America’s Low-Tech Profit Pump Is Wearing Out

August 26, 2013, 11:56 a.m. ET

America’s Low-Tech Profit Pump Is Wearing Out

JUSTIN LAHART

MI-BY101A_CAPEX_G_20130826192705

American companies have spent the past decade investing too little in technology, and they’ve done that for a simple reason: They could get away with it. Now the bill is about to come due. The payoff a company expects when it invests in a piece of tech equipment is that somewhere down the line it won’t have to shell out as much of its sales on paying its workers. If the firm worries that labor costs might shoot higher, it will be minded to invest heavily in labor-saving technology. If, on the other hand, it thinks labor costs will be contained, it will have less of a penchant for tech.Thanks in large part to the rise of China as a low-cost manufacturing center, and then the severe downturn that followed the financial crisis, to say that labor costs have been contained would be an understatement. Workers’ total hourly compensation has risen at an average, inflation-adjusted rate of just 0.6% over the past 10 years, according to the Labor Department. That is less than half the 1.6% rate average over the prior 40 years.

As a result, companies have been paying out far less of their revenue to workers. Labor Department economists calculate that the share of U.S. nonfarm business sales going toward wages, salaries and benefits came to a record low 57.9% in the first quarter of 2012, the last period available. That compared with 62.7% a decade earlier.

The availability of cheap labor has translated into slower investment in technology. The stock of privately held tech equipment and software—which measures companies’ accumulated tech spending less depreciation—was already advancing at a meager pace before the recession hit in late 2007, Commerce Department figures show. Then it slowed some more. Indeed, the 10 years ended 2011 (the last period on record), were the weakest period for tech investment since World War II.

Spending less on both labor and technology is a great recipe for boosting earnings. U.S. corporate profit margins, measured by after-tax earnings as a share of gross domestic income, haven’t been so wide since the mid-1960s.

But boosting profits by simultaneously squeezing workers and keeping a lid on spending isn’t something that companies will be able to sustain. “They’ve kind of eaten their seed corn,” says Bank of America Merrill Lynch economist Ethan Harris.

With Chinese workers getting paid more, China is no longer the force it was for reducing U.S. companies’ labor costs. In 2012, private-sector wages in China rose 17.1%, which came on top of an 18.3% jump in 2011.

Meanwhile, as U.S. job gains continue to whittle away at unemployment, companies will have a harder time expanding their workforces to meet rising demand without offering pay increases. And with the Baby Boom generation crossing over into retirement age and population growth slowing, there may be less slack left in the labor market than companies would like to think.

Given how little companies have been investing in technology, meeting rising demand by boosting the productivity of the workers they’ve currently got would be an even tougher trick to turn. Indeed productivity, as measured by U.S. workers’ output per hour, has over the past three years registered its slimmest gains since the mid-1990s.

So it is likely that in the years ahead, U.S. companies will be shelling out more on labor and technology investment. That signals better times for workers—which helps consumption—and opportunities for companies in the business of developing and building technology. But it could be a very long time before profit margins are so wide again.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: