What is a hollow corporation?

Answer 1

In my U.S. database there are 1,076 firms, or 43% of the total, that spend more money on "Transaction Costs" plus "R&D Expenses" than on the "Costs of Goods". The large share of corporate expenditures for the information "overhead" actually understates the leverage that the costs of information activities have on the economics of firms. One must recognize that the numbers recorded by the Accountants as "Cost of Goods" include a very large share of costs incurred by suppliers who have already added the costs of their own information to the prices they charge.

Of particular interest are then "hollow" firms that are largely organized around the management of their transaction costs and R&D expenses while incurring hardly any of their own costs for the goods sold. These are firms that depend on outsourcing, or, on production of products with high intellectual worth.

In my next e-book I will be listing of firms with the highest ranked information intensity ratios while showing a very low ratio of value-added to revenue.

Value-Added and Outsourcing

The driver of efficiency in the industrial age was the concept of vertical integration of production processes. Managerial efforts were concentrated on intra-firm coordination. The objective was to extract maximum profits through self-sufficiency that avoids yielding profits to others. Emphasis was placed on streamlining internal administrative processes with a corporation.

Improvements in communications and computer-mediated coordination have change the bias that favored intra-firm ownership of the means of production. Extra-firm coordination can now take advantage of favorable subcontractor prices without sacrificing responsiveness or quality. These development have given rise to the concept of the "hollow corporation" wherein the production of all goods and services have been outsourced to suppliers. The only remaining corporate functions would then consist of planning, coordination and administration which are pure information management functions.

The extent to which a corporation is "hollow" is not revealed in current financial reports. It would require a different financial statement to reveal a firm's dependency on outside suppliers.

The value of "Purchases" can be calculated by subtracting "Value-Added" from "Sales" where "Value-Added" is defined as:

Value-Added = Labor & Related Expense + Depreciation +

+ Interest Expense + Non-Operating Income + Taxes + Net Income

It then follows that:

Purchases = Sales - Value-Added

The "Outsourcing Ratio" indicator is then:

Outsourcing Ratio = Purchases / Sales

By such analysis we can then calculate tables of Outsourcing Ratios for competitors and start an examination of the competitive significance for firms that operate with an increased dependency on effective coordination with suppliers.

A wide range of Value-Added comparisons can be constructed to gain a better appreciation of the structure and effectiveness of firms where the information workforce makes up most of the employment and where physical assets or the expenses for materials are lesser contributors to overall costs. My favorite Value-Added ratio is the Labor Surplus per Employee, which equals:

Labor Surplus = (Value-Added - Avg. Compensation) / Employee

It is noteworthy that the firms with the lowest outsourcing ratios tend also to show the highest labor surplus ratio while the firms with the lowest creation of labor surplus show the highest two outsourcing ratios. Such an observation may then lead us to explore further a hypothesis that outsourcing may not necessarily favor the creation of surplus in firms that are highly information (and R&D) intensive.

Value-Added analysis can lead us to contrary conclusions than revenue-related ratios based on generally accepted financial statements. Corporate management has a tendency to understate the magnitude of corporate overhead costs. This is usually done by showing that the ratio of SG&A or R&D has remained relatively constant with increases in revenues. Since accounting reports do not reveal the amounts of outsourcing a constant revenue-based overhead ratio can actually hide a growth in overhead expenses relatively to the size of the organization.