IS BIG BEAUTIFUL?
Companies in Asia are small by global standards. The question is, are they too small?
By Justin Wood

By any measure, it's an impressive growth story. Back in August 1995, Maxis Communications took its first tentative step into Malaysia's mobile phone sector. A mere eight years later and the firm has 35 percent of the market. It's now the fourth biggest company on the Kuala Lumpur Stock Exchange with sales last year of US$1 billion and operating profits of US$361m.

"We've been busy," says Maxis CFO James Brodie, with Scottish understatement.

Much of that growth has been organic, mirroring Malaysia's rapidly maturing market - in 1995 just 4 percent of the population owned a mobile phone while today that figure is almost 40 percent. But the company has also expanded by buying a rival, TIMECel, in May 2003. And there's more growth to come. In particular, Maxis has continued to explore regional acquisition opportunities.

"Inevitably, growth in our home market is slowing down as it becomes more saturated, so we're looking at other opportunities overseas," explains Brodie.

Size matters

The experience of Maxis and its pursuit of growth at home and abroad is by no means unique in Asia. And yet, ask some observers, are Asian businesses growing fast enough? In particular, they argue, given today's climate of falling trade barriers and deepening globalization, local companies face an onslaught of foreign competition. In response, should local CFOs be gunning for size in a bid to survive?

It's certainly true that, on the whole, Asian firms are smaller than their counterparts elsewhere in the world. For instance, the market capitalization of the 20 biggest firms in the US stands at US$2,891 billion, a figure that dwarfs the equivalent figure of US$305 billion for Asia-ex-Japan. Measured by turnover, it's a similar story: sales at the 20 biggest companies in the US are almost four times as large as sales at the 20 biggest firms in Asia-ex-Japan. Nor do these numbers reflect the size of the underlying economies. When compared to GDP, it's clear that Asia could support bigger companies than currently exist.

Just as illustrative is a report released in August by Interbrand, a marketing consultancy that listed the world's 100 most valuable brands. Unsurprisingly, the US dominated with 66 on the list, followed by Europe with 27, and then Japan with six. Only one brand in the top 100, Korean electronics firm Samsung, came from the Asia-ex-Japan region.

Whether or not size has any bearing on creating value for shareholders is another matter. Some commentators would argue not, such as Kulwant Singh, associate professor of business policy at the National University of Singapore. "There's a widespread perception, especially in Asia, that size and success go hand-in-hand," he argues, "when more often than not the opposite is the case." He points to the fall from grace of the giant chaebol conglomerates in Korea and the keiretsu in Japan to back up his assertion.

Raymond Lim, minister of state for trade and industry in Singapore, is of a similar mind. "Today, nine out of ten companies in Singapore are small and medium enterprises (SMEs)," he said in a speech last month. "They employ half of our workers and contribute a third of total value-added. It is vital that we have a strong cast of entrepreneurial SMEs."

Weighing up scale

All true enough, and yet other commentators still believe that size should be a vital consideration for Asian companies. Many reasons lie at the heart of their claims, not the least of which is the globalization of trade. Consider data from the World Trade Organization (WTO) which shows that, over the past 52 years the value of global exports has risen at a compound annual growth rate (CAGR) of 9.36 percent, while global GDP has increased at a CAGR of just 3.87 percent. It's clear that companies are doing more and more business overseas as they look to grow profits beyond their domestic markets.

At the same time, barriers to trade are falling. For example, membership of the WTO is expanding, especially in Asia, where China's entry in 2001, Taiwan's entry in 2002 and the entry of Cambodia and Nepal this year means that the trade club now includes 16 countries in the region, and 148 worldwide. What's more, given the slow progress in recent years of the WTO to further the cause of free trade on a multilateral basis, a flurry of bilateral free-trade agreements have sprung up. And in South-east Asia, the ASEAN Free Trade Agreement will see all trade tariffs abolished by 2010 for the original six members, and by 2015 for ASEAN's four most recent recruits.

Add to all this the globalization of media, sport, entertainment and marketing, and many observers claim that companies can no longer afford to be small, for globalization is ratcheting up competition. "Companies these days have no choice but to grow beyond their borders," stresses Frank-JŸrgen Richter, Asia director of the World Economic Forum, a think tank. He's written a book about the impact of globalization on Asian companies due out later this year and notes that: "Even to compete successfully in their home markets, companies will need to expand into foreign ones."

The advantages that size and growth bring as a response to competition are well-rehearsed. For one, size creates economies of scale as companies are able to spread their costs over a broader base. For another, it makes it easier and cheaper for companies to raise money. Todd Marin, Asia Pacific head of M&A at JP Morgan, an investment bank, explains: "Portfolio managers prefer companies that have a big enough market value to give liquidity to their investments. Because smaller companies are less liquid, they find it more difficult to attract investors and so have a higher cost of capital."

And it isn't just equity that's more expensive. Small firms pay more to borrow too. "Credit ratings are highly correlated to the size of the company," observes Marin, "because big companies are less risky than small ones."

A bigger shoe size

Such arguments aren't lost on Steve Li, CFO of Hong Kong-based Yue Yuen Industrial Holdings, the world's largest manufacturer of sports shoes and casual footwear. With US$2 billion in annual turnover, and a 17 percent share of the global market, Yue Yuen's sales have grown on average by 19 percent every year for each of the past 10 years, even as the shoe market itself has expanded by less than half that. It's a virtuous circle, says Li, for by growing at a faster rate than the market, Yue Yuen has continued to wring ever greater economies of scale from its factories and so put ever more pressure on competitors.

As for its cost of capital, Li says that size has helped here too. On June 9, Yue Yuen became one of the constituents of Hong Kong's Hang Seng Index, so attracting greater interest from fund managers. "Being on the Index gives us greater visibility and credibility," he says, pointing out that the number of analysts following Yue Yuen jumped from 16 to 20 following the news.

But there's another reason why size has been important to Li, and that's the degree of consolidation amongst his customers. The global sports shoe market is dominated by just five brands: Nike, Reebok, Adidas-Salomon, New Balance and Asics. In order to serve such big customers, and to negotiate with them on their own terms, Yue Yuen has found it useful to be big too.

As you grow, so shall you reap

Of course, many managers might point out that the importance of size varies from sector to sector, arguing that while it's important in the shoe industry, it's perhaps less so in others. However, Graeme Deans, global head of strategy at AT Kearney, a consultancy, would beg to differ. As he puts it: "There is no such thing as an optimal or maximum company size. To survive, all companies must continuously grow."

In July, Deans, and fellow consultants Fritz Kroeger and Stefan Zeisel, published a book called the Winning the Merger Endgame, which looks at the M&A patterns of 25,000 companies in 53 countries over the period 1988 to 2001. Their conclusion is that industry consolidation is inevitable and that it follows a distinct four-stage pattern. Stage one is characterized by newly deregulated industries and start-up businesses that tend to fragment and the corporate population quickly reaches its maximum. By stage two, scale begins to matter, major players emerge and begin to drive consolidation and the population contracts by 70 percent. In the third stage, successful players narrow their focus and aggressively outgrow the competition, until in the final stage just a handful of players dominate and the population has shrunk by half again.

Examples of fully consolidated sectors include tobacco, defence, soft drinks, and automatic controls.

From start to finish, the consolidation of any particular sector takes 25 years, says Deans, but he warns that the pace is speeding up. "Globalization, falling trade barriers, and the spread of technology will mean that the speed of consolidation will quicken from 25 years today to 15 years within a decade," he predicts.

Deans concludes by arguing that managers need to work out where their company and their sector sits on the "consolidation curve" and plot their strategy accordingly. "There are no protectable niches," he says, "all industries become global and niche players get consolidated."

Getting engaged

Maxis Communications has certainly experienced rapid consolidation. When it started out in the mid-1990s, the Malaysian mobile phone sector boasted eight operators. Today just three survive. And the pattern is similar elsewhere in Asia too: last year, China Mobile snapped up eight of its local competitors, and in July this year, Far EasTone Telecom of Taiwan agreed to buy its smaller rival KG Telecommunications, so creating the country's second biggest operator.

For Maxis, consolidation has brought numerous benefits. Its acquisition of TIMECel is set to reap important economies of scale, mostly in the form of reduced capital expenditure. By maintaining and upgrading just one mobile network instead of two, the Maxis/TIMECel combination can slash its overall capex costs and spread them over a bigger subscriber base. Brodie calculates that the merger will yield around Rm1 billion (US$263 million) of savings over three years - and that excludes the impact of adding new subscribers during that period.

The big question now is when regional, and even global consolidation will happen. With companies like the UK's Vodafone - sporting 296million customers in 28 countries - getting ever bigger, the pressure for Maxis to expand outside Malaysia looks set to increase. For his part, though, Brodie remains sanguine. "Competition [from the likes of Vodafone] is a concern," he concedes, "but it doesn't keep me awake at night. We don't have an EU-like trade environment in Asia, at least not yet, so regional consolidation will take some time."

And anyway, adds Brodie, Maxis can achieve scale without necessarily making acquisitions. One way is via alliances and partnerships. For example, in April this year, Maxis signed an agreement with four other regional telcos - CSL in Hong Kong, Smart of the Philippines, Singapore's MobileOne and Telstra in Australia - to work together on ways to boost mobile data services. Known as the Asia Mobility Initiative, the partnership will see all five members sharing ideas and experiences on how to grow mobile data usage beyond simple SMS text messages. "It's a way for all of us to get economies of scale in terms of generating ideas," enthuses Brodie

Lilliput, not Brobdingnag

Ideas such as this draw applause from Singh at the National University of Singapore, who likes to highlight the often-neglected issue of diseconomies of scale. While he doesn't dispute the benefits that size brings, he also notes that, "large companies are frequently unresponsive, slow-moving and difficult to manage."

In order to reap the benefits of size, adds Singh, it's critical that companies not only hire managers capable of handling the challenges of growth, but also that they get their business model right before they think about expanding. "Companies need to get efficient before they grow, not the other way around," he stresses.

That's good advice, reckons Lai Chin Yee, group financial controller of Singapore-based Qian Hu, Asia's biggest breeder of ornamental fish. Qian Hu is a relatively small business - sales last year amounted to S$63m (US$26m) - but it's experiencing massive growth. Thanks to a program of regional expansion into Malaysia, Thailand and China, the company's sales rose by 52 percent in 2002, while profits rose by 96 percent. "We started from a small base," says Lai modestly of the strong growth rate. Nonetheless, she's expecting "strong double-digit growth for the foreseeable future".

As Lai sees it, much of the credit for Qian Hu's success lies in perfecting its business model at home in Singapore before exporting that model to new markets. "It took quite a few years to get the basics of the business right," she says. The expansion effort, adds Lai, is designed to grow profits, to gain market share in order to fend off competition, and to spread the company's risk geographically - an over-concentration of breeding tanks would be dangerous were disease to strike.

Falling trade barriers are helping Qian Hu in its aims. Last year, for example, Taiwan deregulated its market for dragon fish - Asia's most prized variety - and almost overnight Qian Hu's sales there shot up by 25 percent. Not surprisingly, Lai would welcome a reduction in other sorts of obstacles to free trade too, especially invisible ones. "In China it takes a long time to work out how government agencies deal with many key business issues," she sighs.

Growing up is hard to do

Just like Singh, Lai also underscores the complexities of growth. The biggest challenge as a CFO, she says, is managing the performance of an expanding operation to make sure that the growth is "good growth". In an environment of rapid expansion, Lai explains, managers are apt to lose control of costs. "They see absolute profit numbers going up but they don't look at the margin."

Harder still, is managing acquisitive growth. A report written in January by three academics in the US - Sara Moeller, Frederik Schlingermann and RenZ¹ Stulz - shows just how tough it can be. In the study, the academics looked at 12,023 acquisitions made in the US between 1980 and 2001 and concluded that, altogether, those deals lost shareholders a staggering US$218 billion.

However, if the sample is broken down into small acquirers, defined as the 25 percent of firms on the New York Stock Exchange with the lowest market capitalizations, then this group actually created US$8 billion of wealth through acquisitions. It was their larger brethren who dragged down the overall total by vaporizing US$226 billion through bad deals.

At Maxis, such results come as no surprise to Brodie, which is why he says that he's already walked away from several major acquisitions because he felt the targets were overvalued. As he notes: "This company has a Scottish CFO and a Chinese treasurer [Chan Yew Thai], so we're pretty careful with our money."

Justin Wood is executive editor of CFO Asia, based in Singapore