April 11, 2022
In recent decades a well-trodden and widely accepted path to success for corporates has been growth via centralization. Industrial empires have been built upon layers of middle management and hierarchical chains of command. While bureaucratic structures shine in areas requiring repetition and small, incremental efficiency gains they tend to ultimately prove cumbersome, fragile in the face of change and reliably extinguish any entrepreneurial spirit amongst the rank and file. A poster child for this philosophy, GE, built a sprawling conglomerate that spanned jet engines, insurance, derivatives and TV media amongst a raft of other peculiarly unrelated sectors. In what may prove to be the death knell for centralization, GE has recently announced that the once dominant empire is to be divided into three focused standalone companies. The pendulum in corporate strategy appears to be swinging from scale and synergies towards the agility and resilience that decentralization can provide.
Over the history of the portfolio the Fairlight investment team has witnessed several long tenured holdings eschew traditional complex reporting structures with great success. While these investments superficially appear vastly different by sector, product and customer, this piece explores the similarities in the competitive advantages derived from their decentralized operating structures.
CDW is a reseller of IT hardware to small businesses in the US and UK. On first glance this business appears to operate in a low margin, highly competitive industry with little hope of generating sustainable economic profits. However, results since its IPO a decade ago have been spectacular, compounding earnings at 19% p.a. and delivering shareholders an annual return of 32% p.a. It is Fairlight’s view that a driving force in these returns is its decentralized management structure.
CDW affords a significant degree of autonomy to its salespeople, trusting them with full discretion on pricing and to chase opportunities into whatever products/niches they see fit. CDW provides back office support and technical resources where needed, however ultimately the business can be thought of as a collection of thousands of small, nimble businesses. Salespeople are paid based on a percentage of gross profit with unlimited upside, with relatively meagre base salaries meaning they are held accountable for falling short. The combination of the autonomy and incentive structure results in an incredibly motivated sales force that retains all the benefits of a large organization (e.g. buying power, technical resources) while maintaining the agility and entrepreneurial spirit of a small business.
Landstar is a US based logistics company that serves as a connector between two highly fragmented parts of the trucking ecosystem. Despite operating in a vastly different industry to CDW, it was the surprising similarities between the two businesses that initially attracted Fairlight to the company. On one side of the network is 50,000 truckers (most of whom are sole traders and own their own trucks) signed up to move loads for Landstar, and on the other side is hundreds of thousands of businesses in the US who require freight moved from A to B. In the center of this network is Landstar’s 1,200 agents who are geographically dispersed across the entirety of the US and incentivized on gross profit with unlimited upside.
Each agent operating under the Landstar umbrella is its own independent small business, while leaning on Landstar for its brand, relationships and back-office support. This relationship enables these agents to compete with the largest firms in the industry, while retaining their entrepreneurial spirit and operational agility. In terms of truckers, Landstar differentiates itself from other trucking companies in that there is no forced dispatch for drivers. Each trucker is treated as a ‘CEO on Wheels’, free to choose when and where to work, while Landstar takes care of the back office and provides access to a greater number of jobs (via the huge number of agents). While Landstar reports only one P&L, under the hood the business is effectively a decentralized network of thousands of small businesses interacting with each other.
Constellation Software (first profiled here) is a serial acquirer of software businesses and fits into our Acquisitive Compounder (profiled here) opportunity set. For decades Constellation has been eschewing traditional wisdom on integrating acquisitions and extracting synergies, instead allowing each of its 500+ business units to operate independently. Constellation has over 25,000 employees worldwide, yet only 10 of those sit in the headquarters at Toronto.
We have a culture of not managing and monitoring. What we really want are a collection of small teams that are self managing, run by trusted individuals, with experience and integrity. We are the anti-economies of scale company. We believe in small teams outperforming large teams. – Mark Leonard Constellation CEO
The Fairlight View
One advantage of Fairlight’s global scope and generalist nature is that lessons can be learnt and applied across industries. While not appropriate in all sectors and businesses, it has been Fairlight’s experience that a decentralized management structure with intelligently designed incentives can often lead to the resilience and growth of a business being underappreciated by the broader market.