This article is the winner of the Best Business Paper award, presented at the Adhesive & Sealant Council Fall 2005 Convention, Louisville, KY.
Editor's note: This article is winner of the Best Business Paper award, presented at the Adhesive & Sealant Council Fall 2005 Convention, Louisville, KY.
Figure 1. Assumed Globilization Process
Consolidation and globalization have been major buzzwords in the adhesives and sealants industry for many years. The industry is constantly referred to as fragmented and said to be both in need of, and benefiting from, consolidation.
Figure 1 shows the unstated but assumed process for globalization. Globalization will proceed by way of firm consolidation in order to achieve the critical mass to effectively compete in a global marketplace. But what is globalization? Over 1,000 definitions and references in various contexts of the word appear on the Internet. Let's review a few with particular relevance to the industry.
Increasing economic integration and interdependence of countries.
Increased flow of goods, services, money and ideas across national borders, and subsequent integration of the global economy.
Processes leading to the integration of economic, cultural and social systems across geographical boundaries.
A process of creating a product or service that will be successful in many countries without modification.
Not one of the above definitions implies economic consolidation; in fact, the word most used in these definitions is "integration." While consolidation can be one form of integration, the two processes can operate on independent paths.
Figure 2. Map of the Internet
William Van Dusen Wishard of World Trends Research, Reston, VA, is an expert in trend analysis. In his book,1
Wishard examines what is really happening in the world today. He contends that we are passing through a rare historic moment when a civilization progresses from a familiar world view to a new, broader outlook. In his book, he defines globalization as being "... far more than integration of economics and finance. The essence of globalization is the individual's expanding awareness of other people's cultures and religions as a result of technological advances in communications and travel."
Globalization means awareness of others' needs, which may be different than yours or mine. I believe we like it that way, and I don't want to see homogenization become globalization. Therefore, the business challenge is to satisfy an increasingly disparate or fragmented customer requirement. The strategic question then becomes What is the best way to serve this global requirement?
Figure 3. Expected Nodes and Links, Internet Distribution
As a model for this problem, I suggest one of the most fragmented markets in the world - the Internet. The Internet as we know it today was conceived during the height of the Cold War. It was created in response to concerns over a Soviet nuclear attack disabling the American telephone network, which relied heavily on highly concentrated switching centers. As a result of this effort, four computers were linked together - at the University of California-Los Angeles and Santa Barbara, Stanford, and the University of Utah. This first network was the Advanced Research Projects Agency Network, or ARPANET, which, in addition to demonstrating a strong method of linking communications, allowed university scientists to share scarce and expensive computing power.
Figure 4. Internet Nodes and Links, Actual
How times have changed. The Internet has grown into a global communication and information superhighway. Lucent Technologies' Bill Cheswick has created a map of the Internet (see Figure 2) that, on the surface, looks like the most chaotic system in the world without any form of organization. In his own research examining the structure of the Internet, Albert-Laszlo Barabasi3
expected to find a typical bell-curve distribution of nodes and corresponding links (the nodes and links of Figure 2; the expectation is shown in Figure 3). Instead of the normal distribution, it was discovered that the connectivity of the Internet followed a plot shown in Figure 4. This figure is an example of a power law distribution. This power law was detected during further research on topology of the Internet by computer scientists and brothers Michalis, Petros, and Christos Faloutsos4
, and is shown in Figure 5.
Figure 5. Power Law Pattern of the Internet
The consequences of this discovery and subsequent investigations into the application of power laws in the natural and business world led to an explosion of research, which in turn has led to a whole field of science known as "Chaos theory,"5
"small world theory,"6
and fractal science.7
The essence of these disciplines is the realization that power laws govern many phenomena in our world independent of the normal distribution we so commonly associate with quality systems and statistics.
In the world of corporate competition, Barbasi3 has argued that the market is a directed network; companies, firms, corporations, financial institutions, governments and all potential economic players are the nodes. Links quantify various interactions between these institutions, involving purchases and sales, joint research and marketing projects, etc. The map of the Internet is a good visual for a market like ours that is fragmented.
Figure 6. Sales Rank for ASC Companies
In his widely read and referenced book on competitive strategy, Porter8
devoted a significant amount of discussion to fragmented industries. As a preamble to this discussion, he stressed that an industry must be viewed as an interrelated system and that this fact applies to fragmented industries as well. In illustrating fragmented industries, he lists many examples (of which adhesives and sealants is one). The common areas where fragmented industries are found are:
Wood and metal fabrication
There is significant discussion devoted to how to compete in this type of environment. Porter's assertion that industries must be viewed as interrelated, and Barbasi's contention that markets are connected networks, are very similar concepts. Yet no one has tackled the implications of a "fragmented" industry competing in a global environment, and there is by no means extensive literature on the subject.
Figure 7. Power Law for ASC Companies
Does our industry follow a power law model in its competitive dynamics? If so, what are the implications of moving forward in this increasingly global environment? We test this hypothesis using sales (as already suggested by Barbasi and Porter) as a proxy for the linking transaction of this network. Figure 6 shows a plot of the sales rank for 35 companies in the adhesives and sealants industry for which reliable data could be obtained. As seen from this plot, the curve is the same shape as the Internet nodes and links plot shown in Figure 5. If one then plots the log-log version of this data, a straight line is obtained, as shown in Figure 7.
Figure 8. Sales Rank for Various Industries
What kind of distribution or fragmentation pattern do other industries follow? Does this relate to financial performance or ability to compete in a global environment and create value? To gain insight into these questions, several industries were evaluated for their tendency to follow power laws. Industry classifications and data were taken from value line.9
In choosing the industries to evaluate, some guesswork was required as to which industries might follow a fragmentation pattern and which may not. Intuitively, it would seem that "creative" industries (as defined by Porter) would be those with primary interests in computer software, computer hardware and other types of information technology. Industries that would be consolidated and, thus, not likely to follow a power law model would be those with high capital barriers to entry and more emphasis on volume of business than the development of new, different, and better products. It would be very difficult, for example, to start a niche railroad company to compete with CSX. The following industries were examined as representative of the two categories.
Figure 9. Distribution Skew Measurement
As an example of how the data were examined, Figure 8 shows a rank plot of the ASC industries, computer software, integrated steel and basic chemicals. The ASC industries and computer software show very similar rank plots with many companies competing in the smaller firm size area.
To better and more efficiently quantify an industry's tendency to follow a power law fragmentation, the industry data was tested for skewness. This is a statistical measure of how evenly distributed about a median data are. Figure 9 illustrates the concept of this measurement. For this study, the coefficient of software skewness10
was used to characterize the data. For industries that follow power law structure (or fragmented industries), one would expect a high positive skew. For others, a slightly positive, neutral or negative skew would be anticipated. We, therefore, use the software coefficient of skewness as an indication of fragmentation. The results of this measurement for the various industries in Table 1 are shown in Table 2.
Table 2. Skewness Test for Industry Fragmentation
From the table, we conclude that the consolidated industries are much less skewed than the creative industries. A judgment of the globality of each is added to show whether there might be a correlation between globality and skewness. From this small sample we find there are as many fragmented global industries as there are consolidated global industries. Therefore, we hypothesize that consolidation is not necessary for globalization and that it is more dependent on the competitive dynamics of the particular industry and market.
We postulate then that a particular industry must globalize within its most efficient overall structure, which could be "completely consolidated" (0 to negative skew; e.g., automotive producers), a hybrid situation (modest positive skew), or fragmented (high positive skew). In fact, the processes of consolidation and globalization are completely separate.
Figure 10. Fragmentation Test and Associated Return
For an industry charged with satisfying a range of customer needs that may depend on disparate technologies, distribution systems or some combination of disparities, a power law structure is probably the best way to meet market needs. In fact, we might expect negative financial consequences for those who try to operate outside of the most robust structure for a particular industry.
Figure 10 shows a plot of the coefficient of skew vs. return on total capital for the industries considered. It seems that for consolidated industries, the closer they are to a normal distribution in firm size, the higher return they receive When these competing firms fragment too much they quickly lose competitive advantage. The "creative" industries seem to fare much better when there is a significant amount of "fragmentation." This can be credited to the fact that "ideas" can be more easily commercialized in these industries and therefore have immediate impact.
Figure 11. The Long Tail of the Music Industry
A Peek at the Future - The Music Industry
There is no business more "global" than the American entertainment industry. Every one of the many countries in which I have traveled plays, enjoys and, indeed, demands American pop music and movies. This is a huge success story for American creativity, and truly qualifies as one of those creative industries to which Porter8
refers. The music and entertainment industry, however, is undergoing a radical change.11
Chris Anderson writes in "The Long Tail," an article in Wired
magazine, that, "For too long, we've been suffering the tyranny of lowest common denominator fare, brain-dead summer blockbusters and manufactured pop. Why? Economics. Many of our assumptions about popular taste are actually artifacts of poor supply-and-demand matching - a market response to inefficient distribution. The main problem is that we live in the physical world and, until recently, most of our entertainment media did, too."11
Figure 11 demonstrates this with only a fraction of the entertainment titles physically available. Hit-driven economics is a creation of an age without enough room to carry everything for everybody. This is the world of scarcity. With online distribution and retail, we are entering the world of abundance, and the differences are profound. The market that lies outside the reach of the physical retailer is big and getting bigger.
Figure 12. The Economic Advantage of the Bit Player
Aggregating the Long Tail
Most successful businesses on the Internet are focused on aggregating the long tail. Niches are where economic success will be in the future, resulting in pulling consumers down the long tail with lower prices. Figure 12 illustrates this as the bit player advantage.11
Because it is impossible to e-mail a drum of adhesive to a customer, this analogy can only be taken so far. However, if we look at Figure 12 and change the word titles to formulas, and then consider this on a global basis, I believe the fragmentation brings more value to the customer. There are many companies out there that have excellent technology in this industry, and as we become more comfortable and capable of doing industrial business over the Internet, the ability to extract value from the long tail of the industry will only increase. As small, foreign companies enter the mix, the industry may globalize through additional fragmentation and not consolidation.
Long-tail businesses can treat customers as individuals, offering mass customization as an alternative to mass-market fare. This is especially applicable to the adhesive and sealants industry, where varying customer processes, rapid dislocation of manufacturing sites, and changing end-use requirements demand mass customization.
Figure 13. Long Tail Globalization
- Globalization in the adhesive and sealants industry may proceed more effectively through fragmentation rather than consolidation (see Figure 13).
Fragmentation (for some industries) presents a higher rate of return on capital.
Fragmentation is a more robust industry structure than consolidation for providing value to the customer on a global basis, given the trend to mass customization.
Both large and small firms play an important role in creative industry dynamics.
The role of mergers and acquisitions in creating value in globalization is currently being examined in order to identify specific strategies for firms along the "power chain" to exploit so that appropriate tactics for growth are identified.
For more information, contact John Lowry, The Chemark Consulting Group, phone (850) 525-0031; fax (910) 692-2523; or e-mail firstname.lastname@example.org.
1 Van Dusen Wishard, William. Between Two Ages: The 21st Century and Crisis of Meaning
, Xlibris Corp.; 2000.
2 Burch/Cheswick Map of the Internet, copyright 1999 Lucent Technologies.
3 Barabasi, Albert-Laszlo. Linked: The New Science of Networks. Perseus Publishing; April 2002.
4 Faloutsos, Michalis; Faloutsos, Petros; Faloutsos, Christos. On Power Law Relationships of the Internet Topology, Comput. Commun. Rev. 29, 251  4.
5 Cambel, A.B. Applied Chaos Theory: A Paradigm for Complexity, Academic Press, Inc. Harcourt Brace Jovanovich Publishers; 1993.
6 Buchanan, Mark. Nexus: Small Worlds and the Groundbreaking Science of Networks, W.W. Norton and Co.; 2002.
7 Barnsley, M.F.; Devaney, R.L.; Mandelbrot, B.B.; Peitgen, H.O.; Saupe, D.; Voss, R.F. The Science of Fractal Images, Springer-Verlag; 1988.
8 Porter, Michael. Competitive Strategy: Techniques for Analyzing Industries and Competitors, Simon & Schuster; 1980.
9 Value Line Ratings and Reports, Value Line Publishing Inc.; 2005
10 Lind, D.; Marchal, W.; Mason, R. Statistical Techniques in Business & Economics, 11th Ed; McGraw-Hill Irwin; 2001.
11 Anderson, Chris. "The Long Tail," Wired magazine October 2004, Conde Nast publications; 2005.