cubicle farms straight out of “Dilbert.” That’s partly why there’s so much investor skepticism around Apple or other fast-growers: no tree grows straight to heaven. Mega-firms create mega-administrative bloat and bureaucratic nonsense: a Soviet-style republic where meeting the plan and compliance are far more important than innovation and customer service.

Lincoln once answered the question, how long a man’s legs should be by quipping, “Long enough to reach the ground.” The answer to how large a firm should be is equally simple: large enough to be efficient—and no larger.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2013-01-14T10:00:11+00:00 January 14th, 2013|Uncategorized|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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