Turning scale to value is essential post-Covid-19
As Asia grapples with the impact of Covid-19 pandemic, the region's top corporate executives are deeply concerned about the impact on business performance and livelihoods in a volatile post-pandemic environment. For many of Asia's largest companies, this complicates the challenges they were already facing.
Over the past decade, the region's corporate giants have grown rapidly in scale. Today, Asia is home to 43% of the world's largest 5,000 companies by revenue (G5000). Companies from Thailand now have a presence on the list, whereas they previously lacked representation 10 years ago.
But scale has not translated to value. Between 2005-2007 and 2015-2017, profits generated by Asia's largest companies fell from US$150 billion (4.63 trillion baht) to a loss of $207 billion. Why has Asia's profitability declined so dramatically?
Nearly half of this decline is due to a cyclical downturn in the energy and materials sectors. Another third can be explained by the allocation of capital to value-destroying sectors, particularly in China. The remainder of the decline is due to the underperformance of Asian firms.
When we measured the G5000 companies on profit, mapped by country and sector, Asia is under-represented in the top quintile (16%) and over-represented in the bottom quintile (24%). In other words, the region has a higher concentration of companies that destroy economic value and a lower share of companies that create it.
Even before Covid-19, Asian companies operate in a hyper-competitive environment, and it is hard even for leading companies to maintain their pre-eminence. In China, only 36% of companies in the top 20% in terms of economic profit maintained that position over a period of 10 years, compared with 53% in North America.
Today, the pandemic has badly hit many sectors, put pressure on many businesses and disrupted global supply chains which run through Asia. This wide impact adds another layer to the region's general performance malaise.
Left unaddressed, this will prolong Covid-19's impact on livelihoods. The performance of large companies affects not just investors and executives, but also workers, consumers and whole economies. For example, Samsung directly employs more than 180,000 South Koreans and its revenues amounted to 12.5% of South Korea's GDP last year.
As Asian companies position themselves for life after the pandemic, they need to improve their profit performance in what may very well be tough economic conditions.
Where are the opportunities in Asia to address underperformance?
We conducted a simulation that suggests Asia could unlock $440 billion of additional economic profit by lifting about 200 of the region's companies out of the bottom quintile of performers into the middle and boosting an additional 250 companies from the middle of the curve into the top quintile. A further $180 billion could be generated if an additional $3 trillion to $4 trillion were to be allocated to sectors that create value rather than destroy it.
There are many bright spots across Asia. For example, financial services are particularly strong in the region. The top 10% of financial service firms in Asia outperform those in the rest of the world. Overall, Asian financial firms generated $43 billion in economic profit between 2015 and 2017, a stark contrast to the $52 billion loss by financial firms elsewhere in the world.
The imperative here is to embrace digital innovations such as machine learning and artificial intelligence to launch a new wave of productivity growth. For example, Kasikorn Business Technology Group (KBTG) Bank in Thailand leaned on data virtualisation to deliver services in a timelier manner through its mobile app. The digital lending arm of Siam Commercial Bank, Monix, which provides microloans to low-income earners relies on data and analytics to gauge each customer's ability to repay. At the same time, the Bank of Thailand has invested more to better prepare for the massive increase in complex microfinance transactions.
The consumer goods sector also holds much promise. In many product categories, Asia is the world's largest consumer goods market, accounting for 43% of food sales and 47% of apparel sales. Yet, this sector also represents one of the largest gaps in profit performance between large Asian firms and those in the rest of the world -- Asia accounts for only 10% of the profit generated by G5000 consumer goods companies worldwide.
There is clearly an opportunity here, given expectations that the region's middle-class consumers will return to spending once the pandemic subsides -- and consumer goods companies must be prepared when they do. Southeast Asia, for example, is home to some 80 million households in the consuming class and this is on track to double to 163 million by 2030.
At this point, going digital is non-negotiable. The use of e-commerce exploded during Covid-19, alongside delivery services and e-payments. For Thailand, this is not particularly surprising. Even before Covid-19, it had already achieved one of world's highest penetration in mobile commerce.
Covid-19 has changed everything about the way we live and work -- and it will fundamentally alter the performance challenge facing corporate Asia. But the region has coped with adversity before and emerged stronger for it. The Asian financial crisis, for example, hit Thailand hard but the country returned to positive GDP growth within a year or two.
The harsh reality is that Covid-19 could weed out underperforming companies, but it could also enhance the competitiveness of those resilient enough to plot a path through the challenges ahead -- and rise even more prominently on the global stage.
Oliver Tonby is Asia Chairman, McKinsey & Company.