Why are profit margins so high?? I offer a few reasons:
1) Those that fund equity have high demands placed on them.? Many are pension plans and endowments, and they push firms to achieve higher profits.? This is true whether the business is public or private.
2) With globalization, there is downward pressure on wages for those in industries where goods are tradable internationally.? That downward pressure allows profit margins to stay fat.
That said, the big return is going to those who have scarce resources amid global growth.
Now will profit margins mean-revert? Certainly, but the proper question is when will it happen?? Profit margins will mean revert when, labor begins to be scarce again.? Given the changes in the world, that could be a long time.
If it is a long time, one could take heart that it means the world as a whole is developing.? It will mean greater opportunities for your children who will be able to sell to those who have developed.
Those are my summary thoughts; please feel free to comment below.
“Profit margins will mean revert when, labor begins to be scarce again.” How about other major determinants of net profit? Say, taxes? Or revenue?
One thing I don’t get about the lower labor cost theory of today’s high profits– if laying off so many people fattens margins during a recession, it should fatten them even more when sales are booming. Thus, as profit maximizers, the companies would have done it by now. So layoffs by themselves cannot be the reason. There must be something else. What I think is actually happening is that companies and their profits are riding on the coattails of the people they fired. Example, shortly after the first Chrysler bailout with Lee Iacocca, the company fired something like 4,000 engineers. For the first few years, things looked great. Chrysler had the new K car (and its highly successful minivan spinoff) designed by all those now departed engineers, without having to pay their salaries. Profits looked great. But Chrysler no longer had enough engineers to do proper product development, and the K car, its minivans, and their thinly disguised successors became increasingly outmoded and obsolete. In a few years, Chry sales had plummeted and the company was effectively bankrupt again. It had to be bailed out ultimately by Daimler-Benz. If this is indeed what is happening today on a larger economy-wide scale, the current apparently robust corporate profits are simply a mirage.
I’m not sure the answer is so simple. In theory companies should be chasing investments with lower returns upon comparison the the risk free treasury rate.
One answer may be that firms find that generating accounting profit via share buy-backs, and applying their energies to tax avoidance by setting up off-shore divisions better alternatives.
David,
Why are corporate profit margins so high?
US companies pay a 5% effective tax rate. Versus, what, a 35% headline tax rate?
There?s your answer.
btw, your first reason above has been the case for over twenty years, so I doubt that this is a major driver today.
Your second reason is ?spot on?, for labour intensive industries. But, in most manufacturing today, direct labour is <10-12% of cost of sales. Service industries, eg help desks, radiology, customer service are where labour cost arbitrage has its greatest impact.
Chuck,
The tax code is definitely part of it, and I could tell you some stories from my days as an insurance analyst, and as an investment actuary inside insurance companies. Much of the change escapes the corporate AMT, because DC aims for social engineering above all else.
My first reason has intensified over the past 20 years. It didn’t happen all at once. As I wrote at RealMoney back in 2004, this force will finally change when we are importing goods have a tag that says, “Made in the Congo.”
Regarding direct labor costs — you also have to take into account the labor inherent in the vendors that supply the company; I’m looking at the economy as a whole — the share that accrues to labor factors through that.
David,
Exhibit ‘A’ , 21 December:
http://dealbook.nytimes.com/2011/12/20/the-benefits-of-incorporating-abroad-in-an-age-of-globalization/
Appreciate your reply to my previous post.
I should have remembered that, with all of the insurance companies in Ireland and Bermuda.
Only thing I can think of would be to eliminate the corporate income tax, and raise the taxes on dividends and capital gains to be revenue-neutral. And, maybe, tax everyone like traders….