Sunday, May 17, 2015

Economy: Why Are Companies Doing So Well In A Sluggish Environment?

(Drivebycuriosity) - The economy may be sluggish, but companies are doing well. Their profit margins (earnings related to revenues) are on a record high. Many skeptics have been predicting that the profit margins have to fall again, back to normal (pragcap). But the reality is defying the pessimism. Profit margings stay close to their record highs as the graph below shows. The blog Philosphical Economcs believes that companies create high high profit because they have not much competition (monopolistic power). He calls that "the winner takes it all economy" (philosophical).

I think he is wrong. Contrary to a common believe, there is a very strong competition, fueled by the Internet and globalization. Even market leaders like Apple are continuously attacked by companies who want to take a piece of their profit cake. For instance the highly profitable Apple has to fight against  Samsung and the Chinese newcomers.

There must other explanations for the high company profits.

1. I think companies benefit from a new industrial revolution. Since the early 18th century automatization has been enabling them to produce more goods & services with the same amount of employees. More and better machines are doing the work of people which translates into lower costs and higher profit margins.

It seems that this process is accelerating again. Car producers and many other manufacturers are increasingly using robots and similar machines to reduce their costs and they are beginning to use 3D-printers to become more cost efficient and flexible.

This developments are boosted by the rapid advance of information technology, meaning combinations of computers, smartphones, Internet and other digital systems. Software - which is increasingly Internet connected and uses more and more the cloud (access to huge external data centers) - organizes the whole business: Creating new products, inducing machines to run more efficient, finding cheap suppliers, manage customer relations and so on.

2. The high profit margins might also reflect the rise of the emerging markets. China, India & Co. create additional markets. Therefore companies can produce more which translates into shrinking average production costs (economies of scale). Emerging markets also deliver cheap supplies (most computers, tablets & smartphones are manufactured there) which reduces the production costs further.

All these developments are working together and are aggravating each other. The described processes seem to accelerate again and to provide a surge of productivity & efficiency which should to keep profit margins above 10% or even to drive them higher.

And everybody can participate by buying stocks (shares of companies) and holding them for a long time. The easiest and cheapest way to do this is buying an ETF (for instance on the S&P 500).

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