How to defend corporate profits in an increasingly competitive world

It is getting more difficult for large Western multinational companies to boost earnings by tapping new overseas markets and consumer classes. Global production and labour costs are no longer falling, and hard-charging challengers from emerging economies and the technology sector are heating up the competition.

The past three decades were a profit bonanza for multinationals. Worldwide, net operating profit less adjusted taxes (net post-tax profit) tripled, from about $2 trillion in 1980 to about $7.2 trillion in 2013, according to a McKinsey Global Institute analysis of more than 28,000 companies around the world.

Multinationals from advanced markets accounted for 68% of the global net post-tax profit in 2013, the McKinsey analysis determined. But the competitive landscape is projected to change over the next decade.

McKinsey projected that by 2025 global net post-tax profits will increase to $8.6 trillion, but the corporate profit pool will shrink to 1980 ratios of world GDP.

The number of multinationals has doubled in the past 20 years, and so has the share of global corporate revenue that emerging economies have claimed. Also, idea-intensive sectors where value is created by brands, patents, trademarks, and copyrights are capturing a larger portion of the profits. In capital- and labour-intensive sectors, such as automotive, machinery, and retail, emerging-market firms have intensified price competition.

“This is exactly what our clients are feeling, and we’re feeling it as a result of our clients,” said Sally Shanks, CPA, CGMA, controller at Merkle, a US-based marketing services company.

Merkle helps large US multinationals manage customer relationships and marketing by running advertising campaigns on multiple platforms and through data analysis and processing. As Merkle’s clients are coming under increasing pricing pressure, their marketing budgets are stagnating or decreasing, Shanks said. “So we then have to make sure we’re more effective in delivering our services to conserve our margins.”

To be able to work “smarter, harder, and faster,” as Shanks put it, Merkle follows a strategy that includes multiple acquisitions per year to expand the company’s footprint, scale, and services. Branching out into online services five years ago was part of that strategy, as was opening offices in Shanghai and Nanjing in the past six years to cater to US multinationals doing business in China and adding an office in London after buying two UK companies this year.

After 25 years in the business, Merkle, which employs about 3,000 people worldwide, also has to keep track of the next generation of tech-enabled companies stepping up competition and price pressures in its own industry.

Take KeyInsite for example. The US-based startup was launched in 2014 and consists of about 20 employees and 100 to 150 freelancers. KeyInsite pulls together on-demand teams in the US and India that research and implement online marketing strategies for small and midsize companies. Training and algorithms are key to the startup’s proprietary quality check.

Large consulting firms to which multinationals have traditionally turned for such services offer databases and frameworks they’ve built over many years, said Pratibha Vuppuluri, a former investment banker who is founder and CEO of KeyInsite.

“Their business model is based on time and material,” Vuppuluri said. “Our ability to crowdsource is a lot more nimble. We move a lot faster, and we don’t run on high infrastructure costs. By being able to source the people based on the skills required, we’re able to reduce the cost by half.”

Global trends reflect increasing competition

What’s happening at Merkle and KeyInsite fits with the trends McKinsey’s analysis found among large Western multinationals and their up-and-coming competitors.

Deals. In the past eight years, the number of mergers and acquisitions has increased to about 30,000 deals per year, from 11,500 deals in 1990.

Profits. Industry sectors with the highest average profit margins (net post-tax profits over sales) were pharmaceuticals and medical devices (19.8%), telecommunications (13.4%), media (12.4%), and IT and business services (11.7%). Ranked on the bottom were retail (3.5%), health-care services (3.9%), construction (4.4%), consumer discretionary (5.0%), and automobiles (5.4%).

Investments. Companies based in North America and Europe had the highest return on invested capital in 2013 – 15.6% and 15.2%, respectively – but companies based in emerging countries in Latin America and Asia invested at least twice as much of their revenue. The share of revenue turned invested capital was 23.5% for North American companies, 18.6% for Western European companies, 40.5% for companies in India and countries that are part of the Association of Southeast Asian Nations, 44.5% for Latin American companies, and 77.3% for Chinese companies.

Characteristics of winning companies

McKinsey’s analysis also distilled characteristics of companies that stood apart by being the most profitable despite increasing competition. Lessons to be learned from these companies include:

• Go after fast-growing markets.
• Focus on spotting tech disruption developing outside the company before it hits. Monitor developments by holding competitions and “hackathons”, or by partnering with venture capital firms as your eyes and ears.
• Learn the nuances of emerging markets down to the city level to understand and monitor the new landscape.
• Avoid strategic inertia.
• Plan ahead for resilience by creating multidisciplinary risk teams, diversifying supply chains, implementing more flexible procurement contracts and manufacturing systems, and gaming out worst-case scenarios.
• Remember that software, data, algorithms, and brands are the new weapons and that intellectual assets matter in all industries.
• Fight for the best talent and consider mergers and acquisitions to gain capabilities.
• Seek out patient institutional investors, who will positively respond to a long-term business strategy of improving corporate performance and innovation.
• Create incentives for long-term value creation over short-term returns.

—Sabine Vollmer (svollmer@aicpa.org) is a CGMA Magazine senior editor.