Superstar companies capture 80% of economic profit
Large companies tend to dominate the global market, with the top businesses capturing the vast majority of economic profit globally. While being a so-called ‘superstar company’ clearly pays significant dividends, however, it can be easier said than done to maintain such a status.
In a global free market, it is perhaps inevitable that the biggest businesses still take the lion’s share of the spoils. Going largely unchecked by meaningful regulation for the best part of four decades, the companies at the top of the food chain have come close to operating an international monopoly, with the biggest 10% of entities capturing 80% of economic profits globally.
Yet while this winner takes all outcome seems unlikely to disappear any time soon in the current market, the churn among even the top has increased in recent years. According to a new study into ‘superstar companies’ by McKinsey & Company, the crown is not incontestable, and while superstar companies are becoming more diverse, the odds of becoming or remaining one are unchanged.
Superstar status remains highly contestable, and despite the increasing concentration of economic profit, it is easy to fall from the top. In McKinsey’s analysis of 5,750 public and private companies whose revenues exceeded $1 billion, the firm found nearly half of superstars lost their status in every business cycle – a churn rate which remains broadly unchanged from the past three business cycles, going back more than 30 years.
However, it should be noted that superstar companies from developed markets – which are broadly likely to command the highest amount of profit – were less likely to forfeit their crowns. 40% of superstar companies in developed regions ceased to be superstars, compared to 60% of those in emerging markets.
Among top performing companies, McKinsey’s analysts found that the largest tend to be more focused on intangibles as part of their wider investment strategy – including both R&D investment as well as strategic M&A to pick up the projects of other firms. In terms of R&D spending, up to 10% of total revenues were invested by the top 1% of companies – these companies also tend to have the highest revenues by far, at up to $70 billion.
Top performing companies were also noted for their focus on international markets – they tend to be more globalised – as well as vastly better returns on invested capital as they are able to much better leverage their resources to generate returns. However, these trends may be putting the cart before the horse, to a certain extent. Superstar companies have higher revenues, and so can put more money toward the ‘luxury’ of intangible development, or international expansion, before benefitting from the yields of these tactics – preserving their stranglehold on the top, by taking advantage of the fact they are at the top.
Further down the pecking order, meanwhile, firms which previously struggled are doing even worse now, as a result of the top companies’ expanding dominance. The bottom 10% destroyed as much economic profit as was captured by the top 10% of companies – reflecting the depths to which companies can fall while remaining liquid.
At the absolute pinnacle and the absolute rock bottom, this disparity is even more incredible. McKinsey noted that between 2014 and 16, the top 1% of businesses averaged economic profit of $6.4 billion – rising from $3.5 billion between 1995 and 1997 – while at the bottom end economic profit destruction increased from an average -$1.02 billion to -$1.56 billion.
Commenting on the findings, McKinsey Partner Sree Ramaswamy said, “The average amount of profit that these [superstar] firms are making has increased over time. So there is a concentration of economic value, and that concentration is accelerating today… When these superstar firms fall out, however, they tend to fall very far, destroying a lot of value."
Ramaswamy, who is based in McKinsey's Washington D.C. office in the US, continued "That has important implications for the economy; there is something which has changed in the economy that is allowing firms to create a lot of value when they create it, but when the market takes that away, it ends up destroying a lot of value.”
