We’d call it the opposite of a perfect storm: a set of external circumstances that together create an exceptionally favorable economic environment. The largest North American and European multinational corporations have been sailing through one for the past 30 years. In that time they have enjoyed their longest and strongest run of rising profitability in the postwar era, thanks to an environment that has supported robust revenue growth and cost efficiencies.
From 1980 to 2013 global corporate after-tax operating profits grew 30% faster than global GDP; today they stand at about 9.8% of global GDP, up from 7.6% in 1980. Corporate net income grew more than 50% faster than global GDP, from 4.4% of global GDP in 1980 to 7.6% in 2013. North American and Western European companies now capture more than half of global profits. North American firms increased their post-tax margins by 65% over the past three decades; today their after-tax profits, measured as a share of national income, are at their highest level since 1929.
It has been a remarkable era, but it’s coming to a close. Although corporate revenues and profits will continue to rise, the overall economic environment is becoming less favorable, and new rivals are putting the Western incumbents on notice. Many of the new players are from emerging markets, but some are surprise intruders from next door, either tech companies or smaller technology-enabled enterprises. Those competitors often play by different rules and bring an agility and an aggressiveness that many larger Western companies struggle to match. In this new world, corporate performance will no longer outpace the global economy. We forecast that in the decade ahead, although operating profits will continue to grow in absolute terms, they will fall to 7.9% of global GDP—around what they were when the boom began. In other words, the stratospheric gains of the past 30 years could all but vanish in just 10.
In the following pages we’ll explain what is changing in the global economic and competitive environment and consider how today’s leaders can be tomorrow’s as well. To set the context for that, let’s look at the main drivers of success so far.
Why Profits Rose
The start of the profit boom coincided with the spread of deregulation and privatization around the world. That trend first took hold in Western countries and moved on from there; in the early 1990s India, China, and Brazil all undertook varying degrees of privatization. The movement introduced private-sector competition to vast swaths of global business, from automobiles, basic materials, and electronics to infrastructure industries such as telecom, transportation, and utilities—all of which had a strong legacy of state ownership. In 1980 those infrastructure industries, most of which were tightly regulated, generated more than $1 trillion in revenue. By 2013 they were generating more than $10 trillion, two-thirds of which was open to private-sector competition. (All revenue and profit figures for 1980, 2013, and 2025 are in 2013 U.S. dollars.)
During the same period a huge wave of urbanization and industrialization in emerging markets contributed to the growth of the global consumer class (which includes people with disposable income exceeding $10 per day). That segment has grown from around one billion in 1980 to around 3 billion today, creating new markets for the offerings of Western multinationals and spurring global investment in infrastructure, factories, and housing. In China alone, capital investment grew from 29% of GDP in 1980 to 47%, or $4.3 trillion, in 2013, and countries across Asia have undertaken ambitious capital projects, from oil refineries and power plants to steel mills and cement plants. Globally, fixed capital formation has nearly tripled in real terms since 1990, with the private sector accounting for a vast majority of the increase. For Western multinationals, those investments have more than made up for declining capital investment at home: Publicly traded companies from advanced economies have poured almost $4.5 trillion into the build-out, much of it across the emerging world, just since 2000.
The multinational companies that have been best placed to exploit those factors have come mostly from North America and Europe. Although Japanese and Korean companies accounted for nearly 10% of global profits in 2013, their margins haven’t risen as much as those of their Western rivals, which dominate the more profitable sectors: idea-intensive industries such as pharmaceuticals, media, finance, and information technology, which account for about 22% of revenues but 41% of profits.
The strong position of multinationals from developed countries rests on three advantages:
In some industries—even idea-intensive ones—the bigger a company, the higher its profit. Just 10% of public companies accounted for 80% of the profits generated by all such firms in 2013. In North America, public companies with annual sales of $10 billion or more captured 70% of the profits in 2013, up from 55% in 1990 (after adjusting for inflation). Here, developed countries had a head start because they were home to the world’s biggest businesses. They still are. Some of these companies are as large as nations: Walmart’s profits are comparable to Botswana’s GDP, and its workforce is bigger than the population of Latvia or Slovenia. Exxon Mobil’s profits are the same as Bolivia’s GDP. At nearly $750 billion in early 2015, Apple’s market capitalization was almost as large as the whole of Russia’s stock market.
A global presence.
Successful Western companies have used their size to expand aggressively abroad, thus capturing the increase in global revenue driven by economic development in China, other parts of Asia, and Latin America. In 1980 just 21% of global corporate revenue came from the emerging world; by 2013 that had almost doubled, to 41%. In response, large Western corporations have transformed themselves from predominantly national corporations into truly global ones. GE, for example, generated $4.8 billion in revenue outside the United States in 1980, but by 2014 that figure had climbed to about $80 billion, more than half the company’s total. The story was similar at other firms: By 2010 nearly half the revenues of the S&P 500 came from outside the United States.
Developed-world multinationals have exploited unprecedented opportunities for reducing costs. The biggest sources of savings have been falling labor costs and the higher productivity of both capital and labor. Greater automation has gone hand in hand with falling technology prices; since 1990 the gap between the cost of industrial robots and the cost of labor has decreased by 50% in advanced economies. Since 1980 the global workforce has grown by 1.2 billion people, most of them from emerging markets that have become more connected to the rest of the world through supply chains and migration. Falling tax rates and borrowing costs have accounted for about 15% of the total gain in net income. Since 1980 corporate tax rates have dropped by as much as half (from a high of 45% to 60%) in a range of nations, including Australia, Canada, Germany, and the United Kingdom. At the same time, the cost of borrowing has tumbled. Back in 1982 the yield on 10-year U.S. Treasury notes was nearly 15%. Today it’s about 2%, and U.S. firms have seen a full percentage-point decline in interest expenses relative to revenue. Similar dynamics have been at work in Europe and Japan, where benchmark interest rates are close to zero.
So, what has changed?
Growth and Costs Have Bottomed Out
Powered by the twin engines of a growing workforce and increasing productivity, the global economy has expanded by about 3.5% annually since 1980. In contrast, annual GDP growth averaged less than 2% in the 100 years prior to World War II. However, as populations age in the developed world and China, workforce growth is slowing and even declining in some regions. Absent a step change in productivity growth, GDP growth will fall to 2.1% globally and 1.9% in developed countries within the next 50 years.
In addition, the favorable cost drivers that Western multinationals were able to exploit have largely run their course. Interest rates are now so low in many countries that borrowing costs simply can’t fall much further and might even be starting to rise. The big tax-rate decline of the past three decades also seems to have ended. Indeed, tax inversion schemes, offshoring, and the use of transfer pricing are drawing political flak in several deficit-ridden countries.
As for labor costs, wages in China and other emerging markets are rising. Rather than continuing to reap gains from labor arbitrage, companies will fight to hire skilled people for management and technical positions. New jobs require disproportionately greater skills, especially in science, engineering, and math. In China, once the main source of new workers, the demographic pressures of an aging population and falling birth rates could further increase the country’s labor costs. And most other emerging markets do not yet have the high-quality rural education systems required to build a disciplined workforce.
The cost drivers that Western firms exploited have largely run their course.
Aging is also a big problem in the Western multinationals’ home markets. One-third of today’s workers in advanced countries could retire in the next decade, taking valuable skills and experience with them. In countries such as Germany, Japan, and Korea, nearly half the workers will be over the age of 55 in another 10 years, and replacing them with younger individuals would require politically challenging changes in immigration policy.
Talented people in emerging markets now have more options. The most coveted jobs used to be with Western multinationals, but that is changing. As companies from China, India, Brazil, and elsewhere in the emerging world become global firms themselves, they are closing the gap in terms of remuneration and opportunities for career growth. They tend to have young, skilled, and highly motivated workers who are willing to put in long hours or work nonroutine shifts—and some have exported that model to their foreign acquisitions.
The result is an intensifying global war for talent. In a recent McKinsey survey of 1,500 global executives, fewer than one-third said that their companies’ leaders have significant experience working abroad—but two-thirds said that kind of experience will be vital for top managers in five years.
Emerging-Market Competitors Have Changed the Rules
There are now twice as many multinational corporations as there were in 1990—85,000 is a conservative estimate. Although two-thirds are still headquartered in advanced economies, the balance is quickly shifting. In 1990, 5% of theFortune Global 500 came from emerging markets. In 2013, 26% did. By 2025, we estimate, more than 45% will.
These new competitors are growing more than twice as quickly as companies in advanced economies, both in their home markets and beyond, eroding the traditional Western advantage of scale. Although their track records for profit and performance are uneven, the most successful of these players are now as big as or bigger than competitors from the U.S. and Europe. For example, the world’s three largest makers of domestic appliances as measured by profits are Chinese: Gree Electric Appliances, Midea Group, and Qingdao Haier, with combined revenues of $60 billion and profits of $4.5 billion. So are the three largest banks: Industrial and Commercial Bank of China, China Construction Bank, and Agricultural Bank of China. The Indian telecommunications firm Bharti Airtel has about 310 million subscribers worldwide—more than the populations of France, Germany, the United Kingdom, and Spain combined.
The growth of these players has been supported by their ownership models. Major U.S. and European companies’ broad public ownership, board structure, and stock exchange listings typically enforce a sharp focus on near-term profitability and cost control. But many emerging-market firms are state- or family-owned and so have different operating philosophies and tactics. Many of the new competitors take a longer-term view, focusing on top-line growth and investment rather than quarterly earnings. Growth can be more important than maximizing returns on invested capital: Chinese firms, for example, have grown at a blistering pace—four to five times as fast as Western firms over the past decade, particularly in capital-intensive industries such as steel and chemicals.
Aggressive mergers and acquisitions are often the means to achieving growth. In 2013 Chinese firms completed 198 overseas deals worth $59 billion—one-third the total value of their acquisitions that year. Over the past four years, Chinese firms’ share of global deal value has exceeded their share of global revenue by almost 30%. But China is not alone. India’s Sun Pharmaceutical Industries, for example, has made a stream of acquisitions since the 1990s to become one of the world’s largest generics companies. The Tata Group, based in Mumbai, encompasses 19 companies with more than 50,000 workers in the United Kingdom alone, making it one of that country’s largest private-sector employers. Brazil’s JBS has become the world’s biggest meat producer through a series of acquisitions, including U.S.-based Swift & Company and Pilgrim’s Pride.
What’s striking is that size doesn’t necessarily lead to a loss of speed and agility. Indeed, a few of the most globally competitive emerging-market giants have managed to stay lean. Some of the newer competitors, even in durable goods manufacturing, operate with greater capital efficiency and higher asset turnover than industry incumbents in advanced economies. For example, Hyundai, founded in the late 1960s, has a larger average plant size and fewer legacy factories—and produces more vehicles per worker—than longer-established companies such as Volkswagen and Toyota.
Some of the new players focus on responding rapidly to the market, recombining technologies, and squeezing out costs. Others are adept at capturing new growth opportunities or reaching underserved markets with low cost structures and no-frills products. And all of them have the tenacity to operate in other fast-growing emerging markets. South Africa’s MTN and Kenya’s Safaricom, for example, provide mobile financial services to millions of customers who have no bank accounts, credit card histories, or identification numbers. Indonesia’s Indofood has successfully introduced its Indomie noodles across Africa, becoming the most popular brand in the huge Nigerian market.
The scale equation has clearly shifted in favor of the new players. In 1990 Chinese companies represented only 4% of the global production of aluminum, and the marginal cost throughout the industry (averaged across producers in 2014 U.S. dollars) was approximately $2,500 a ton. By 2014 Chinese smelters represented 52% of global production and had lowered the average marginal cost in the industry to less than $1,900 a ton—driving out more than half the Western producers that were active in 1990.
Of course, it would be a mistake to think of emerging-market companies as a monolithic group, since they tend to reflect their home countries’ business climate, market structure, corporate culture, and endowments. Understanding such differences is crucial to understanding how these firms compete.
In our research, we have found some clear regional patterns. Asian companies, for instance, have been the most aggressive in expanding abroad, while Latin American firms tend to focus on their home markets. The industry mix in China resembles that in Japan and Korea, reflecting a similar legacy of using massive investments to drive growth; for instance, four of the five most profitable iron and steel companies in the world are from those three countries. Even the overall corporate performance of firms from those countries is similar; the margins of Chinese firms appear to be falling toward the 3% to 4% range of their Northeast Asian counterparts in most industries, compared with about 8% for Western companies.
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This article is adapted from the McKinsey Global Institute report Playing to Win: The New Global Competition for Corporate Profits, coauthored by Richard Dobbs, Tim Koller, and Sree Ramaswamy.