Corporates have seen their net income increase by more than 500% in the past 30 years, from $1.1 trillion in 1980 to $5.6 trillion in 2013, research by McKinsey & Company shows. As a percentage of global GDP, annual income went up from 4.4% of to 7.3%, an increase of 73%. Particularly North American and European corporates bring in large shares of profits, with a total of 51% of the global $7.3 trillion in net profit from 2013.
In a report, titled ‘Playing to win’, McKinsey & Company’s Global Institute explores the changes in global profitability of corporates since the 1980s. The report is built up from a wide range of sources, including macroeconomic data obtained from mostly public sources such as the World Bank, the OECD, and the IMF. The report uses a combination of financial metrics from McKinsey’s Corporate Performance Analysis Tool (CPAT), as well as firm-level share distribution and financial performance for a sample of 69,090 public and private companies.
Sky high profits
The world has been changing rapidly in the past three decades. More than 1.2 billion consumers have joined global markets and technological changes are increasingly changing human interaction. The opening of new markets, the lowering of costs through technology, as well as international competition forcing down corporate tax rates and labour cost, have provided corporations with a means to leverage massive profits for themselves and their shareholders.
In the decades between 1980 and 2013, corporate entities have harvested record profit after record profit. Globally, corporates across all industries have seen their earnings before tax more than triple in real terms, up from 5 trillion in 1980 to 17.3 trillion in 2013. Net income for corporate entities increased even more starkly, up more than 500%, from $1.1 trillion to $5.6 trillion. In terms of a % of world GDP, profitability for corporates jumped significantly both in pre-tax and net income terms. Pre-tax earnings are up from 19.4% of GDP to 23.7% – a 22% increase. Net income has gone up from 4.4% of world GDP to 7.6%, a 73% gain in net profitability over the same period.
Although the above captures the global averages, closer inspection finds that it is particularly companies in advanced economies that are making the big dollars in profits, in terms of net income. Particularly Western Europe and North American companies are doing well – with 25% and 26% of the $7.3 trillion in 2013 going to companies situated in those regions respectively. Chinese corporates take home 14%, while Japanese corporates collect 7%.
The report finds that large entities are scooping up the biggest piles of money. Companies with annual revenue of more than $1 billion account for nearly 60% of global revenue and 65% of market capitalisation. The biggest scoops are in the hands of 10% of publically traded companies which collect 80% of profits. The piles of money are ending up as large cash reserves, with US company cash holdings increasing to 10% of GDP in the US, 22% in Western Europe and 47% in Japan. Following low borrowing costs, large corporates have been consolidating further through a massive wave of M&As, with the total value of worldwide M&A deals in 2014 at $3.5 trillion, up 47% from the previous year.
A number of factors have influenced the increase in corporate profitability since the 1980s. The global revenue pool has grown from $56 trillion in 1980 to more than $130 trillion in 2013, on the back of growth in consumption, investment, and international supply chains. Emerging economies’ contributions to revenue increased from 20% in 1980 to 40% in 2013. Massive infrastructure projects, as well as deregulation have further expanded the domains in which corporates can act and generate revenues.
At the same time as corporates have expanded globally, costs associated with their products and services have been slashed due to a number of macroeconomic factors. Corporate tax has fallen significantly since the 1980s, down by 50% in some countries; with effective tax rates even lower. Low borrowing costs to near zero in some instances has significantly reduced (by up to 40%) interest costs for expenditure. Technology has further provided a means to slash costs, as the cost of industrial labour and robots has shrunken 50% in the past decades.
For labour, the massive addition of new workers from globalisation, as well as the reduction of labour laws, has seen corporates take advantage of low-cost labour. As productivity advances have been steady, revenue and profits for corporates have benefitted, while employment and wages have come to lag. Across advanced economies for instance, labour’s share of national income has fallen from 76% in 1980 to 66% today. According to the report, between 1980 and 2013, profits have increased significantly in the US – from 5.6% of national income to 11.6%. In the same period, worker compensation dropped from 67% to 60.9% of national income.
McKinsey states that the growth in profitability enjoyed by corporates will, in the coming decade, come to decrease. The consulting firm developed a number of scenarios with the most likely model seeing the corporate profit pool fall to 19.6% of GDP, with net income down 21% to 6% of global GDP. In absolute terms global net profit will increase slightly, up from $5.6 trillion in 2013 to hit $6.5 trillion in 2025.
The declining level of profitability is due to a number of factors. One key change is that emerging players are ramping up competition both internally as well as externally, hereby reducing margins. In addition, tech companies are disrupting market places by opening up opportunities for small competitors, further increasing competition in some markets. Low borrowing costs are expected to come to an end as the financial crisis is overcome. The cost of labour is also expected to increase as workers and their governments crack down, with the global demand for talented workers likely to see costs increase as corporates start competing for workers.