In a report analysing corporate profits, the McKinsey Global Institute identifies intellectual assets and inorganic growth as key factors for business success. The era of high profit margins is said to be over.
In their recently published report “Playing to win: The new global competition for corporate profits”, the McKinsey Global Institute (MGI) analyses the behaviour of corporate profits within a three decade time frame starting in 1980 and predicts changes in the corporate environment until 2025. Due to an increase in the average variations of corporate profits of 60 percent, the competitive landscape has become more dynamic and complex. In this environment, they predict that intellectual assets and inorganic growth is key to survive.
Profit shift to knowledge intensive industries
The MGI sees profits shifting from capital and labour intensive industries to idea intensive sectors. Asset-light and idea intensive sectors accounted for 17 percent of the profits generated by Western companies in 1999. Today, the share of industries as pharmaceuticals, media, finance and information technology increased to 31 percent. This value is created using patents, brands, trademarks and copyrights.
Although size does not matter and guarantees a market position for long in those knowledge intensive industries, the most profitable industries in knowledge intensive sectors are 40 to 100 percent largest than the median firm.
As emerging markets have entered labour and capital intensive sectors, they have put pressure on prices and have drove down marginal costs through whole industries including automobiles, machinery and retail.
The importance of M&A
A second key factor for business success are M&A transactions. In order to “muscle out competitors”, as the MGI report call it, M&A transactions are used to capture new markets and add new business lines. In 1990, the report identifies 11,500 M&A transactions accounting for about two percent of global GDP. In 2008, there were nearly three time as many deals accounting for three percent of global GDP. Looking at 2014 figures, an enormous growth in size can be identified: More than 95 deals have exceeded a market value of $5 billion.
Idea intensive industries also have a large stake in M&A transactions. A pattern identified by MGI is that the larger firms are, the more they use M&A to grow further. Besides, the deal size in these industries as well as the valuations of companies are increasing. The report points on examples as Facebook acquiring Instagram for $1 billion or WhatsApp for $19 billion.
Emerging markets have used M&A transactions in recent year. Accounting for less than ten percent of M&A transaction volume in 2018, they account for 30 percent of transaction volume in 2014.