The Nation’s Profitability Challenge

I thought I would share a report by Phil Ruthven founder of IBISWorld Pty Ltd who recently took a good hard look at business profitability in Australia and has shatter some myths about excess profits that some well-intentioned, but uninformed or envious people suggest are the norm, but aren’t. So over to Phil Ruthven . . .

It is astonishing to know that, for all the ups and downs in the economy and for all the management and business training, there has been no improvement in the nation’s profitability – measured as the return on shareholder funds after tax (ROSF) – over the past several decades. And the average ROSF has been no better than the long-term bond rate over the same period.

We will get the bad news out of the way first, so we can look at – and finish on – the good and truly impressive performances of our best businesses. Because we do have excellent businesses; hundreds if not thousands of them, among our 840,000 employing-businesses in Australia. These businesses are a tiny minority indeed, but a minority we would surely all like to become more mainstream…

Businesses are started for all sorts of reasons: to buy a job, to satisfy an entrepreneurial or freedom-seeking passion, or to make more money than in a job, via profits on top of a wage or salary. Most businesses don’t achieve any of these.  Around 280,000 businesses start up each year and nearly the same number close each year, mostly within three years of start-up. Which is tragic.

However, in 2017 we have just over 2.1 million businesses alive, although less than 40% of them – around 840,000 – employ any of the nation’s 12 million strong work force. These companies are called employing-businesses. The remaining businesses are trusts, SMSFs, sole traders and the like.

The average profit of all 2.1 million businesses, in terms of ROSF, has averaged just 3.8% over the past 30 years, or less than the 10-year bond rate over the same period. If we exclude general government activities, the average rises to a still-unimpressive 6.6%.

But surely the situation is better among our big corporations, say the 1,500 biggest, which account for around 42% of the nation’s revenue. Sadly, no. Over the past 5 years, their average has been just 8.7%. This result is much the same as the return on commercial property, which is a passive asset. Some 20% of these 1,500 giants ran at a loss over the five-year period. Yes, one in five.

The 100 worst loss-making enterprises ranged from a five-year average ROSF of minus 16.0% per annum to more than ten times that annual loss. The average over the 100 corporations was minus 44.7% per annum, although this result is slightly less scary on a weighted average basis, at minus 30.0%. It should be said these 100 negative earners were evenly split between foreign and local corporations. Almost one in five of these 100 enterprises were caught unprepared for the collapse in mineral prices over the five-year period. Of course, several of these companies were investing heavily for the long term and could not be considered mismanaged.

Our 100 best government businesses – made up of government business enterprises (GBE) and general government organisations – fared a lot better, and had an average ROSF of 9.8% over the five years through 2016. Eleven of these businesses achieved world best practice (WBP) profitability of 20% or more. Around 80% of them bettered the average 10-year bond rate (3.2%) over this five-year period: no mean achievement for government enterprises. Half of the best 100 government businesses are listed below.

Interestingly, none of the 100 best government enterprises ran at a loss.

The 100 biggest corporations, which account for just under a fifth (19%) of the nation’s revenue, had an average ROSF of 11.6%, but only 8.4% on a weighted basis – also around the passive return on commercial property. Almost one in six (17%) of them ran at a loss over the five-year period.

Cutting company taxes a bit wouldn’t improve this awful performance much. Why just get a 7% improvement to the bottom line by cutting the tax rate from 30% to 25%, when knowing how to achieve world best practice profitability could double or even quadruple the bottom line, as well as the top line, profit.

We now head into serious territory where WBP profitability is common rather than scarce. The chart below shows the high-flying clusters among publicly listed companies, private companies, foreign companies and the best-of-the-best in the best 100 cluster at the top of the ladder.

Our 100 best publicly listed companies on the ASX had an average ROSF of 23.3% over the five years through 2016. Some 47 of these firms had an average over 20%, matching WBP. Among those in the top 10 were Tamawood (house construction), Platinum Asset Management (funds management), Blackmores (vitamins), DuluxGroup (paint manufacture), Cochlear (hearing implants) and Telstra (telecommunications). These companies and a dozen others achieved over 30% in their returns on shareholder funds after tax over the five years through 2016.

The 100 best local private companies’ average ROSF, at 26.4%, was better still, although not by a lot. Over half (53) of these companies did better than WBP over the five-year period. Names that are familiar to us include Wotif, Lorna Jane, Penfold Motors, Carpet Call, GHD Group and Kennards Hire.

The 100 best foreign companies averaged a much higher 51.3% ROSF over five years: double the 100 best local publicly listed companies and nearly double the 100 best local private companies. All 100 of the best foreign companies beat the cut-off for WBP profitability in ROSF terms at over 20%. There are a lot of well-known and household names in this list, including Bechtel, Hilton, FedEx, Diageo, Philips, Colgate-Palmolive, Nestle and Apple.

The 100 best companies over the five years through 2016 – regardless of the type of company or ownership – saw the average ROSF jump to a staggering 62.9%. But the best 100 companies have averaged well over 30% for decades, without suggesting they have always been the same companies. That doesn’t happen: companies get taken over, split up, or new management breaks the rules of success that got the company there in the first place.

What is particularly interesting is that there is little difference in profitability between types of ownership, locality of ownership (local or foreign) or industries over the five-year period.

Indeed, when it comes to industries, the results imply there is no such thing as a ‘bad’ industry, only inadequate or inappropriate management. In fact, three of the best 100 companies were in mining, while 18 miners featured in the 100 worst companies during a time when mineral prices plummeted. And there were 16 manufacturers in the best 100 list, an industry considered to be one of the toughest around these days.

The ladder below is an interesting one in this regard.

These returns are well above the entry level of WBP profitability of 20% ROSF, and should not be seen as the yardstick of success. Too few can ever achieve these levels, and it is not expected.

Plans are underway to set up a new Ruthven Institute later this year, with strategic alliances with the nation’s leading university business colleges and schools, to help businesses get to know how the firms that do achieve WBP profitability do it. And, importantly, how to stay there.

The Ruthven Institute is also aiming to equip MBA and business graduates with more knowledge and evidence-based decision making skills, to take on top executive roles so that WBP performances hopefully won’t be so rare in a decade from now.

Phil Ruthven

Founder of IBISWorld

 

source: IBISWorld Pty Ltd.