It’s been am historically great run for business. Aside from an occasional hiccup like the 2008 financial crisis, companies across the globe have enjoyed record profits, new market opportunities and steadily decreasing costs for more than 30 years. According to a new report from McKinsey&Company suggests the long run of good times for business may be coming to an end. The report argues that “new rivals are putting industry leaders on notice as the business environment turns more uncertain and hypercompetitive.”
A strong three-decade corporate boom for global businesses
Earnings before interest and taxes for global corporations as a group were up by more than 300% in real terms from 1980 to 2013; and net net income after interest and taxes increased by more than 500%. This corporate boom has been a big deal for Europe and the U.S., as firms from developed economies produce more than two-thirds of global profits.
According to lead author McKinsey&Company Director Richard Dobbs, multinationals have long benefited from increasing consumption and industrial investment, constant new sources of low-cost labor, and the gradual development of global supply chains.
Dobbs points out, however, that the “benefits of this corporate boom have not been shared evenly.” He highlights the trend where “profits are increasingly shifting from heavy industry to idea-intensive sectors that revolve around R&D, brands, software, and algorithms.”
He goes on to explain that industries such as pharmaceuticals, media, finance and IT have worked the economic system where they enjoy the highest margins. These industries are on top in the winner-take-all dynamic of modern capitalism, and there is a giant gap between the most profitable firms and everyone else. On the other hand, margins are continually being pressured in capital-intensive industries like manufacturing or refining, where operational efficiency has become the mantra.
Stiff competition from emerging economy firms
It’s important to keep in mind that emerging economies represent 40% of global revenue today, but this rapid growth has also led to a highly competitive environment, especially in capital-intensive sectors. Many of these companies have embarked on aggressive expansion campaigns over the last few years, driven by M&A, and according to Dobbs, ” they are proving to be hardy, risk-taking, and lean competitors.”
The report highlights that many of rapidly growing EM firms are state- or family-owned, and unlike most public companies that today focus almost solely on quarterly earnings, these EM businesses are using thoughful longer-term strategies, such as prioritizing revenue growth over short-term profits and engaging in fierce price competition, to become industry leaders. Dobbs notes that Chinese firms, for example, have expanded 400% to 500% faster than Western firms over the last 10 years, but their margins also declined by around 5% on average.
The final factor in the equation is the cost of doing business, which has steadily dropped for more than three decades. However, as the report notes, the competition from emerging-market companies and technology and tech-enabled firms is heating up, and the trend of “falling costs may have bottomed out. Although global revenue could reach $185 trillion by 2025, these pressures could slow profit growth and produce an after-tax profit pool of $8.6 trillion.”
Corporate profits may be set to slide
Dobbs et al. say their models suggest that corporate profits, nearly 10%of world GDP today, could drop to as low as 8% in few years, “undoing in a single decade nearly all the corporate gains achieved relative to the world economy over the past three decades.”
The report goes on to note that real growth in corporate net income could drop from 5% to 1% annually. Keep in mind that as profit growth slows down, you face the ugly scene of more companies fighting for a slice of a shrinking pie.
In this kind of hyper-competitive economic environment, incumbent industry leaders can no longer just focus on defending their market niche. That said, agile businesses with leaders possessing vision, optimism and a long-term perspective can take advantage of the enormous opportunities of the 21st century, but only if they are willing to completely reinvent themselves and their business operations before some new challenger does it for them.