Size matters and what the tech on The Future, This Week

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Intro This is The Future, This Week on Sydney Business Insights. I'm Sandra Peter, and I'm Kai Riemer. And every week we get together and look at the news of the week. We discuss technology, the future of business, the weird and the wonderful, and things that change the world. Okay, let's start. Let's start!

Sandra Today on The Future This Week: size matters when there's scarce abundance, and what the tech? I'm Sandra Peter. I'm the Director of Sydney Business Insights.

Kai I'm Kai Riemer, professor at the Business School and leader of the Digital Disruption Research Group. Okay Sandra, what are we going to do today?

Sandra Well Kai, we need to talk about the fact that size does matter.

Kai It turns out small is the new large, at least when it comes to corporate size.

Sandra And abundant is the new scarce.

Kai And that's about data, that comes into there. That's going to be a lot of stats, so we'll have to pretty much get through this. But there's an interesting point.

Sandra There's always a lot of stats when you're talking about size.

Kai Of course. Because it's not that straightforward at least not when it comes, to you know, corporates.

Sandra And that's the point about tech companies, right?

Kai Yeah. And there's also a story about what is a tech company or what isn't, because you know there's this real estate company that's doing an IPO and they claim to be tech.

Sandra Yeah, if WeWork as a tech company, we really thought we should ask what exactly is a tech company, 'cause what the tech?

Kai Okay let's do this.

Sandra Let's go.

Kai So Sandra, what happened in the future this week?

Sandra Well something very surprising, which is that we picked an article from the Harvard Business Review.

Kai Yeah, we haven't done that in a while.

Sandra So the article is titled "The Gap Between Large and Small Companies is Growing. Why?” the authors ask. And the article makes the point that contrary to popular opinion, large corporations are more and more likely to remain successful and maintain their dominant positions, while small companies are less and less likely to be able to grow and become more profitable and displace those large companies. And the authors give a number of ways in which the large companies have gotten larger, and smaller companies have stayed small.

Kai And the authors don't stop there. They actually show with their data that it is the large companies that invest more in research and development, and are therefore more innovative. Which again goes against popular wisdom that it is the smaller, more nimble companies that will come and disrupt the large incumbents, which is after all the dominant disruptive innovation narrative. Now let's have a look at what the authors actually did. They took data from the top 30 percent of stock market listed companies in the US, and compared it to the bottom 30 percent of firms on the stock market, and that is by market value of equity.

Sandra So they showed that from the mid 1990s the size difference between the large companies and the small companies has continuously increased, except for the global financial crisis period.

Kai And that is based on median values, which means that a few outlier companies such as Apple and Amazon that are really really big wouldn't actually make a difference here. And the gap has grown significantly from less than half a billion in difference to north of 3 billion, so that's more than a six-fold increase in those 35 odd years.

Sandra And so overall they find that the large companies are getting bigger and bigger, whilst the small companies at best stagnate.

Kai They also find an increasing performance gap between large and small businesses. While the difference in the median return on operating assets was about 15 percent in the 1990s, that has more than doubled to 30-35 percent, meaning that large companies are not only getting bigger, they're also getting way more profitable than the smaller ones.

Sandra So it's not just that the large companies are getting more profitable, small companies are shown to suffer from chronic on profitability.

Kai And so the question then is why? And one of the answers the authors locate is in what companies in each group spend on research and development or innovation. The median difference in R&D spend increased even more than profitability, that is six-fold. Which means that in 2017, the average that a large company would spend on innovation is about 330 million, which compares to about 6 million for one of the smaller companies.

Sandra And this is what the authors term the 'small size trap'. What this means is that it's becoming harder and harder for these small companies to escape the size that they are. Whilst 20 years ago 15 to 20 percent of the companies were able to become medium sized, or even grow up to be large companies. This percentage was down by half in 2017. Similarly for large companies, they manage to remain in their group for longer and longer, whilst in 2000 75 to 80 percent of large companies remained large, that percentage is now up to almost 90 percent.

Kai Okay, that was a lot of stats. Thanks for sticking with us, surely some of you will have lost the will to live by now. What are we doing with this Sandra? Sandra? She fell asleep. And then we snoozed.

Sandra Yeah, well I did. Because this is one of those articles that just sounds really great when you read the headline, and of course it's a narrative that is counterintuitive and perfect, and you get to this point, and the article does go on to tell us why this happens: because big companies invest more. But then if you take a step back and ask what exactly do we mean by large companies and what exactly do we mean by small companies, and why is this happening? Not because they're investing more, but why are they investing more? You realise that actually the interesting part of this argument comes when you start asking those questions.

Kai The article takes size of a company to be market cap, which is a fair point because after all we talk about share market listings. But there's other ways in which we can talk about what makes a big company, and how large companies of today might be different to the large companies twenty years ago, and how that difference actually accounts for the fact that we do not see the sluggish incumbents of old at the top of the share market, but companies that are fundamentally built on an innovation ethos.

Sandra So let's remind our audience that if you do have a look at the top 10 companies by market cap, most of those companies, actually eight out of the top 10 companies are technology companies.

Kai Yes, and they are also the top companies by revenue.

Sandra And this is a marked change from 10-15 years ago, where only one of those companies was a technology company.

Kai But they are by no means large when it comes to the number of employees. So let's take as three examples Walmart, Apple and Amazon. So WalMart is the largest company by far when it comes to employees, 2.2 million employees, Generate a revenue of 514 million US dollars. Apple on the other hand generates about half of this, 265 million, with only 132 thousand employees. And even Amazon, which is a direct competitor of Walmart, and also a retailer, has almost the same revenue as Apple, 232 million, and they do this with only 650 thousand employees. And quite obviously both Amazon and Apple are vastly more profitable. So what we see is, that the companies that are on top these days, and we can include Google and Facebook as large companies, have far fewer employees than the large companies of old. As a reminder Facebook only has 25 thousand, and Google just under 100 thousand employees.

Sandra So as the article makes the point that large companies today invest a lot more money in R&D, and spend a lot more money on innovation, clearly they spend a lot less money on employee costs by an order of magnitude in the case of a company like Apple, also spend a lot less money on overheads, on managing these organisations and physical assets.

Kai So on the basis of this you could make the argument that these large companies these days are much smaller and much more nimble than the large companies of old, which were part of this disruptive innovation narrative where the incumbent is large and sluggish and can't really react to the market. And this is now finally where this argument is going places; because what sets many of these large companies apart is that they derive value from data.

Sandra But this is a counterintuitive observation. The argument has been for a long time that we live in an era where data is abundant. Where every company, no matter how big or small it is, can make use of this data and create new products and services. And data would be the equaliser, the thing that levels the playing field for small companies to disrupt the large incumbents. And yet that's not really actually true, is it?

Kai What we see is a growing corporate inequality, so to speak, the gap between large and small companies precisely because large companies are able to utilise data in certain ways, which tells us a little bit more about data itself as a resource.

Sandra So data that doesn't benefit companies equally. There are only very few companies that can create, make use, monetise very large data sets, and they are the likes of Google, the likes of Facebook and Amazon, who not only have access to these large data sets, but have a quasi-monopoly on them.

Kai And this is where the argument ties in with our previous episode on 'data is not the new oil', because data does not behave like a commodity, like typical resources in the capitalist or industrialised economy of old. It's not like you have a little bit more data, you get a little bit more value out of it. But that data is accumulatorial, the more data you accumulate the more value you can get out of it in an exponential way. So the companies that appropriate large amounts of data in a real-time way, say Facebook, Google, Amazon, they get vastly more value out of this than any small company could ever get.

Sandra So in this way the argument is akin a little bit to the general inequality argument that we've seen on this podcast previously, in our chat to a Nobel prize winner Joseph Stiglitz, where we spoke about the fact that the way we've grown the economy over the last 30 years benefits have accumulated unequally at different levels of society. The rich got richer, and the poor got poorer. So we've seen this polarisation where the benefits accrue to a particular, very small, part of the population. Which is in turn exactly what we're seeing in the case of data. The more data we have, the more certain companies that were large to begin with can reap the benefits, at the expense of smaller companies. What's more, in this case regulation seems to behave slightly differently than in the case of income inequality. In the case of income inequality we have regulation, we have taxation, we have income redistribution that can help alleviate some of those problems. In the case of data, we've seen actually legislation like GDPR, the General Data Protection Regulation in the European Union, that actually tends to strengthen the position of companies that have already accumulated these large data sets.

Kai And that happens because as every company is now required to alert customers of the privacy implications, and users might grow a little bit wary of data, smaller companies find it harder to grow bigger data sets, whereas the large companies already have many users, already have consent, and already are able to accumulate these data sets on a regular basis, as a by-product of users using these platforms. And what is important here is while the amount of data in society is growing, it is not abundant in the sense that it is freely available for everyone. These large companies are actually guarding their data assets quite closely; the algorithms and the data are not even open to regulators to scrutinise. We've talked a lot about big tech and the problems with the algorithms, which means that they actually hold their data quite close to their chest. But you can equally see how having more data actually leads to better services, because the more these companies know about their users, for example, the more targeted the advertising can be, and the more useful these products become for the companies who are actually paying for the services derived from data, be it end-consumers at Amazon, or advertisers at Google and Facebook.

Sandra But let's return a little bit to this idea of corporate inequality, because there is one other dimension of it. And we see that with income inequality as well. We see inequalities of hope. This is when people do not believe that they have equal opportunities to become rich, or to pursue certain occupations or certain careers in life. And we kind of see the same thing happening with startups these days. Whereas previously you saw start-ups who all wanted to become the next unicorn, to become the next billion-dollar company. Now we see more and more startups having as their ultimate goal to actually be bought out by one of these large companies. And that is a trend that is not only present in places like Silicon Valley, but we've had Barney Tan on the podcast, (and we'll put the link in the shownotes) talking about how this is the trend in places like China as well, where a lot of the innovation that happens in small companies is done only to be bought out by large companies the likes of Baidu, or Alibaba or Tencent.

Kai So that means that it is harder for smaller companies to grow, and even startups now settle for the idea that they're going to be bought up. So that's a clear corporate inequality argument. And the other is of course, as we just mentioned, that these tech companies generate their revenue with less and less people. Which means that the society also derives less and less employment from these top companies.

Sandra So to wrap this up, we actually have two surprising takeaways from debating this article. One thing to unlearn is this idea that's been so prevalent over the past 15 years, the idea that large companies are sluggish and will be disrupted, can be disrupted by small nimble companies that innovate and displace the large incumbents.

Kai And the second one to unlearn is that large companies can actually be innovative, and that the largest companies today are built on an innovation ethos. So the large companies of old are not the large companies today. And actually, that small is the new large, because those companies by employee-size are by no means the behemoth that they used to be when we were talking large industrialised companies.

Sandra And underpinning both of these counterintuitive observations is the fact that data abundance is really not for everyone.

Kai No it's actually a form of scarce abundance. Which reminds me of a good title for a study that someone could do. Here she goes, 'Scarce abundance: How big tech cements its position by building cumulative data assets'. Wouldn't that be a good title for a study someone could do?

Sandra They'd be an excellent paper. But what I would really love to see is one titled 'The gap between large and small companies is growing. Why?’

Kai Isn't that the title of the paper we just discussed?

Sandra Yes it is, but it would be great if someone went a bit further in answering that question. And speaking of answering things today has been a bit of a nerd-out on what's big, what's small, does size really matter? So, we thought for our second story we should include the debate we had in the coffee shop this morning. Since it there is a nerdy podcast, today we're going all in and we're gonna try to answer a question that Vox has also asked this week, which was "What does it even mean to be a tech company" these days. We thought well since both of us talk a lot about technology, and we've just made the case about big companies which are all tech companies, what exactly is a tech company? And the question has actually been hotly debated this past week since WeWork (the co-working company) has had its public filings raise some questions about its claims of being a tech company.

Kai And here we have a bullshit warning because we're going to read straight from the WeWorks IPO prospectus.

Sandra And here's how WeWork describes its mission statement: "We are a community company committed to maximum global impact".

Kai "Our mission is to elevate the world's consciousness".

Sandra I think we should just pause here to let this sink in.

Kai What's so hard to understand? WeWork is a real estate company, obviously they are in the business of elevating the world's consciousness.

Sandra So WeWork went to great lengths in its pitch to tell a very different story about who they are, and elevating the world's consciousness was just one part, but they went to great lengths to make the company sound like a tech company. Even though they did choose 'miscellaneous business services' at the top of its public filing, they made a really strong case about them being a tech company, and by extension trying to justify the price tag that WeWork expects for its shares. WeWork made a lot of acquisitions in the tech space, buying a lot of the small companies we previously discussed, made a great case about it using "scanning technologies and software to automate the design and construction layout of any given space", and applying, and I quote here, "data science to compare new buildings with similar proven locations", and, using machine learning, to "forecast demand for each building to said the opening day price and optimize on a real-time basis".

Kai So the article in Vox Recode that we're discussing, goes on to say that WeWork is of course slightly different to other real estate companies, because it is very much part of the tech industry, because all of its tenants are typically startup companies in the tech space, and so they live and breathe in this tech ethos, with the bullshit prospectus around it and everything.

Sandra But its main business really is just leasing buildings on a long term basis, remodelling and styling them, so that people want to hang out in them, and then sub-leasing those buildings to people and companies on a short to medium term basis.

Kai And that's why the question comes up here, what actually then makes a tech company? Everyone obviously wants to be a tech company, because it comes with a better price tag when it comes to IPO, investors invest more in tech companies because they expect higher growth rates and higher returns on assets, which is all part of the tech narrative, you know harking back to the earlier story. And it's also shown that it can spontaneously combust the share price, as in the Long Island tea company that famously added blockchain to its name, and then shooting up 500 percent at the stock market. But the final point here is the question, what then makes a tech company?

Sandra So the options on the table are: you could be a tech company if you're in the business of selling technology.

Kai Well I can go to Aldi, and every couple of weeks they sell computer equipment, and they sell televisions, so does that make Aldi then a tech company?

Sandra But seriously, Apple as a tech company, Apple sells hardware and software. You could argue it is a tech company.

Kai And so is Microsoft for example. So some companies are tech companies that manufacture and sell technology.

Sandra Or technology services. But that would make a company like Uber or Airbnb a tech company, right? Because they do not sell the technology.

Kai So you could make the argument that companies that utilise tech, software, algorithms at the heart of their business model to, for example, disrupt an industry or do something in an entirely new way that wasn't possible without technology, would be a tech company. The business model wouldn't exist if it wasn't for technology.

Sandra But that presents a different problem, because it wouldn't just be Uber and Airbnb, it would make our 'ghost kitchens' from last week a technology company.

Kai That is true, because they wouldn't exist without technology.

Sandra So a third way you could go about this would be to think about whether the products or services that the company offers are infused with technology, or whether technology is the competitive advantage that allows them to be profitable. So Tesla for instance, has at its core renewable energy technologies, battery technologies, self-driving technology, which makes Tesla a tech company.

Kai But then on the other hand, you have GM, which does not normally count as a tech company. But GM is investing a lot in self-driving technology. They have the Chevrolet Volt, a electric hybrid car, so for all intents and purposes they're working on the same kinds of technology as Tesla is. Yet they are not valued as a technology company, much like Tesla. So what then is the difference?

Sandra And you could keep going on and on. There is an article in Tech Nation that makes the case that a tech company is the one that has technology as the culture and the values of that company.

Kai It is one that will never stop learning, it's run by a diverse group of passionate people who are looking to build a better, smoother and exciting future for our next generation. And it is probably that kind of narrative that WeWork is buying into here. Technology as a state of mind, as being part of the tech industry. Although, tech is neither driving the core product, or service, the business model, or the way in which value is generated. So being a tech company then is a matter of degree and a matter of perspective.

Sandra So there is no one right answer to what makes a technology company. Clearly it is a matter of degree, it's also largely a matter of perception. But one really critical thing to whether a company is or isn't technology company in this scarcely abundant data age, is the ability to generate, protect and exploit large amounts of data in unique ways.

Kai And we see this in the platform businesses Facebook, Apple, Google, and Amazon. And Tesla might well move into this space as all its cars have sensors, and they might one day be connected and become a large platform for generating data that can then be exploited.

Sandra And at this point someone might ask 'well why does it even really matter whether or not you call a company a tech company?' But there are very real world effects to calling something a technology company. And there are some upsides. Obviously WeWork is trying to attract money on the back of calling itself a tech company, but it also makes companies more attractive to talent. Everybody wants to be in a tech startup, or work in a tech company. And there are also financial implications. In many places there are clear tax incentives and subsidies if you qualify as a tech company.

Kai And where there's pros, there's also cons.

Sandra So once you call something a tech company, yes it can mislead investors into thinking that they will get the abnormal returns that we are used to with some of the tech companies. They might expect a certain level of growth that does not actually manifest for non-tech companies. And for consumers as well, there is a lot of optimism around tech that is sometimes unwarranted, and people are willing to overlook a lot of the problems that we have in companies. We've seen this with Uber, and with a culture of sexism, and sometimes exploiting the drivers. But probably the biggest problem that can stem from this is the fact that once you call something a tech company it abides by different rules and different regulations, than if you were to classify something else. And we've seen this really play out with companies like Facebook and Google, or with companies like Uber and Airbnb, where they are not seen as media companies, not seen as financial companies, not seen as being in the hospitality business, and hence they do not have to abide by the same rules and regulations that apply to those traditional industries.

Kai So as we have previously shown with milk and fake milk, what you call a thing matters. Thanks so much for sticking with us on this arguably quite nerdy podcast. We leave you with this title for a paper we wish someone would do, or maybe you have done such a study: 'How tech are you? A framework for determining the digital nature of business models'. If you have done such a framework, send it to us; we'll discuss it on the podcast.

Sandra And that's all we have time for today. But before we go we might want to remind people that it is that time of the year...

Kai We're doing Disrupt Sydney again on the 20th of September in the Sydney CBD. We are rethinking success this year. Come and join us, www.disrupt.sydney.com for further information and registration.

Sandra And that's really all we have time for this week.

Kai See you soon.

Sandra On The Future...

Kai Next week.

Sandra This week?

Kai Yes, but next week.

Sandra On The Future, This Week. Next week. Thanks for listening.

Kai Thanks for listening.

Outro This was The Future, This Week, made possible by the Sydney Business Insights Team and members of the Digital Disruption Research Group. And every week, right here with us, our sound editor Megan Wedge who makes us sound good and keeps us honest. Our theme music was composed and played live on a set of garden hoses by Lindsey Pollak. You can subscribe to this podcast on iTunes, Stitcher, Spotify, YouTube, SoundCloud or wherever you get your podcasts. You can follow us online on Flipboard, Twitter, or sbi.sydney.edu.au. If you have any news that you want us to discuss, please send them to sbi@sydney.edu.au.