Phil Ruthven examines the size and profitability of Australia’s business sectors and suggests it may be time to do things differently.
There is surprisingly little profitability in Australia’s economy for the amount of equity invested. With $4.4 trillion invested in the 2016 financial year, the net profit after tax was a paltry 2 per cent on that investment. The average has been an unimpressive 2.8 per cent over the past three decades, peaking at just 3.8 per cent in the 2008 financial year. Fortunately, there is an upward trend and it could get a whole lot better if all enterprises take up the challenge.
When considering sector size, it is useful to see where the equity is, and who is profitable. The chart on page 27 provides perspective: private sector businesses (including listed companies) account for 46 per cent of all equity and the public government business enterprises (GBEs) add a further 3 per cent. So, the non-financial business sectors account for virtually half of the equity that produces the nation’s revenue of some $4.7 trillion and gross domestic product (GDP) of around $1.7 trillion.
However, in 2016, these business enterprises provided just 36 per cent of the net profit, a far cry from the 58 per cent of the total in 2006. Savage writedowns in the private enterprise sector following the collapse of mineral prices didn’t help.
Financial corporations, accounting for 11 per cent of all equity, provided 63 per cent of all profit in 2016, by the default of the others, but this sector’s more normal contribution is a third of this share. General government, which includes public administration and safety, education and many other tax-funded services and welfare, is a big sector at 40 per cent of all equity, but is a recalcitrant loss-maker. It has contributed losses to the overall net profit of the nation for most of the past three decades. Only one of the four sectors has shown any improvement in profitability over recent decades: GBEs. They are a smaller sector as a result of privatisation over the past quarter of a century, but have more than trebled return on shareholder funds (ROSF) to a trend value of around 10 per cent, perhaps due to the states demanding better commercial returns and the privatisation of lost causes.
General government is the lead in the economy’s saddlebag. This sector’s ROSF has been profitable for only 10 of the past 28 years, and its average ROSF has been -1.9 per cent per annum. The only federal government to help make this sector even marginally profitable was the Howard/Costello Government. Of course, this sector should not be judged by the same profitability yardsticks as the business sectors. That is not the role of a sector whose prime purposes are safety, justice, economic growth, full employment, wealth distribution, education, equal opportunity and other civilising roles. But it should pay its way; and it isn’t doing that. The simple reason is inadequate revenue (taxes) to match outgoings. This is made all the more damning by the fact that Australia is one of the lowest taxed nations in the developed world at 29 per cent of GDP compared with an Organisation for Economic Co-Operation and Development (OECD) average of 35 per cent, with some six nations above 40 per cent and in the “nanny state” category. We are in the “denial” category, and have been trying to cut costs to balance the federal budget to no avail for many years.
A bigger disappointment has been the private sector. It has had an average ROSF of just 3.5 per cent over the past three decades, reaching peaks of around 5 per cent. Financial corporations have had an average of twice that level, at 7 per cent ROSF.
Part of the reason is that there is a high turnover of enterprises in the economy. One in eight departing businesses of our 2.1 million total are replaced by new entrants each year; and over half of the new entrants don’t survive three years. Barely 40 per cent of businesses have any employees other than the owner.
Over 120,000 rural businesses have had an average ROSF of just 2.3 per cent over the past 30 years to 2016. At least double that number do little better across many other industries. At the same time, it is a reasonably open economy where businesses can succeed or fail on their own merit.
However, the nation’s Top 1,000 corporations that control more than 10 times that many subsidiaries, do a lot better with an ROSF average of around 11 per cent. Even without the financial corporations, they are close to double-figure ROSF averages.
In the industrial age, it was considered best practice to have an ROSF of double the 10-year government bond rate. With the bond rate around 5.5 per cent, an 11 per cent ROSF was considered very good. The term “world best practice” (WBP) wasn’t in use at that time, so hardly any international benchmarks or comparisons were used. But the industrial age has been gone from the OECD for 50 years and replaced by the new age of service industries and information and computer technology (ICT).
Commercial property trusts can just about match the old performance yardstick of twice the bond rate as a passive asset. The new hurdle height for businesses with active assets (shares) is four times the bond rate, or 20–25 per cent in normal times. We are now into international comparisons, and use the term WBP accordingly. The good news is that we have a lot of corporations that match this WBP profitability, or six times the all-private sector business average of 3.5 per cent mentioned earlier.
Our 100 best performers within the nation’s largest 2,000 enterprises, each exceeded an ROSF of 35 per cent with an average of 56 per cent over a five-year period to 2015. And there is double that number with an ROSF over 20 per cent. Our 100 best private companies averaged 26 per cent over the five-year period, but given the difficulty of getting data on all large private companies, there are probably three times that number of high-fliers.
The best 100 listed companies averaged 26.5 per cent with a range of 19 per cent to greater than 100 per cent ROSF over the five-year period. The 100 best foreign companies averaged a whopping 46 per cent ROSF over five years; but then again, being international operators, they are far more likely to know how to make better profits with WBP in strategy and operations that produce WBP at the bottom line.
Our local companies, their CEOs and directors, our tertiary business faculties and MBA schools would benefit from going deeper into these success guidelines. Rising profitability is badly needed across the nation’s enterprises, and it can be achieved. Ironically, it has always been easier to achieve an ROSF of 20 per cent than 10 per cent; it is just a matter of doing things differently.
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