Economic & Business Focus: Seeking New Paths to Profitability

Conditions supporting U.S. businesses' recent profit surge will fade by the end of the year.

There is one big business story this year: the unprecedented rise in profits. U.S. companies are on course to set a new record for profitability in 2004, outstripping last year's windfall. Economic profits rose 18.3 percent in 2003, hit 10.7 percent of GDP and topped $1 trillion for the first time in history. For the first half of 2004, earnings are up another 20 percent to 30 percent in most sectors on revenue gains of less than 10 percent.

The trend extends beyond U.S. borders. Companies in developing markets are showing their best results in years. But the forces behind the surge vary with geography. In the developing world, rapid revenue growth has stoked earnings. In the United States, slower increases in sales have required companies to slash costs.

Domestic efforts to boost earnings have been supported by an uncommon combination of macro-level forces: cheap capital, cheap labor, low taxes, high productivity, a weak dollar, and fairly strong business and consumer spending. The relatively unique coincidence of all of these overwhelmingly favorable conditions cannot last, so CFOs of U.S. businesses must prepare for a less lucrative future.

Cost-Reduction Model

Companies in the United States have pursued down-to-the-bone cost reductions over the past few years as the path to improved profitability, with tangible success. Pitney Bowes Inc., the global provider of mail and document management solutions headquartered in Stamford, Conn., is a prime example. Caught in the slow-growth economy of 2001 and 2002 and hemmed in by a lack of pricing power, the company announced a two-year restructuring program in January 2003 and fought its way back to solid earnings on slim revenue growth. Pitney Bowes' revenues rose just 4 percent, to $4.6 billion, last year, and much of this growth derived from favorable currency translations. But cash from operations rose 7 percent. In the first quarter of 2004, revenues rose slightly, to $1.17 billion, and the company pulled in $275 million in cash from operations, compared with $851 million for all of 2003.