This is a great article published recently by columnist Christopher Mims in the Wall Street Journal.  Mims explains that recent research shows that the reasons why some companies make it while others don’t have to do with how much money companies spend on proprietary information technology systems and processes.  The reason the FAANG stocks have become such a disproportionate percentage of the market cap of the stock market is that the FAANG stocks account for a disproportionate amount of the proprietary IT spending.  Moreover, the gulf between these huge FAANG companies and smaller competitors will likely grow, not shrink.

Key Quote

Here is the key quote from Mims’ article, in my opinion:  “IT spending that goes into hiring developers and creating software owned and used exclusively by a firm is the key competitive advantage. It’s different from our standard understanding of R&D in that this software is used solely by the company, and isn’t part of products developed for its customers.”

Right Way/Wrong Way

Mims goes on to show that there is a right way and a wrong way for companies to spend on IT.  He uses the example of Wal-Mart and Sears, back a few decades ago.  Sears spent heavily on IT at the time but it spent it on outside consultants.  Wal-Mart built their own systems internally and developed their own proprietary scanning and inventory system.  Guess who won?  It appears that companies that develop their own software and systems and keep them for their own uses are the companies that win.

How to Tell

It is difficult to look at a company’s financial statement and tell how much they are spending on proprietary IT systems and how they are spending that money.  There may be narrative in the Annual Report or in press releases about IT spending and how it is being spent, which is helpful.  However, figuring out IT spending is more a qualitative rather than a quantitative skill.  I believe you have to read, ask, and read between the lines to figure out if a company knows what it is doing when it outlays money for IT.  It is helpful if you understand IT and have a working knowledge of what works and what doesn’t work.

IMO

This Mims article made me alter my opinion about why established companies grow bigger and why it is difficult for smaller companies to grow.  Although I still believe that regulatory hurdles are one issue why it is difficult for smaller companies to grow, I now understand that the scale and amount of money it takes to establish and maintain proprietary systems and processes means it is difficult for smaller companies to allocate sufficient resources in that direction.  Only the largest, most well-capitalized companies have enough money to pay for the brainpower they need to develop systems that set those companies apart.  Small and mid-cap companies face an uphill battle in order to compete with larger competitors who have a head start and more resources to spend on their own proprietary systems.