Going along with our series on Big Beer – and the concept of horizontal vs. vertical integration – we wanted to touch on a few industries that jump off the page that are super concentrated. As we noted in our Big Beer article, the Brewery industry has 4 firms that make up over 79% of marketshare. See below.
The Size Premium
So how does this impact business valuation? In most industries there is a premium for size. Simply put, larger companies are worth more. Why?
- Diversification of Risk. A bigger company is less likely to have a single point of failure.
- Access to Private Capital. Lower risk implies lenders are more inclined to 1) loan money and 2) do so at more favorable rates
- Access to Public Capital. Public companies have the benefit of a liquid stock market has a tangible impact on value.
- Forecast Growth. Often times as companies scale they are in a position to have a better ability to forecast growth and future earnings.
Given the above, as companies get larger and begin to minimize their risk profile valuation multiples tend to rise. In terms of valuation for smaller companies, the more attractive you are as an acquisition candidate to the big boys at the “deep end of the pool,” the higher potential valuation you can realize.
Impact of Consolidation on Valuation
So bigger is better. Larger size equals outsized valuations. But what happens when an industry becomes completely dominated by larger firms? Our beer series is a great example – in order to show meaningful non-organic growth, AB/Inbev needs to buy a really big company. A craft brewer with $2 million in revenue may very well be a decent sized business in that niche, but it’s a rounding error to AB/Inbev. That’s why all four companies are eyeballing one another posturing to see who can buy whom.
Where does that leave the little guys? With a cap on valuation. Until a company can achieve scale (revenues, national distribution, more than a cult following), it’s hard to rationalize an outsized business valuation multiple.