We (okay, Jeremy Grantham and we) have been banging on since 2011 about how, in theory anyway, profit margins should be the most mean-reverting series in finance, at least if capitalism is working as it is supposed to, and that the failure to mean-revert is a sign of something being deeply wrong with either the theory or the reality.
A major piece from McKinsey and the HBR:
Competition: The Future and How to Survive It
We’d call it the opposite of a perfect storm: a set of external circumstances that together create an exceptionally favorable economic environment. The largest North American and European multinational corporations have been sailing through one for the past 30 years. In that time they have enjoyed their longest and strongest run of rising profitability in the postwar era, thanks to an environment that has supported robust revenue growth and cost efficiencies.
From 1980 to 2013 global corporate after-tax operating profits grew 30% faster than global GDP; today they stand at about 9.8% of global GDP, up from 7.6% in 1980. Corporate net income grew more than 50% faster than global GDP, from 4.4% of global GDP in 1980 to 7.6% in 2013. North American and Western European companies now capture more than half of global profits. North American firms increased their post-tax margins by 65% over the past three decades; today their after-tax profits, measured as a share of national income, are at their highest level since 1929.
It has been a remarkable era, but it’s coming to a close. Although corporate revenues and profits will continue to rise, the overall economic environment is becoming less favorable, and new rivals are putting the Western incumbents on notice. Many of the new players are from emerging markets, but some are surprise intruders from next door, either tech companies or smaller technology-enabled enterprises. Those competitors often play by different rules and bring an agility and an aggressiveness that many larger Western companies struggle to match. In this new world, corporate performance will no longer outpace the global economy. We forecast that in the decade ahead, although operating profits will continue to grow in absolute terms, they will fall to 7.9% of global GDP—around what they were when the boom began. In other words, the stratospheric gains of the past 30 years could all but vanish in just 10.HT: The Big Picture
In the following pages we’ll explain what is changing in the global economic and competitive environment and consider how today’s leaders can be tomorrow’s as well. To set the context for that, let’s look at the main drivers of success so far.
Why Profits Rose
The start of the profit boom coincided with the spread of deregulation and privatization around the world. That trend first took hold in Western countries and moved on from there; in the early 1990s India, China, and Brazil all undertook varying degrees of privatization. The movement introduced private-sector competition to vast swaths of global business, from automobiles, basic materials, and electronics to infrastructure industries such as telecom, transportation, and utilities—all of which had a strong legacy of state ownership. In 1980 those infrastructure industries, most of which were tightly regulated, generated more than $1 trillion in revenue. By 2013 they were generating more than $10 trillion, two-thirds of which was open to private-sector competition. (All revenue and profit figures for 1980, 2013, and 2025 are in 2013 U.S. dollars.)
During the same period a huge wave of urbanization and industrialization in emerging markets contributed to the growth of the global consumer class (which includes people with disposable income exceeding $10 per day). That segment has grown from around one billion in 1980 to around 3 billion today, creating new markets for the offerings of Western multinationals and spurring global investment in infrastructure, factories, and housing. In China alone, capital investment grew from 29% of GDP in 1980 to 47%, or $4.3 trillion, in 2013, and countries across Asia have undertaken ambitious capital projects, from oil refineries and power plants to steel mills and cement plants. Globally, fixed capital formation has nearly tripled in real terms since 1990, with the private sector accounting for a vast majority of the increase. For Western multinationals, those investments have more than made up for declining capital investment at home: Publicly traded companies from advanced economies have poured almost $4.5 trillion into the build-out, much of it across the emerging world, just since 2000....MORE
