Like, Company A posts 5 Billion in profits. But if they post 4.9 billion in profits next year it’s a serious failing on the company’s part, so they layoff 20% of their employees to ensure profits. Am I reading this wrong?
In: Economics
They need to make a profit year on end because shareholders want to sell their stocks at a higher value than what they bought them for.
This doesn’t apply to privately owned companies, by the way.
Consider this on a greater scale.
Company A sees an increase
Company B sees an increase
Company C sees a decrease
A and B have grown larger, creating profit for their shareholders, and have a greater ability to expand. This is a great sign of longevity
Company C is now at a disadvantage, this is not a good sign of longevity.
This is amplified when you add in inflation. It costs more to produce your product, pay your employees, and to have facilities every year.
If you become stagnant while these costs are growing, you are actually making less.
1. inflation makes all numbers go up over time, which accounts for *some* of this
2. Increasing profits is what the owners want. More specifically, increasing stock value is what the owners want, because the owners own the company through stocks, for the purpose of selling those stocks later. That company that made $4.9 billion in profit represented a loss on the investment made by the owners, or even just less of a return-on-investment than they expected. *Some* businesses truly don’t expect growth, and their stock owners expect a steady cut of the yearly profits (a dividend) instead, but most investors buy shares because they expect the share price to go up.
3. No, you’re not the first to say that this is inherently unsustainable. It’s not crazy to think that the economy as a whole could grow forever, since new technologies and new information is always being developed, but it’s an ownership structure that is ripe for prioritizing short-term gains over long-term health. For further reading you’d have to go beyond ELI5 though.
At some point, many companies get so large that they shift to payout out dividends with their revenue instead of focusing on growth. Some large caps like Coca-Cola(KO) are a good example of this, they are already a global presence, they don’t have anywhere left to expand to, so they pay out most of their profits(>75%) to their shareholders instead of making new factories or expanding their market.
They also had a peak revenue/net income/EPS in 2011/2012 but their stock is nearly 3x the price is was then.
Company A has a board of directors and they are looking to hire a new CEO for the company. There are two good candidates for the position so they interview them.
Candidate 1 says they will keep the company running smoothly, no changes, just keep making money. Candidate 2 says they will make some changes and increase the amount of money the company is making.
The board hires Candidate 2, because why hire someone who is going to make the same money when there is someone who can make them more money? A decision is made and Candidate 2 becomes CEO.
Now that they are CEO they have to live up to that promise. They got hired because they said they would make the company more money, so they start pushing the company hard to earn more money. Increased sales, decreased costs, or both.
If the CEO succeeds they get to keep their job, if they fail they are fired and the process starts over again from the top.
The push for more and more money comes from a series of individual pressures. The stockholders want a return, the board is there to ensure that return, they hire a CEO to make that happen, the CEO has to make it happen.
This is more true for public companies. The problem is that investors will buy shares, and they have an expectation that those shares will grow in value so they can eventually sell them and make a profit. Posting better and better revenues is a way to grow the share price. Failing to do that risks the CEO or other execs getting ousted and replaced by someone who can give the results they want.
But a public company doesn’t necessarily *have* to get super aggressive about it. The other way to provide shareholder value is through dividends, giving them a cut of profits just for owning shares. Generating a stable passive income just for holding the shares also has value.
With private companies, where it’s one owner or a few owners, if $10M a year pays all the bills and keeps everyone employed and keeps the owner(s) happy, there’s no need to post higher and higher profits unless that’s what the owner wants.
It’s not tenable in the long term. I worked for almost 20 years in a highly regulated industry where our prices were held basically at the same level for years at a time, but we were expected to grow profits every year in spite of that. The first couple of years axed things like training, business-related travel, and marketing. Then they killed the pension plan and quadrupled the price of our health insurance. After that, we had to start cutting staffing levels by 5-6% every year to meet the growth targets. Meanwhile, our CEO’s compensation increased by 400% over that time period. I changed employers at that point, only to see the new company follow the same basic steps over the next decade.
Companies that aren’t at least growing with inflation and population growth are doing worse than ‘average’.
Many businesses want to also grow with average productivity increases, and some companies (e.g. Tech or really growing companies) expect to grow even faster than that.
If you are doing badly you need to rapidly set things right or you will be in a position where you can’t save yourself.
It’s just inflation.
Money today in the US is 20% less valuable than 4 years ago because of high post-Covid inflation. So a company with the same profitability as 4 years ago is reporting 20% higher profits today.
There are outliers, like NVDA which makes AI chips where the demand has skyrocketed since ChatGPT, but that’s not how most companies are doing it.
1) Inflation is usually a few percent a year. A company serving the same customer base should grow a few percent annually.
2) The population is growing. A company serving the same geographical location, even with no growth, should serve more customers each year.
3) Free markets grow the economy. Because successful businesses prosper financially, there is an incentive to provide better or equal goods and services at a lower price. Overall the “economy,” the total value of goods and services produced, will increase. The value of all companies 300 years ago was much smaller than it is today. There is no end in sight for this trend to continue.
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