Peak Profits: A Conversation on Corporate Profitability

Bain's Andrew Schwedel and James Root discuss how the rise in profitability over the past few decades may be ending, and what business leaders can do to adapt to the new environment.


Peak Profits: A Conversation on Corporate Profitability

Is the golden age of corporate profitability coming to an end? Bain partners Andrew Schwedel and James Root, who cochair our global think tank Bain Futures, discuss how business leaders can harness trends such as automation over the next decade to continue to create value at their companies.

Read the Bain Report: Have We Hit Peak Profits?

Read the transcript below:

ANDREW SCHWEDEL: Hello, everyone. This is Andrew Schwedel, cochair of Bain Futures, based in New York. And I'm here tonight with my colleague James Root, also a cochair of Bain Futures and based in Hong Kong. And we're here to talk about some of the recent work we've done around corporate profitability, which we've published under the title Peak Profits. And really, the question of will the recent rise in corporate profits that has persisted over several decades continue in the future?

So James, this was a big study that we undertook recently in conjunction with Oxford Economics, where we looked at over 13,000 public companies across 25 markets, and really tried to dissect what has happened with total profitability, and then some of the differences by market, by sector, by size of firm. And just a few of the interesting highlight findings, and then we can dive into what it means for the future.

The first is that profitability overall across the developed world has gone up considerably over the last three or four decades. Profits have grown at almost twice the rate of GDP. The profitability in the US—to take one example—ROE has gone from 13% to over 16%. And you see some differences across countries and sectors. But that's a pretty consistent global story around the sustained rise through multiple business cycles.

One of the things we did with Oxford was really try to dissect what drove that at a microeconomic level. And we saw six overlapping waves of change, everything from increased automation and globalization, to the declining power of labor, commodities. And so there are a variety of factors that played out across the three or four major business cycles in this period. But what we really wanted to say was, you know, will those trends persist going forward? Will we see these things continue to be tailwinds driving corporate profits, or will some of them reverse and become headwinds?

The final point I'll just make at a macro level is this performance was very uneven across industry sectors and across size of firm. So it was very much an uneven distribution, where the largest firms were the most successful, drove the fastest increase in profits and really separated from the pack. And so that's another trend to watch. Will that continue? Will we continue to see the top 1% of firms taking 40% of the profit pool, which is a pretty staggering number, and up from 30% a few decades ago?

So that's a very high-level kind of global tour. You know, James, you spend a lot of time with some of the markets in Asia. We'd love to hear what you're observing in the region.

JAMES ROOT: Yeah, I mean, the remarkable thing was the—as you said—the growth of the global profit pool in that 20-year period that we looked at, from about $1 trillion in 2000 to $4.5 trillion. And the share of that pool ending up in Asia-Pacific has changed a lot, mostly because of China, obviously. Developed market share of the pool has declined significantly. China's share went from 2% of that global profit pool in 2000, up to 13%, so 6x increase. By the way, still only 13%. Plenty of headroom.

Widely differing stories in other parts of Asia. Japan basically missed out on this golden age. The smaller markets, Hong Kong, Singapore, South Korea, Taiwan—what we used to call the Tigers—phenomenal story of high growth, stable high returns, shareholder value creation. The issue for those markets is going to be the exposure to the deglobalization effects, because they're so reliant on international trade, as you know.

And then the commodity-driven markets down in Australia and New Zealand—again, different story. They're off their peak highs of profitability since the commodity cycle started to downturn in 2010. And at least in our view, unlikely to get back to those high levels of profit, because the cost of labor in those markets has just become unsustainably high, due to the resource pool. So as you said, wide variation. But still, as you know, we do think there are some things that companies can still do to react to this.

SCHWEDEL: Yeah, and James, you know, you touched on something important there, which is some of these trends have already started to reverse. So globalization, which was one of the big drivers, is in kind of full retreat everywhere we look. You know, we do see a more interventionist government policy in many markets.

But on the other hand, there are favorable trends as well. So automation we would say is in the early innings, in terms of its ability to drive continued margin expansion. So there were three or four big implications we took from this for what business leaders should do to try to get out in front of all this change that's going to manifest over the next decade, and continue to drive profitability and value creation.

And the first of which may sound a little bit obvious, but it really is continue to execute some of the tools and techniques that have worked well over the last three or four decades or more. So being really sharp on the core business focus, on differentiation. And there are many more opportunities to differentiate in new ways, due to the explosion of data and digital modes of engaging with customers. Really driving automation to take step function improvements in cost, even if the globalization lever is no longer available.

And so we observe that in part, just because of the continued differences in performance across firms, there is a lot of opportunity still for underperformers to catch up. You know, we see that, by the way—that's a big part of the private equity playbook, which is another aspect we looked at: the incredible growth of private equity firms, particularly in the kind of midsize company segment over this time, and their track record of helping those firms improve margins.

ROOT: Yeah, by the way, you're absolutely right to talk about some of these trends already in reverse. We did some work, as you know—it's not in the report, we kind of did it after the report was written—which suggests the average profitability in China and India are already declining. It's a topic for another day.

So I think a second implication beyond the one you just mentioned is many firms are trying to adopt what we would call a scale insurgent kind of playbook. It's a concept of a firm's behavior and activity around strategy, and around people and talent management, that we've been writing about and thinking about at Bain Futures for a while. Essentially, not being constrained by the traditional trade-off between scale and speed and agility, delayering the organization, much wider spans, much more self-managing teams working on some mission-critical activities.

And it's a very liberating focus on just building businesses. The scale insurgents are great business builders. And I think that is another very appropriate response to these trends that we've observed.

SCHWEDEL: Yeah, it's a great point. And obviously, we're big believers in the scale insurgency playbook. And that's really the business model that is winning this new era. And they've been some of the most profitable firms, particularly in the last decade or so.

One of the challenges I think we observe those firms—all firms, but including scale insurgents—facing is this issue of corporate citizenship, and how to get out in front of this trend. And it's going to be one of the increasing headwinds on profitability, of governments demanding more from business in response to public pressure in their countries, public opinion pressure, some of the social indicators that have not kept up with the growth in profits.

And, you know, the scale insurgents in many ways are like the trusts of 100 years ago. And they don't have some of the same reservoir of goodwill and favorable ties to regulators and other stakeholders that maybe some older, more established companies have. And so that's an asset in trying to maintain the right balance of growth in profits and sustainable profits for some of the incumbents.

A related issue I think we see is the need to invest in more resiliency. And that is an area that's certainly been highlighted in importance as a result of Covid. You know, we've seen part of what's happened over this four-decade period is continued optimization of every aspect of profitability, but at the expense of increasing fragility.

And you know, again, I take the scale insurgents that you mentioned—they've proven to be very resilient in the current crisis. I think the question may be, will they be resilient in the next crisis, which could be something totally different. And so that's another dimension to this puzzle. Business leaders will need to find some capacity to invest in resilience, while continuing to improve the business, and respond to some of these shifting tailwinds and headwinds.

ROOT: Very important, and both unknowns, I think. Some would say citizenship will pay for itself, because you will attract the great talent, and you will attract the favorable regulatory oversight, etcetera. But there's still cost involved in that.

And then particularly, in your second point on resiliency, who pays for that? Do we just have to turn to shareholders and say, you will now expect lower returns? Hence the concept of peak profits, in part. Particularly true for the smaller firms. If we look at the ROE of the largest firms ($25 billion-plus) vs. the ROE of the smaller firms ($1 billion or less in revenues), you know, back in 1980, they were almost the same. They were 1.3 to 1. Today, you know, it's over 4 to 1 in favor of the large firms. And in some sectors—tech, for example—it's like 10 to 1.

So the larger firms can absorb some of these costs. For small and medium-sized firms, I think this is an enormous question to resolve. How do I absorb the additional cost? I now realize I have to invest in my business to have more resiliency in it.

SCHWEDEL: Yeah, you know, it's funny, we started out this work kind of asking the question of, is this sustainable? You know, we had a sense that some of these trends are meaningful, and if you just continue to project forward the rates of change for the next 40 years, do you just get to levels of profitability and concentrations of profitability that just don't make sense? Or will something change in the external environment, either from the market or for government to change it?

And I think our view is it's not likely to be sustained. The next decade is likely to be the time when the rubber really hits the road. And that's going to be an enormous change, but also an enormous opportunity for leaders to get out in front of some of those trends, shape them to their advantage and really separate from the pack. So thanks, James. Always good talking to you about these topics, and I look forward to the next one.

ROOT: Thanks, Andrew.


Have We Hit Peak Profits?

Even before Covid-19, the golden age of corporate profitability was showing signs of topping out.