The Big Shift

Posted by: Michael Mandel on November 10

In recent months, I’ve repeatedly made the point that the financial crisis was a symptom, not a cause. Innovation was weaker than expected, private sector job growth outside of healthcare was virtually nonexistent, while real wages and real stock values showed little gains from the late 1990s to the end of 2007, when the recession supposedly started. Most distressingly, stock prices for the nation’s innovative sectors, biotech/pharma and information technology, showed a sharp plunge in real terms from 1998 to 2007.

Now there’s a new report out today from Deloitte’s Center for the Edge which provides additional confirmation that the underlying problems extended well beyond the financial sector, and started well before the housing bubble.

Back in June, the Center—led by John Hagel III, John Seely Brown, and Lang Davison—released a report showing that U.S. corporate return on assets has fallen by 75% since 1965. They suggested this decline in corporate performance was driven by the “Big Shift”—a tremendous increase in competitive pressure, combined with the increasingly pervasive digital infrastructure.

At the time, I told Hagel that I didn’t want to write about his “Big Shift” until I saw industry data, so I could understand which industries were driving the corporate performance decline. Well, the new report from the Center takes a closer look at nine industries, out of which seven show the same pattern of deteriorating corporate performance.

For example, here’s the ROA chart for the tech sector.

tech.JPG

As the report says:

And what about innovation? At least as conventionally defined and practiced, innovation may not help the trend. The Technology industry, known for innovation, experienced one of the steepest ROA declines of all the industries we studied. This suggests that while product and technology innovation may be necessary, they also are not sufficient.

There are two industries where corporate performance is still strong, according to Hagel & Co: Aerospace & Defense and Health Care. The report notes:

We do not believe it is an accident that two of the most highly regulated industries in the U.S.—Aerospace & Defense and Health Care—are outliers in a broader trend of performance erosion. The ever-more-powerful digital infrastructure increases the potential for competitive intensity and performance pressures, but public policy shapes the degree to which specific industries feel that pressure

I still have to chew through the report some more. But it’s pretty interesting.

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Reader Comments

CompEng

November 10, 2009 02:22 PM

Fascinating, thanks Mike. Isn't it true that in the long term in a hypothetical fully efficient market, average ROA would be expected to approach 0? Maybe the hyper communication of a digital age really has made information cheap and competition efficient?

That would imply the investment casinos are on the way out and that capitalism will be quite harsh to those that can't compete, whereas I would say the labor market has been pretty forgiving in most of living memory.

Comer

November 10, 2009 04:25 PM

During the Clinton Administration it was like everyone was working and gung-ho, but ever since 9/11 things have been tricky, on an economics-wise level. Then the undoing of Real Estate too! But when West Germany absorbed East Germany, things got really sluggish for a while, for the West German Economy, and then started picking in some ways! But now Europe is absorbing Eastern Europe as well! My uncle, big in Forbes Business and the schemes of this nations economics, would say that some of the most interesting and new innovative ideas, never got the funding to make the leap from engineering through all the flaws to the consumer market, and that because of this consumers missed out! Simple things like a fax, or copy machine are just part of legal, and governmental regimen, which business more efficient, but a person making a loan likes to know what he get in return profit, but my uncle was saying that the guys who bring something new to bat, and then the gentlemen who say yes to financing the idea are the big players! My uncle seemed to think that if finances freed up there more, and the engineers still innovatively testing everything out had more time instead of meeting a date for when the profits would be in, then consumers and business would benefit. Now it appears the economy has gone through a period where things were free, without expectation on profit. And that was not the answer either! But in the past, the IMF would moneys to places like Argentina when their surrounding economies were flailing at least to keep the big one they leaned on stable, and keep an entire region stable, rather then sinking! But what would it take to catchup on 60 years of reconstruction in Eastern Europe like what Western Europe benefitted from after WWII from our American efforts at rebuilding those economies? What would it take to expand infrastructure, education, jobs and opportunity, and innovation in Eastern Europe the way it has been coming in China! Granted, China has a population under one government though they do speak one dialect in the north, and another in the south. But the sooner we make more regions a little more "this century friendly" the sooner this globe starts rebounding forward! Not sure if everything presented in the picture I share adds up too well, but still sharing, Mike! Thanks for your work though! Out! Although for Nation building in Iraq I give this nation much credit, but it still does not seem like enough, and then also, the success in the former Yougoslavia, I give this nation a lot of credit, but a place like Somalia that needed more Nationbuilding expertise, as well as Ethiopia, and Haiti, .....well for these nations, I do not give the United States or any nations any credit at all! And these three have needed it very badly for along long time! How long would it take for a military presence in these places the same as there was in Iraq to turn these small weak economies around, and without any more losses to our men? What if Somalia were to find out it had a staple like oil, or gold, or diamonds? That help but noone but noone would want to invest there, and the french seem to know that region just a little better then others, or they did for a time! Hmmm? What does our nations brightest have for ideas and solutions to these problems rather than something like the killing fields? Clinton was smart and went to Oxford, and our nation seems to forgive him, then he worked for peace in Northern Ireland, as Carter had for Israel and Palestine! But now days, beeting Uncle Sam out of a dollar still makes America happy! So, for right now one of the best innovative ideas I have is to let Willie Nelson and his peanut oil run fleet of winnebagos, and cars, hook up with the industries Carter seems still to be friendly with if not in charge of! If American people don't have to wait in lines at a gas station, nor pay taxes on their car fuel, then this economy will start moving forward quickly! What is stopping us? Oh, blame beaucracy, monopolies, AIG executives, and lobbyists putting their hands on the taxpayers's dollars! Am I on target on any of these issues, or is Canada just going to suddenly leave the US behind by economicly outdoing us? Gotta go! Adios and God bless everyone! Furthermore what can be done to absorb more spanish speakers into our economy, as well as Native American peoples who have had difficulties assimilating until the GI Bill and they became the heroes of WWII with their codebreakers? Thank God the Casinoes are going to be kicked aside! Adios!

LAO

November 10, 2009 06:22 PM

Stunning. Since I'm certain that no corporation has ever approved capital expenditures projected to return a mere 10% or less, this has the appearance of proof that our business leaders do not know what they're doing. That they/we will automate people out of their jobs at any price also vindicates the cynical view.

Why all of industry isn't screaming over what they've paid to provide health care's outsized returns, I cannot understand.

All that investment looked really great, though, as part of GDP.

Mahagwa

November 10, 2009 08:38 PM

Let me propose something (NOT novel because i have heard others discuss it). HUMAN CAPITAL. If I own a company and have employed a group of people for, say 10 years, and decide I am now going to automate the jobs these people did..well, i no longer need them (in their former capacity). I could now take these people and retrain them or send them to college (say at a cost of $40,000 per head). Once graduated, these people are now focused on innovative activities as opposed to replicative activities.
Just imagine if the employees of corporate america focused their energies on improving business performance or generating new products..and the mundane repetitive tasks were automated. You would have a much more enlightened, motivated and driven work force. You would also eat your competition alive each and every day.
Maybe this is the future for America...redefining work as we know it..and it all starts with recognizing employees as assets to be developed.

Ajay

November 10, 2009 09:04 PM

Nothing surprising here, the obvious result of the triumph of the market. What's surprising is that you label high ROA as "corporate performance," when the truth is that highly regulated sectors like weapons and medicine are able to make higher returns through rent-seeking behavior, avoiding competition through exclusive govt contracts or idiotic medical licensing laws. The perverse implication of that excerpt, that more regulation is necessary, is laughable. Consumers benefit from greater competition, as they well know. Investors sobbing about their job getting harder need to man up and embrace competition head on.

Strategery

November 10, 2009 09:22 PM

Coincidence that this decline happened during the same time that "free trade" agreements were being made or were going into effect? I don't think so. In addition, any "savings" from the cheap imports are kept as profit for the CEO, instead of being passed on to their customers. Finally, the executives continue to take more and more, depriving workers of income that would be spent in the economy.

LAO

November 11, 2009 10:48 AM

Remember the hoards of corporate cash that BW has tried more than once to elucidate? There have been companies sitting on more cash than their market valuation represents. I wonder how much of the asset base that cash represents, how much of the increasingly lousy ROA was nothing but fodder for Wall Street shell games, how much of the corporate treasure and hope for the future lies waiting for monetary instrument values to be clarified, or for Obama /Geithner /Bernanke to succeed in getting us to overlook the near worthlessness of a lot of investment.

On the flip side, I wonder how industries with steadily declining ROA can possibly service their debt. It is not really a surprise, considering that the population's deep pockets have been pretty well emptied, but it is painful. It redefines what diversification has to mean -- maybe home solar panels, for instance, are a better bet than equities or bonds or chasing the dollar's decline. Seeing Buffet transform cash into rail did not make me feel gloomy, but this feels like doom.

cm

November 12, 2009 10:34 PM

Pretty much unrestrained "trickle up" has drained funds from the "real" economy. Consumer/corporate credit, in part backed by asset values but in another part by opaque financial shenanigans compensated for a while, but that gambit has now failed. That grocery prices are (apparently) falling and we are seeing more frequent, longer, and deeper "sales discounts" (really price rollbacks) after more than a decade (?) of relentless hikes is a clear indicator of that.

As for tech "innovation" failing, it is not so much the lack of new (and quite frankly a lot of warmed over old) ideas but the realization, and funding for the latter. In many areas, the state of the art is "good enough" to support applications (business as well as private), and the complexity needed to deliver incremental improvement has risen to a point where it is difficult for small up-and-comers to challenge the established players. To an extent the big players are driving "artificial" complexity with ever more overwhelming standards revisions and "industry platforms" as they know that only raising barriers to entry will keep out emerging competition and protect their rents.

Moderately successful and not so successful startups were always bought out by the big guys, but I have an impression that "back then" quite a few successful startups grew large and/or founded new industries, while today the definition of success has largely shifted to being bought out at a good to acceptable price. I'm sure in part this is related to the barriers to entry thing, but also it appears there are currently not many "white spots" on the map for startups to claim.

Mary Adams

November 13, 2009 10:58 AM

Mike- This is another side of the story you reported in GDP Mirage. The same intangibles information gap that exists at the macro level also exists at the corporate level.

The problem with the ROA calculation is that corporations do not book investments in knowledge assets on their balance sheets. Yet corporations are investing much more on knowledge intangibles than on the tangible assets that they do book on their balance sheet (in 2007, $1.6 tr versus $1.2 tr for tangibles, as you cited in the GDP piece).

Until we solve the intangible information gap, we will not be able to have a good discussion of of the true capacity and productivity of our nation's businesses. Kind of scary given the challenges we face.

bruce

November 15, 2009 03:50 AM

The problem with the ROA calculation is that corporations do not book investments in knowledge assets on their balance sheets. Yet corporations are investing much more on knowledge intangibles than on the tangible assets that they do book on their balance sheet (in 2007, $1.6 tr versus $1.2 tr for tangibles, as you cited in the GDP piece).

i don't think so

bruce

November 15, 2009 03:50 AM

i don't think so

Kaleberg

November 16, 2009 11:03 PM

You should get rid of that silly trendline in the graph, it makes it hard to see what happened. If you just drew a few flat lines, you'd see a slight decline in the 60s, the stable 70s, then a new normal, slightly lower ROA starting in the mid-80s, punctuated by severe downturns.

The real salient change seems to have been a drop in the 80s and an increase in volatility with periodic collapses. This corresponds to the big cuts in wages and corporate taxes of the Reagan years and the well documented decrease in economic stability as a result of our nation's new pro-business policies.

In truth, I don't have a good idea as to what happened, on the other hand, putting in chartjunk like that pale gray line just makes it even harder to figure out.

CPM

November 24, 2009 09:49 PM

Three possibilities that explain the steady decrease in ROA:
Assets are no longer a source of competitive advantage, everyone with sufficient financial backing can purchase similar assets – implies an increase in competition and a reduction in competitive advantage implies non differentiation and reduction of profits, hence the ROA decline.
Decline in the marginal productivity of labour – While the productivity of capital increases, the increase in complexity lead to increases in specialization that requires a corresponding increase in labour to sustain production. The rate of increase in labour is higher than the rate of increase in productivity attributed to assets explaining the decline in ROA.
Increases in financing costs – those that control money supply require increases in return on investment which corresponds to the decrease in return on assets.

Dirtec

February 18, 2010 12:46 PM

ok, teste

Juares

February 18, 2010 12:47 PM

ok! teste

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About

Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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