By Shoeb Kagda
Over the past three decades, global corporations have enjoyed record profit growth on the back of the rise of emerging markets, lower costs and deregulation. This golden era is coming to an end, according to a new report by the McKinsey Global Institute, and corporations will have to brace for more intense competition.
In the dog-eat-dog world of competition nothing lasts forever. Over the past 35 years, corporations have enjoyed record profit growth, new market opportunities, and declining costs.
But unprecedented run may be coming to an end. New rivals are putting industry leaders on notice as the business environment turns more uncertain and hypercompetitive.
A new report by the McKinsey Institute titled “Playing to Win: The Global Competition for Corporate Profits,”
maps the changes underway and provides a picture of what lies ahead for corporations.
The report notes that corporate earnings before interest and taxes more than tripled from 1980 to 2013, rising
from 7.6% of world GDP to almost 10%. Corporate net incomes after taxes and interest payments rose even more sharply over this period, increasing as a share of global GDP by some 70%.
In real terms, post-tax net profits, for instance, grew from $2 trillion in 1980 to $7.2 trillion in 2013.
Size matters, because large firms (those with more than $1 billion in annual revenue) have an outsized economic
impact — and they have been the biggest beneficiaries of this extended bull run, the report noted. They account for nearly 60% of global revenue and 65% of market capitalization.
Moreover, relatively few firms drove the majority of value creation: among the world’s public companies, just 10% of firms accounted for 80% of profits, and the top quintile earned 90%.
Companies once reinvested most of their earnings, but they are increasingly holding on to their profits. Since 1980 corporate cash holdings have ballooned to 10% of GDP in the United States, 22% in Western Europe, 34% in South Korea, and 47% in Japan. With low borrowing costs and plenty of available cash on hand, companies in some industries have engaged in a massive wave of mergers and acquisitions. The biggest names are getting even bigger.
The end of a golden era
This remarkable era may be coming to a close as profit growth slows. Between now and 2025, the corporate
profit pool could decrease from 10% of global GDP to about 7.9% — practically reverting to its level in 1980, before the boom began.
Part of these changes are a result of increased competition from the emerging world as well as new high-tech companies muscling in on established industries. Powerful platforms such as Alibaba and Amazon are also leveling the playing field as they allow small and medium-sized companies to compete head-on with the larger companies.
“The last 35 years have been a golden age for business,” Richard Dobbs, director of the McKinsey Global Institute told GlobeAsia. “Over the last 35 years, profitability has grown 75% faster than GDP, driven by consumer demand, efficiency and businesses being able to benefit from lower tax, interest and labor costs.”
“It’s been a wonderful period but it’s coming to an end. Changesvin the economic and changed intensity means that
companies no longer enjoy the labor arbitrage and rising taxes. The global environment is not as hugely supportive as the last 30 years.”
As a result, competitive intensity amongst corporations will rise. As companies from emerging markets become part of the global supply change, they will raise competitiveness. Emerging markets companies, for example, are more willing to accept lower return on capital.
Korean companies are happy to earn 5% return on capital while American companies demand 15%. Chinese firms already make up some 20% of the Fortune Global 500, while the share of US and Western European companies dropped from 76% in 1980 to 54% in 2013.
Going forward, real profit growth will fall from 5% to 1% in the next decade. And as profit growth slows, more companies will be fighting for a smaller slice of the pie. As such, incumbent industry leaders cannot afford to focus simply on defending their current market niche. Firms with vision, optimism and agility who are willing to disrupt their own operations will continue to prosper.
Tech is king
The second major disruption in corporate profits is being unleashed by high-tech companies stepping out from their core industries, according to Dobbs. Amazon has transformed itself from being an online retailer of books to offering delivery services. Apple is moving into finance with Applepay while Google will compete with automobile companies.
For tech giants, achieving scale goes hand-in-hand with building and operating a platform or network. In many cases, strong communities of users and developers reinforce the attraction of the platform, according to the report.
This phenomenon poses two distinct types of competitive threats. The first is from the platform operator itself. Digital platforms can drive down the marginal cost of storing, transporting, and replicating data, giving the
operator the ability to add new interactions and business lines quickly.
As tech firms look for expansion opportunities, they can make rapid moves into adjacent sectors. Chinese e-commerce giants Alibaba, Tencent, and JD.com have moved into financial services, including small business
lending, consumer finance, and money-market funds.
The second challenge for incumbents stems from the hundreds of thousands of smaller enterprises that
are empowered by these platforms. The largest e-commerce marketplaces — such as Alibaba, Amazon, eBay, Flipkart
and Rakuten — can host an entire universe of vendors, giving them the kind of payment infrastructure, logistics
support and global visibility once reserved for large firms. Thousands of small and medium-sized Chinese manufacturers and wholesalers, for example, now sell to overseas customers on B2B marketplaces that have
millions of registered buyers.
This trend toward greater variability in corporate performance is playing out at the sector level as well, the report said. Today sectors such as pharmaceuticals, media, finance, and information technology have the highest profit margins, and Western firms remain the dominant players within these industries.
Asset-light, idea-intensive sectors accounted for 17% of the profits generated by Western companies in 1999. Today that share is 31%. Value is increasingly created from patents, brands, trademarks and copyrights rather than industrial machinery or factories.
Impact on Indonesian companies
Given this fast-changing scenario, just how will Indonesian corporations fair? According to Dobbs, the question
for large Indonesian companies is will they join large emerging country companies to become large global players? Even if they don’t, are they ready to face the increased competition at home?
“The second point for all Indonesian companies is that they now have the ability to sell around the world on platforms,” he added.
“You now have an opportunity to compete with large corporations. Are Indonesian companies plugged into
these platforms such as Ebay, Amazon marketplace and Alibaba? Currently Chinese and Indian companies are present on these platforms but unfortunately Indonesian companies have not caught on. The good news is that the story is just beginning and there are still plenty of opportunities for Indonesian companies.
“So I would not say the game is all over,” Dobbs noted. “The new competitive era is just starting and for the Indonesian companies, they need to be ready for greater competition. They need to get efficient enough to compete.”
While Indonesian companies can still leverage on cheap labor and resources, they will have to form a deeper understanding of competitiveness and knowing who their competitors are.
The tailwinds that drove corporate profits to such unprecedented heights are weakening. The era of cheap money may soon be over while governments, concerned about societal impact that companies create are beginning to roll back deregulation in some industries.
In an era of slower profit growth and increasing competition, Indonesian corporations will have to adapt to this changing environment. Large emerging-market firms in industries such as extraction, telecom and transportation have been relatively protected so far, but that is changing rapidly, the report noted.
These firms currently hold large shares of global profits — primarily by virtue of their size — but their margins are declining, due in part to deregulation and technology disruption.
In the next 50 years, ideas will matter more in terms of generating corporate profits than hard assets, capital or access to natural resources. The new weapons for corporations will be software, data, algorithms, brands and R&D.