Corporate profits were showing signs of peaking even before the pandemic, said Bain & Company recently.
The firm teamed with Oxford Economics to study 13,000 listed companies in 25 developed economies spanning the US, Europe, Asia, Canada, Australia and New Zealand, with a focus on developed-market companies because of their outsize share of the global profit pool and comparable macroeconomic dynamics, the consulting company noted.
The research 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 the pandemic, but like many historic crises before it, the health crisis has the potential to accelerate gradual currents of change that otherwise might have taken a decade or more to play out,” Bain & Company pointed out.
What powered the rise in profitability in the past few decades
The study found that over the past several decades, six waves of change have powered the steady rise in corporate profitability:
- Labor’s waning bargaining power, due to a decline in unionisation and simultaneous expansion of the labor supply.
- Financial liberalisation, which drove up the profitability and economic share of financial services.
- Globalisation, which allowed firms to access lower cost supply chains and new export markets.
- A commodity super-cycle, driven by surging industrialisation 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 fueled the displacement of labor with capital in an expanding range of sectors.
Two emerging mechanisms that reverse profit trends
As powerful as these macro trends have been, Bain said it sees two emerging mechanisms — the reversing globalisation and labour market changes — that could exert downward pressure on corporate profitability and perhaps force a reversion to the historical mean.
Recent trade wars had already pushed companies to rethink their commitment to offshore supply chains, said Bain.
Then the coronavirus pandemic exposed how risky those stretched, low-cost supply lines really are, the company observed, adding that a move toward reshoring to better manage risk will likely pressure margins.
At the same time, labor market changes will exert upward pressure on costs for many companies, according to Bain.
Though the baby boom generation has assured a steady supply of labor that has had a dampening effect on wages over the past few decades, the boomers’ retirement and the decline of the share of the working-age population might cause that trend to reverse, Bain added.
While the unemployment shock during the pandemic 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, the firm warned.
Will automation help?
Asked if acceleration in automation and continued growth of Internet platforms will support high profitability levels, Bain predicted that 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 shock caused by the pandemic could prove devastating for mid-size 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.
“On balance, these factors alone might not be enough to slow the corporate profit juggernaut,” said James Root, partner at Bain & Company in Hong Kong and co-chair of Bain Futures. “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.”