The network effect
American e-commerce platform Etsy is a stellar example of a smaller company growth success story, with its market cap now more than $20bn. It is an online marketplace that acts much like a global digital craft fair. The pandemic underlined the value in the firm’s approach to building a platform through the customer lens, with strong network effects.
Etsy mobilised market participants to overcome a global social problem – the shortage of protective masks. By empowering market participants in this way, the firm was able to convert many one-off users of the service into fans that frequently return to the platform.
We have reached a defining moment for well-positioned small and mid-cap firms, who have the opportunity to narrow the gap between themselves and their larger counterparts. But in order to access this small and mid-cap growth potential, investors must be scrupulous and take a long-term approach to firm selection.
Firms at a relatively early stage in their development are more susceptible to volatility in down markets, so it pays to select a concentrated number of firms that are built to last.
Strength through the cycle
We look for firms that demonstrate robust earnings driven by sustainable revenue growth, high returns on capital, “proven management behaviours and powerful products or services driven by long-term vision. If any of these indicators are absent, the firm presents a long-term risk.
This multifaceted approach is crucial. In a scenario such as a pandemic where most businesses suffer earnings losses, it becomes more difficult to draw comparisons and make long-term projections based solely on the numbers. However, assessing the strength of leadership decisions, and how they measure up to the vision, becomes critical.
A crisis acts as a pressure cooker for management behaviours, revealing in a short time how a company interacts with shareholders in periods of stress and market instability. It also reveals whether the leadership will makeong-term growth decisions. When the tide draws out, we can see who has been managing with strategic vision.
