Australia / From the Founder
Profitability From The Right Strategy

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by Phil Ruthven, IBISWorld Founder and Chairman
Mar 27 2019

One in ten of Australia’s largest 2,000 businesses (which account for nearly half our revenue of $5.5 trillion this year) are achieving world best profitability of 22% or more on shareholder funds after tax consistently over a three-year period (some even over a five-year period). This level is four times the historical average 10-year bond rate.

Along the way, these businesses seem to be looking after their employees and the triple bottom line too. Probably better than those that don’t achieve such profitability.

Most boards can’t conceive of such performance, and yet with the right strategy it is easier to get there than the much lower profitability levels of the average business.

In the Industrial Age up to the mid-1960s, world best practice profitability was twice the historical average 10-year bond rate, at 11% or more. The US lifted the high jump bar to 22% because even passive assets such as property and property trusts could achieve 11%, and more if leveraged. So, when leading corporations began to get passive assets off their balance sheets in favour of intellectual property (IP), they found that achieving 22% wasn’t as frightening a challenge as first thought.

In Australia, we have found that shareholders now place much more importance on IP as a component of share prices, as we see below. The ratio is even higher in favour of IP in the United States.

Intellectual property: Growing importance

This emphasis on IP was helped by other new age rules such as focusing on one industry, planning from the outside-in rather than the inside-out, outsourcing non-core functions, developing strategic alliances, and a handful of other new ways of strategizing and running a modern business.

The Dow Jones 30 largest listed have averaged four times the bond rate now for over three decades. The ASX 30 largest have averaged 11%, but that is not solely due to the hard assets factor, as we will see shortly.

It is not well known how low average profitability among the nation’s businesses has been over recent decades, and indeed further back. But the chart below shows a truly worrying history over the past three decades. It excludes sole traders and partnerships (around 5% of the nation’s revenue).

Profitability: Australian enterprises

It shows the nation’s businesses did not beat the 10-year bond rate, except over the past few years when the bond rate fell below 3%, and then only just.

This is alarming, but fixable, albeit slowly and over a long time period.

We have around 2.2 million businesses in Australia, with some 40% of these being employing companies. Around 300,000 new businesses start up each year, most with no business knowledge, and it is not surprising that nearly the same number exit the economy each year (around 13-14% of all businesses). After all, unlike a driver’s license, which requires written, oral and driving tests, no business license or experience is required to start or run a business.

But performance at the top of corporate Australia has challenges too. Australia’s two largest corporations had returns of 5.8% and 4.7% on average over the past five years. The largest 10 corporations, all listed on the ASX and with revenue of $443 billion in 2018 (representing 8.5% of the nation), averaged just 10.7% over the past five years. Only one, Telstra, achieved world best practice returns with an average of 25.8% over the five-year period.

All but one is diversified as a theme or classic conglomerate. This is in contrast to the New York Stock Exchange, where most are focused on one industry. Only three of our Top 10 have expanded overseas, with the rest diversifying at home. This is in stark contrast with Australia’s 100 best enterprises, as shown below, where nearly all are focused businesses.

100 best enterprises

When we analyse the largest 100 businesses that account for one-fifth of the nation’s revenue, their average return has been 8.7% per annum over the past three years, lower than passive property returns.

While banks have done better than most of our large corporations, they are part of a financial sector where profitability has been trending down over several decades.

Long-term profitability: Private sector enterprises

This is largely the result of diversification into other financial services to become theme conglomerates, resulting in a loss of focus through concentric marketing. In turn, this may have contributed to the cheating and corruption, emerging in a boiling frog syndrome way, and uncovered in the recent Hayne’s Royal Commission: the favouring of senior executive and broker rewards over customers and perhaps over shareholders.

Our poorly performing share market over the past decade has reflected inadequate performance by businesses.

The University of Melbourne, through its Centre for Workplace Leadership, is embarking on education and executive development programmes this year to help executives and boards, and undergraduates and MBS students know how to achieve world best practice profitability and sustainable success.

So, there is light at the end of the tunnel. Better strategy, better leadership and better management practices are hopefully on the way.

For a printable PDF of this release, click here.