There is an article on CNN titled, Coronavirus is bringing a plague of dangerous doomsday predictions, that talks about an increase in the number of doomsayer predictions pointing to any number of disasters – some local like the locust infestations in parts of Africa, the near global COVID-19, and a host of calamities of various origins.
These are distractions opportunists milk for their own benefit because there will always be believers willing themselves to be taken for a ride.
There is no masking, however, the reality that business profits are on the decline with COVID-19 contributing significantly to the reality. Yes, the on-going China-US tit-for-tat, Brexit, the Europe in some constant state of shambles – these all contribute as well but not as immediate and impactful as COVID-19. Afterall, how can F&Bs, entertainment facilities, hotels and airports under the threat of COVID-19. For that matter, even factories are in a near predictable open-and-state of operations – one day they are asking employees to report to work, and another day, they are locked down because of an infection from within.
With revenues expected to go down, profits will be even more slim for the picking.
A joint report by Bain & Company’s Bain Futures and Oxford Economics, puts into question the “golden age of profitability” of businesses and whether this will persist into the future.
Based on that research, a new report, Peak Profits: The Golden Age of Profitability is Ending, identified several key factors involving both market dynamics and potential backlash from governments and societies that could dampen profit potential for public companies in the years ahead. These forces predate Covid-19, but like many historic crises before it, the pandemic has the potential to accelerate gradual currents of change that otherwise might have taken a decade or more to play out.
The study found that over the past several decades, six waves of change have powered the steady rise in corporate profitability:
- Labour’s waning bargaining power, due to a decline in unionization and simultaneous expansion of the labour supply.
- Financial liberalization, which drove up the profitability and economic share of financial services.
- Globalization, which allowed firms to access lower cost supply chains and new export markets.
- A commodity super-cycle, driven by surging industrialization in China and India.
- The rise of the Internet platforms (in the US especially), which powered extraordinary profitability for a small cohort of firms through network effects and curation economics.
- Automation, which fuelled the displacement of labour with capital in an expanding range of sectors.
“These six waves have been particularly strong in the United States, pushing returns for US public companies to historic heights. Yet, while average profitability has been steadily rising, median profitability has actually fallen,” said Andrew Schwedel, partner at Bain & Company in New York and co-chair of Bain Futures.
Two forces pulling profits down
As powerful as these macro trends have been, Bain sees two emerging mechanisms that could exert downward pressure on corporate profitability and perhaps force a reversion to the historical mean.
The first is the market itself. Favourable market trends typically ebb and flow. The move towards of globalization has begun to reverse. Recent trade wars had already pushed companies to rethink their commitment to offshore supply chains. Then the coronavirus pandemic exposed how risky those stretched, low-cost supply lines really are. A move toward reshoring to better manage risk will likely pressure margins.
At the same time, labour market changes will exert upward pressure on costs for many companies. Over the past several decades, the baby boom generation has assured a steady supply of labor that has had a dampening effect on wages. But as the boomers retire and the share of the working-age population declines, that trend may reverse itself. While the Covid-19 unemployment shock will offset this shift in the short term, finding talent with the right skills for the right job is getting harder in many areas of the economy.
On the upside, it is likely that an acceleration in automation and continued growth of Internet platforms will support high profitability levels. But those benefits will mostly flow to the biggest and fastest companies.
The rest will continue to suffer from their lack of scale in a market that just got tougher. Indeed, the Covid-19 shock could prove devastating for midsize companies with too much leverage. Some may get acquired or disappear entirely, but others may find themselves joining the growing cohort of “zombie firms”―struggling companies that survive on evergreen loans only because banks are unwilling to cut them off and book the hit to capital.
James Root, partner at Bain & Company in Hong Kong and co-chair of Bain Futures said on balance, these factors alone might not be enough to slow the corporate profit juggernaut.
“But there is a wild card that could dramatically reshape corporate return profiles as we emerge from this pandemic: an expansion in the role of the state,” he added.
Bain expects the Covid-19 pandemic will be a catalyst for change. The crisis will likely accelerate trends that were already in place, making it harder for global companies to generate the level of profit growth they have enjoyed over the past 40 years.
Peak profits coincide with a historic shift in business eras―from the era of shareholder primacy to what we call the era of scale insurgency.
For business leaders, winning in this new era will require:
- Sharpening your competitive edge. While macro tailwinds have pushed up aggregate profitability in recent decades, our modelling suggests that nearly 60% of the variance in firm-level profitability still comes down to factors specific to a given company or sector. In other words, much is still directly within the control of business leaders and their strategic choices matter immensely. As profit pools shrink, competition for customers will intensify. To survive, firms will need to deliver the benefits of both scale and intimacy.
- Rediscovering business building. In an environment of heightened competition for profits, creating value will require firms to rediscover the lost art of business building. This will be especially important if governments raise barriers to M&A. Intrinsic value in low-interest rate environments is far more sensitive to growth than to margins, meaning the stakes are especially high.
- Resilience. To offset margin pressure, many firms will be tempted to trade greater efficiency for lower resilience. In a more turbulent world, this will prove to be a false economy. Instead, firms should look beyond this year’s earnings and consider the implications their strategic, operational, and financial choices will have across the business cycle. Doing this well will require a candid dialogue with investors, who have not borne the full cost of firms’ lack of resilience over the past two business cycles.
- Elevating citizenship & sustainability. Demands for business to take on a greater civic role will likely get only louder, as the recent groundswell around racial and social justice has shown. The ability to effectively navigate an increasingly complex web of societal expectations will come to a moral issue as well as a significant source of competitive advantage. The new era will require firms to proactively identify and meaningfully address the issues their employees and customers care about -- or risk losing both.