Is Corporate America Too Focused on Profit Margins?

×
Corporate AmericaA few days ago I penned a column in this space -- Why to Be Glad America Isn't Making TVs Anymore -- pointing out that when America "lost" the television manufacturing industry to Japan back in the '80s and early '90s, it wasn't necessarily a bad thing.

Having "won" the contest way back when, Japan finds itself struggling today to compete with lower-cost manufacturers in Korea and China. Powerhouse TV manufacturers like Toshiba, Sharp, and Hitachi are eking out a living, earning profit margins so low they'd make Walmart (WMT) blush -- that is, when they're lucky enough to earn a profit at all. Sony (SNE) and Panasonic (PC), two of the best-known brands in TVs today, expect to report a combined $17 billion loss for their consumer electronics businesses. So if America lost the TV business to Japan, I said good riddance.

Not everyone agreed.

Readers Fire Back

In fact, responses to the column were pretty heated. More than 300 of you posted comments here on DailyFinance, many challenging the notion that profits should play a role in industry at all -- especially "in this economy." One reader email was typical. I'd like to share it with you here today ... and respond.

"I happened to read your article regarding TV production and the deplorable returns those companies post. [But] considering our country's unemployment rate, even if a firm posts a modest return or even loses money, wouldn't it be preferred to have manufacturing jobs in these low margin industries? Only investors and managers whose compensation is tied to profits care about the margin..."

-- Brian G., Florida

Why Profits Matter

Now these are fair questions. But the fact is that profits do matter -- and not just for "investors and managers." Let's take a look at how profit margins affect a few other key players.

Customers: Is it good for customers when a company earns low profit margins? The answer seems obvious: Surely customers must benefit when companies sell them goods at the lowest price possible, instead of charging higher prices and padding their profit margins.

But put yourself in the place of a hypothetical manager, asked to find a way to charge these low prices, and earn these low profits. How would you go about it? Probably your first move would be to find a way to cut costs. Laying off workers. Automating more production. Offshoring jobs to China. (Sound familiar?)

You could also try cutting costs by substituting cheaper component parts. Maybe skimp a bit on quality. Tighten up the terms on warranties, and figure out new ways not to honor them.

Customer service? Expensive. That gets outsourced to India, and live customer service reps get replaced with "post a question on our customer forum" policies, and robots answering phone calls. I could go on, but you get the gist. Low profit margins ultimately lead to lower-quality products, and low customer satisfaction. Think for a moment what your impression is of Dell (DELL) (6% profit margin) as opposed to Apple (AAPL) (26%.) Who makes the better products? Who gives you the better service?

Employees: Customers aren't the only folks who lose out when companies can't earn a good profit margin. An unprofitable or minimally profitable business may struggle, for example, to maintain health benefits, 401(k) matches, and other fringe benefits for its workers.

Indeed, health insurance is probably the biggest concern. Every year, small business owners across the country see their cost of insuring employees rise 10%, 20%, and more. Minimal profits and little or no profit growth will not be able to keep up with that cost growth. For that matter, do you ever wonder how companies manage to pay "raises" to their employees? Raises come straight out of rising profits.

Management: One thing Brian G. was right about: Management also has an interest in earning high profits. Oftentimes, bonuses awarded to corporate officers are tied to how much profit their companies make. But don't go thinking that if companies agree to take lower profit margins, management will be sharing the pain right along with assembly line workers. They won't.

When Bethlehem Steel filed for bankruptcy back in 2001, the company cut worker pensions and health benefits. Management, however, made out like a bandit. One year after Beth Steel went belly up, its CEO cashed a $900,000 paycheck. Similarly, the head of General Motors earned a cool $2.5 million in 2010, after drastically cutting that company's workforce. Bank of America, which nearly went under during the financial crisis, paid its boss $1.9 million in 2010.

These sums may pale in comparison to the payouts for more successful corporate insiders -- for example, the $400 million that ExxonMobil paid its outgoing CEO in 2006. But it goes to show: In good times and in bad, management will always make sure it gets paid.

As for the rest of us, the moral of the story is this: Profits are good. High profit margins are better.

Motley Fool contributor Rich Smith does not own shares of any company mentioned above. The Motley Fool owns shares of Bank of America and Walmart Stores. Motley Fool newsletter services have recommended buying shares of Wamart Stores and General Motors, as well as writing covered calls in Dell and creating a diagonal call position in Walmart Stores.



Increase your money and finance knowledge from home

Introduction to Retirement Funds

Target date funds help you maintain a long term portfolio.

View Course »

Goal Setting

Want to succeed? Then you need goals!

View Course »

Add a Comment

*0 / 3000 Character Maximum

165 Comments

Filter by:
bptr

garryangel is more confused about all this than the author even is!!!

Salaries don't come from profits!! Profits are defined as the EXCESS after all operating costs and salaries are acounted for.

In reality, the reason for profits is to make stocks rise to appease investors, make the company "grow" ( these days growing does not equate with new jobs at all - it is only on paper), and to pay for huge executive pay raises and bonuses. Remember, executives get stock options too. So they have a selfish interest in raising stock prices.

The Republican leaders have been conning all the gullible public for years to believe that whatever is good for business is good for them. IT IS NOT!!! In the old days, a successful company meant jobs for everyone. These days, executives CUT jobs to increase profits and increas their own pay. The rich get richer and the middle-class pays for it all. This is what the "Occupy Wallstreet" protests were all about.

The author's scenario about cutting back to lower profit margins makes no sense whatsoever. They cut back to INCREASE profit margins!!!!!!!!!!!
Companies make huge profits then still ask departments to cut back more so they can pad their salaries and "grow" 10% each year.

It is precisely this nonsense, and the confused stupid "conservative" public that keeps this idiotic system going.
Our country is being destroyed because of this giant scam.

In this country,enterprises are either "government-run" or run corporate scammers who care about profit only.
No one seems to be able to figure out that the answer is to elliminate these venal 'profiteers at all costs' motivation and have well-run companies that are NOT for profit!! This would put QUALITY, JOBS, HEALTH AND WELFARE, ENVIRONMENT, and PEOPLE all ahead of profits.

February 18 2013 at 8:39 PM Report abuse rate up rate down Reply
garryangel

I just cringe when I read some of these articles ... and some of their responses. Lets face it when you read that profits aren't important but jobs are "... if you are losing money ..." Can someone please explain just where the money will be comming from to support the jobs? I'm very interested as I found that my company needed to make money otherwise I had to close the door.

There are really plenty of jobs available in this country today, however they are skilled labor jobs required in manufacturing. And, they require a technical education ... not a four year degree! Currently Siemens has over 3500 positions available. Everything from Electronic Technicians to tool and die makers. An experienced tool & die maker can make over 100K today. An experienced electronic tech trained on repairing medical imaging equipmenmt can make over $100K. Steve Joobs referred to this as one of the reasons Apple is manufacturing in China. Today's manufacturing requires trained and qualified technicians and engineers who can repair and maintain the robotic assembly lines and support manufacturing.

I have two sisters who have been fortunate and smart enough to attain PHD's. Both are school district superintendents. Their goals are to see that 100% of the students are college bound. And, it appears, that's what the Washington crowd and elites want to see. So, who is going to fix the CT Scanner or MRI, or your electric car? I suggest you go out and take a look at how these skilled labor jobs are being filled. Indians, Chinese, Japanese ... Why do you think the high Tech companies want to expand the Visa program. Because they can't find enough here.

February 24 2012 at 2:02 PM Report abuse rate up rate down Reply
1 reply to garryangel's comment
bptr

Aside from your completely simplistic and confused understanding of what profits even are, are you suggesting tha a college education actually limits opportinuties yet is also somehow "elitist".

WOW you "Conservatives" are brainwashed and deluded!!! Keep watching Fox Fake "news' and listening to your millionaire fathead radio cult leaders.

February 18 2013 at 8:36 PM Report abuse rate up rate down Reply
gvolkland

America has forgotten how important manufacturing is. You are more likely to improve a product that you are making than one you are trying to play catch up with and design from scratch. When you work with something day after day you learn what its short comings are and you learn how to improve it. Manufacturing supports the insurance industry, the shipping industry, it supports cities by paying taxes directly and the people who work there pay more taxes. It also supports banking, other manufacturing businesses, lawyers, accountants, the fuel industry, and electricity production, personnel businesses, mines and farmers for raw materials, the chemical industry and the list goes on and on. From the Wealth of Nations, the three bedrocks are farming, mining and manufacturing and maybe today we could add a fourth one and that would be intellectual property. i would submit that each is dependent on the others. Any manufacturing is important, certainly we should be in the ones that turn a profit, but to blindly say we should not go there is short sighted. Maybe we could automate better that the Japanese and the Chinese, maybe we can figure out a whole new way to make them using electronic ink or something else. But I suspect we will not lead the revolution in 3-D systems if we and not making 2-D systems.

February 20 2012 at 11:47 AM Report abuse rate up rate down Reply
2 replies to gvolkland's comment
bggdg

Since you mentioned The Wealth of Nations:

From Book IV, Chapter II, p. 458, para. 15.

"By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?"

and

From Book IV Chapter II, pp. 456-7, paras. 11-12

"It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy...What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom."

February 20 2012 at 9:31 PM Report abuse rate up rate down Reply
garryangel

I just cringe when I read some of these articles ... and some of their responses. Lets face it when you read that profits aren't important but jobs are "... if you are losing money ..." Can someone please explain just where the money will be comming from to support the jobs? I'm very interested as I found that my company needed to make money otherwise I had to close the door.

There are really plenty of jobs available in this country today, however they are skilled labor jobs required in manufacturing. And, they require a technical education ... not a four year degree! Currently Siemens has over 3500 positions available. Everything from Electronic Technicians to tool and die makers. An experienced tool & die maker can make over 100K today. An experienced electronic tech trained on repairing medical imaging equipmenmt can make over $100K. Steve Joobs referred to this as one of the reasons Apple is manufacturing in China. Today's manufacturing requires trained and qualified technicians and engineers who can repair and maintain the robotic assembly lines and support manufacturing.

I have two sisters who have been fortunate and smart enough to attain PHD's. Both are school district superintendents. Their goals are to see that 100% of the students are college bound. And, it appears, that's what the Washington crowd and elites want to see. So, who is going to fix the CT Scanner or MRI, or your electric car? I suggest you go out and take a look at how these skilled labor jobs are being filled. Indians, Chinese, Japanese ... Why do you think the high Tech companies want to expand the Visa program. Because they can't find enough here.

February 24 2012 at 2:11 PM Report abuse rate up rate down Reply
gvolkland

America has forgotten how important manufacturing is. You are more likely to improve a product that you are making than one you are trying to play catch up with and design from scratch. When you work with something day after day you learn what its short comings are and you learn how to improve it. Manufacturing suports the insurance industry, the shipping industry, it supoorts cities by paying taxes directly and the people who work there pay more taxes. It also suports banking, other manufacturing businesses, lawlers, accountaints, the fuel industry, and electricity production, personel businesses, mines and farmers for raw materials, the chemical industry and the list goes on and on. From the Wealth of Nations, the three bedrocks are farming, mining and manufacturing and maybe today we could add a forth one and that would be intelectual property. i would submit that each is dependent on the others.

February 20 2012 at 11:39 AM Report abuse rate up rate down Reply
sgtdjusmc

how come BAC nearly went under but not GM in your article? ahh..a little biased are we. You also didnt address the number 1 reason profit is important; BECAUSE WITHOUT IT THE COMPANY WONT SURVIVE!! and everyone will lose their jobs..anyone want to take a job where you pay your employer? yeah i didnt think so..too many left wing non thinkers.

February 19 2012 at 5:43 AM Report abuse rate up rate down Reply
bggdg

If investors who risk their capital are suposed to focus on something other than return on their investment, I wonder why non-investors refuse to invest their capital with objectives other than return on investment?

February 16 2012 at 9:07 PM Report abuse +1 rate up rate down Reply
Sandra

The problem is that corporate America is too focused on short-term quarterly profits at the exclusion of long-term profit and stability. Companies that look only at immediate quarterly profits are penny wise and pound foolish. They pass up opportunities to increase profitability in the future through investment in training, equipment, research, etc. because they reject paying the cost now. They do what's profitable at the moment even though it will cost them much more in the long run. They are tempted to use accounting tricks to maintain high quarterly reports of profit instead of sound business practices that yield reliable, long-term investment stability even if it means an occasional low or even (gasp!) negative earning report. They don't hold on to their employees in slow times patiently waiting for business to pick up again, but instead they slash staff at the slightest downturn, which in turn slows the local housing, business, and public services community. When business improves, these companies then waste time and money looking for good staff who are no longer available locally and are difficlut to attract to a location which is now struggling to provide services due to a lower tax base. Corporate America is too focused on short-term profit margins and has lost sight of the big picture.

February 16 2012 at 7:44 PM Report abuse rate up rate down Reply
1 reply to Sandra's comment
bggdg

While corporations areowned by shareholders who are certianly capalbe of amkeing mistakes, just as are consumers or employees, it's also obvious you've never been part of a corporate stategy meeting.

Business owners (by and large) aren't stupid, As a result, they regularly engage in BOT long and short term strategic planning.

February 16 2012 at 7:57 PM Report abuse -1 rate up rate down Reply
Peggy

I thought I was reading the news but in reality I fell down a rabbit hole....the reasons a company needs to make a profit has to be spelled out in a fashion an 8 year old can understand? OH wait this isn't a news article it's instructions for Obama....

February 16 2012 at 6:17 PM Report abuse rate up rate down Reply
1 reply to Peggy's comment
bggdg

You have to simplify things for the dumbest 1%.

Even then the useful idiots are unlikely to comprehend.

February 16 2012 at 8:29 PM Report abuse rate up rate down Reply
hgonz57491

Rich profitable companies hire many non union people paying good wages and benefits, buy equipent , parts etc.., non profit goverment agencies hire union people , promising them lifetime pensions and healcare with the money they receive from taxing buisnesses ,the rich and the middle class.

Consumers drive the prices, through supply and demand and the US is the largest consumer and the price of goods is in direct relation to or nescessity and ability to buy.

February 16 2012 at 6:15 PM Report abuse rate up rate down Reply
gbaker9916

Many companies weren't worried about profits. Went broke. Then defaulted on the employee pensions. Any company that doesn't stay competitive, falls prey to the real competitors.

February 16 2012 at 6:14 PM Report abuse rate up rate down Reply