McKinsey warns on profits

An unprecedented run of global corporate profit growth may be ending, and three decades of gains could be undone in the single decade, warns the McKinsey Global Institute.

It predicts the global corporate profit pool could shrink from almost 10 per cent of world GDP to less than 8 per cent by 2025, a level last seen in 1980.

“There are indications of a very significant change in the nature of global competition and the economic environment,” McKinsey says in Playing to Win: The New Global Competition for Corporate Profits, released in September. Two forces will weigh on global corporate profits: rapid growth in emerging-market companies and the rise of technology companies that disrupt business models.

McKinsey says emerging-market companies, which account for 40 per cent of global corporate revenue, are expanding aggressively overseas through mergers and acquisitions, engaging in fierce price competition, and prioritising revenue growth over short-term profits.

Tech-enabled firms are another unpredictable source of competition. The largest ones have built digital platforms and networks that provide never-before-seen scale in users and customers, revenue and profits – and can drive marginal costs to almost zero.

“As profit growth slows, there will be more companies fighting for a smaller slice of the pie,” McKinsey says. “Incumbent industry leaders cannot focus simply on defending their current market niche. Firms with vision, optimism and agility can realise enormous opportunities, if they are willing to disrupt their own operations before a competitor does it for them.”

McKinsey’s view reinforces the need for boards to test business models and challenge the assumptions behind them like never before. Boards must understand how corporate strategy could be disrupted by a new wave of competition from emerging-market companies, and from technology disrupters that are crushing longstanding business models.

McKinsey suggests four key responses to this threat:

• First, focus on offence: go after growth markets, spot disruption before it hits, and learn about emerging markets.
• Second, ensure the organisation is lean and agile: focus on asset-light operations, avoid strategic inertia and plan ahead for resilience.
• Third, focus on intangibles. Ensure your organisation owns the new weapons: software, data, algorithms, brands, and research and development. And that it fights for the best talent, either by developing people organically or acquiring talent through M&A.
• Finally, play the long game: find investors with long horizons and create incentives for long-term value creation over short-term gains. That will help respond to new competitors that prioritise sales and scale over profit margins.

For more information, see Playing to Win: The New Global Competition for Corporate Profits.