The Long-Term Decline in Performance is a Result of Firm’s Slow Response to The Big Shift
The Shift Index
For further context and insight on this topic, please reference the following sections of the 2011 Shift Index report:
One of the central themes of the Shift Index and the topic which generates the most questions each year, is that asset profitability (ROA) has shown a downward trend over the past four decades; a trend illustrating a steady decline in firm performance that not many have even noticed, much less investigated. Indeed, there continues to be a profound cognitive dissonance around this point: on one hand, we all acknowledge experiencing increasing stress as performance pressures mount; on the other hand, we seem unwilling to accept that all of our efforts continue to produce deteriorating results. We contend that the long-term decline in performance is the result of firms’ slow response to the Big Shift. If anything, the imperative to adapt to the changes in the Big Shift will become all the more pressing as interest rates- and expectations- rise in the future.
To measure long-term corporate performance, we calculated economy-wide Asset Profitability (ROA) for all publicly traded firms (numbering greater than 20,000) between 1965 and 2010. We use ROA as a measure of firm performance for two reasons. First, as opposed to other asset-oriented metrics, such as Return on Equity (ROE), ROA is a comprehensive measure of firm profitability and is not affected by distortions associated with a firm’s capital structure.
This year, our analysis confirmed that the decline in ROA is occurring consistently across almost all sectors of the economy. With the exception of aerospace and defense and health care services, all other industries in the economy exhibited a downward trend in ROA. This suggests that the fundamental forces of the Big Shift are driving down Asset Profitability across the entire economy.
ROA Performance Gap
Economy-wide, ROA is declining as competition intensifies and consumers and talented workers gain market power. Yet we all know averages can be deceiving. Maybe good companies are generating high returns, but the bottom companies are losing big and dragging down ROA? The ROA Performance Gap shows a bifurcation of winners and losers; this finding is by no means new. What is surprising, however, is how little winners have gained during the past 45 years. Technology has enabled firms to leverage talent in new and innovative ways and cut costs from operations on an unprecedented scale, however, even top quartile performers have failed to convert these advances into ROA gains. The ROA for the top quartile of firms has actually declined gradually over the past 45 years from 12.7% in 1965 to 9.9% in 2010. While ROA for the top 1% of firms has improved, ROA in the top decile firms has only held steady over the past 45 years. Only a very small group of companies has succeeded in improving ROA. In the bottom quartile, weak performers are deteriorating at an increasingly rapid pace. Over the same 45-year time period, average ROA for companies in the bottom quartile dropped from 1.3% to -9.9%.
Firm Topple Rate
We know winners are worse off in terms of returns—but are they at least winning longer? Or is it increasingly difficult to develop a sustained advantage in the world of the Big Shift? The Topple Rate addresses these questions. Between 1965 and 2010, the topple rate for all companies in the economy with more than $100M in net sales increased almost 40%, as competition exposed low performers and ate away at their returns. This trend indicates that competition is increasing in the top strata of performers, making a firm’s time at the top all the more tenuous.