The middle 80 percent of firms record near-zero economic profit in aggregate, while the bottom 10 percent destroys as much value as the top 10 percent creates
There is much discussion about “superstar” firms and “superstar effects” in reaction to the rapid growth of very large global companies. This has been accompanied by a growing body of research examining various aspects and drivers of superstar effects in the economy. Yet questions remain, and much of the evidence is still inconclusive as well as incomplete. Our research aims to fill some of the empirical and data gaps, take a global perspective, and examine the issue beyond just firms.
We assess the extent to which a superstar effect can be observed in the global economy in three arenas — firms, sectors and cities — and inspect the dynamics, including churn and changing characteristics, in each of these arenas. We also examine what characteristics, similarities, differences and linkages can be observed across firms, sectors and cities and what economic effects and questions they raise for further research. At the same time, we draw some preliminary implications for leaders.
We find superstars exist not only among firms but among sectors and cities as well, although the trend is most evident among cities and firms. Relative to peers, superstars share several common characteristics. In addition to capturing a greater share of income and pulling away from peers, superstars exhibit relatively higher levels of digitization; greater labor skill and innovation intensity; more connections to global flows of trade, finance and services and more intangible assets than do their peers. Yet there are some variations. We find a higher churn rate among superstar firms compared to cities, indicating higher levels of persistence among superstar cities.
1. We focus on economic profit for firms and extend our analysis to cities and sectors of economic activity
Although a variety of definitions exist, we define superstar to mean a firm, sector, or city that has a substantially greater share of income than peers and is pulling away from those peers over time.
For firms, our metric is economic profit, a measure of a firm’s invested capital multiplied by its return above the cost of capital. We focus on economic profit rather than revenue size, market share or productivity growth because these other metrics have a risk of including firms that are simply large and might not create economic value.
We find that 70 percent of gains in gross value added and gross operating surplus have accrued to establishments in just a handful of sectors over the past 20 years.
For sectors, our metric includes gross value added and gross operating surplus accruing to various types of activities (such as production, sales and services) that cut across business establishments such as factories, laboratories and retail stores. In part, a sector perspective provides an indication of the size of superstar profits in relation to the entire economy — at $3.5 trillion in pretax earnings, superstar firms’ earnings represent 13 to 15 percent of the entire global pool of economic surplus and 22 to 25 percent of all corporate earnings worldwide (Exhibit 1).
For cities, our metric includes GDP and personal income per capita. These measures allow us to discover which economic activities are becoming more valuable over time, where the benefits flow, and what linkages exist, if any, among sector activities and superstar firms and cities.
2. The dynamics of firms
For firms, we analyze nearly 6,000 of the world’s largest public and private firms, each with annual revenues greater than $1 billion, that together make up 65 percent of global corporate pretax earnings. In this group, economic profit is distributed along a power curve, with the top 10 percent of firms capturing 80 percent of economic profit among companies with annual revenues greater than $1 billion. We label companies in this top 10 percent as superstar firms.
The middle 80 percent of firms record near-zero economic profit in aggregate, while the bottom 10 percent destroys as much value as the top 10 percent creates. The top 1 percent by economic profit, the highest economic-value-creating firms in our sample, account for 36 percent of all economic profit for companies with annual revenues greater than $1 billion.
Over the past 20 years, the gap between superstar firms and median firms — and also between the bottom 10 percent of firms and median firms — has widened. Today’s superstar firms have 1.6 times more economic profit on average than superstar firms 20 years ago.
Today’s bottom-decile firms have 1.5 times more economic loss on average than their counterparts 20 years ago, with one-fifth of them (a growing share) unable to generate enough pretax earnings to sustain interest payments on their debt. The growth of economic profit at the top end of the distribution is thus mirrored at the bottom end by growing and increasingly persistent economic losses, suggesting that in addition to firm-specific dynamics, a broader macroeconomic dynamic might be at work.
Superstar firms continue to be displaced from the top 10 percent and the top 1 percent.
Indeed, some firms have risen from the bottom 10 percent to higher deciles — a few all the way to the top 10 percent. In each of the past two decades (corresponding to a business cycle), nearly 50 percent of all superstar firms fell out of the top 10 percent during the business cycle, and when they fell, 40 percent fell to the bottom 10 percent.
The top 1 percent is also contestable, with two-thirds being new entrants to this top rank in the latest cycle. There is also some variation by sector and geography. Superstar firms from emerging economies, for instance, have a higher churn rate of 60 percent compared to 40 percent for firms from developed economies.
Overall, after adjusting for the growth of M&A activity since the 1990s, we find no evidence of an economy-wide reduction in churn over time. In other words, contestability has remained about the same.
Superstar firms are diverse and getting more so over time. They come from all regions and sectors and include global banks and manufacturing companies, long-standing Western consumer brands, and fast-growing US and Chinese tech firms (Exhibit 2 and Exhibit 3).
The sector and geographic diversity of firms in the top 10 percent and the top 1 percent by economic profit is greater today than 20 years ago. The 575 superstar firms in our analysis exhibit widely acknowledged markers of successful firms: they include 315 of the world’s 500 largest firms by market capitalization, 230 of the world’s 500 most valuable brands, 188 of the world’s 500 best employers (as rated by their employees) and 53 of the world’s 100 most innovative companies.
3. The dynamics of sectors
For sectors, we analyze 24 sectors of the global economy that encompass all private-sector business establishments. We find that 70 percent of gains in gross value added and gross operating surplus have accrued to establishments in just a handful of sectors over the past 20 years. This is a contrast to results in previous decades, in which gains were spread over a wider range of sectors.
Fewer fixed capital and labor inputs, more intangible inputs and higher levels of digital adoption and regulatory oversight than other sectors.
While the superstar effect is not as strong for sectors as it is for firms, the superstar sectors over the past 20 years we have identified include financial services, professional services, real estate and two smaller (in gross value added and gross operating surplus terms) but rapidly gaining sectors: the pharmaceuticals and medical-products sector and the internet, media and software sector.
The shift in global surplus to today’s superstar sectors amounted to nearly $3 trillion in 2017 alone across the G-20 countries. As today’s superstar sectors have gained share of gross value added and gross operating surplus globally, other sectors, such as infrastructure, consumer goods and capital goods, have lost share. In addition to global superstar sectors, we identify regional superstar sectors in which the dynamics are more localized. Regional superstar sectors include automobile and machinery production in China, Germany, Japan and South Korea; construction in China, India and the United States; hospitality services in France, Italy, and the United Kingdom and, recently, resource production in Canada and the United States.
Today’s superstar sectors share one or more of the following attributes: fewer fixed capital and labor inputs, more intangible inputs and higher levels of digital adoption and regulatory oversight than other sectors (Exhibit 4). With the exception of real estate, superstar sectors are two to three times more skill intensive than sectors declining in share of income in the G-20 countries are.
In addition, superstar sectors tend to have relatively higher R&D intensity and lower capital and labor intensity than other sectors do. The higher returns in superstar sectors accrue more to corporate surplus rather than labor surplus, flowing to intangible capital, such as software, patents and brands. Although some superstar sectors have stronger multiplier effects on economic growth than declining sectors do, their gains are more geographically concentrated compared to sectors in relative decline. For instance, gains to internet and media activities are captured by just 10 percent of US counties, which account for 90 percent of GDP in that sector.