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Financial Times: The profit paradox. (ExxonMobil must know how Cosa Nostra feels)

By Andrew Hill
Published: June 10 2006 03:00 | Last updated: June 10 2006 03:00

A search for “profit” on the Guinness World Records website returns only one direct reference: the Mafia, the world’s most profitable criminal organisation.
ExxonMobil must know how Cosa Nostra feels. On January 30, the US oil major announced the largest profit in US corporate history – $36.1bn after tax in 2005. With the price of petrol at the pump edging towards $3 a gallon, the results have added fuel to calls for legislation, windfall taxes, a review of merger policy, even the break-up of the oil giants. One of the measures proposed in Congress was a bill making it a criminal offence for petrol refiners, wholesalers and retailers to “price-gouge” – a reference to the old-fashioned gangster practice of extortion.

Re-ordered by profit, the top three companies in the FT500 are oil majors – Exxon, Royal Dutch Shell and BP – and eight make the top 20 (compared with five in the ranking by market capitalisation). Most reported record profits for 2005 on the back of surging crude oil prices, which themselves have touched nominal highs. Most were obliged to go on the defensive.

Yet the strange curse of “record profits” – and the difficulty that companies have in justifying them – is not unique to the oil sector. Most multinationals have learnt to be careful about boasting of their financial success and are finding ways to protect themselves from the sting of criticism.

The biggest sectors in the line of fire – banking, oil, pharmaceuticals – seem to share one characteristic: customers see their products and services as essential but unexciting purchases. Robin West is a former assistant secretary of the interior, responsible for US offshore oil policy in the Reagan administration, and a keen observer of and adviser to the US oil industry. Now chairman of PFC Energy, a Washington-based energy consultancy, he points out: “It isn’t a lot of fun to buy gasoline, and it isn’t a lot of fun to buy medicine. People think of it as a right, not a privilege. Grudge purchases plus high prices is a formula for disaster.”

It is inescapable, however, that grudge purchases also yield high profits for those selling them: 14 of the top 20 FT500 companies by profit are banks, oil companies or pharmaceuticals groups, and the rest include Wal-Mart, Microsoft and General Electric, themselves often lightning rods for public criticism.

In France, record 2005 profits at companies in the CAC 40 – the country’s blue-chip stock index – were a call to arms for students and others protesting against labour reforms this spring. In Britain, though foreigners often marvel at the availability of “free” banking services, highly profitable financial groups regularly come under fire for the fees charged on loans and credit- card balances. In Japan, where the corporate sector has only recently emerged from the economic doldrums, record profits are still mostly taken as a welcome symptom of recovery. Yet by the same token, after years in which record losses were used to justify job cuts, it is hard for some Japanese to stomach “western-style” management that continues to cap costs as profits hit all-time highs.

The annual shareholder meeting of Total – France’s largest company – last month was a good place to see the contradiction of record profits illuminated. Not only is Total a fierce competitor with the other oil majors, it is also both a jewel in the French corporate crown and a target for union and lobby-group ire. France’s consumer association, for instance, has called for a 25bn windfall tax on oil companies. And French politicians, notwithstanding their desire to protect national champions against foreign competition, have shown some sympathy with protests against “excessive” profits.

About 3,000 shareholders nearly filled the Palais des Congres in Paris to celebrate the oil company’s results for 2005 – “by a long way the largest profit realised by a French company”, as Thierry Desmarest, the oil company’s urbane chairman and chief executive, put it. But investors were also there to express publicly their hopes and fears for Total’s position in the world – located somewhere between American-style capitalism and a more nuanced French variety.

“I don’t like the typical Anglo-Saxon way – running companies for profit rather than anything else,” said Fernand Suaudeau, a Total shareholder for the past 10 years. But the backlash against record profits was “ridiculous – a false debate. The French generally don’t like money and they’re jealous of those who have it.”

“In time, the French will understand,” added El-Arbi Moubachir, also a shareholder. “As for political parties, what do they know? [Ex-president Francois] Mitterrand didn’t even know what a share was!”

Could Total be taken over? worried another shareholder. The group’s size (17th in the FT500) made that unlikely, Desmarest responded. “The best defence is to have a good market value and to be extremely profitable – and you see that the profitability of the group is excellent in absolute figures and excellent among oil companies: that’s what allows us to keep the company independent.”

Desmarest’s reply summed up what could be called the Milton Friedman principle of corporate responsibility. He argued in an article in 1970 that the only role of companies was to make money for shareholders. Other benefits – for the state, employees, society as a whole – would flow from that one duty.

But almost since the formation of the first joint-stock company, the profit motive has been tempered by protest, regulation, and political backlash, and companies have recognised the value of paying back some of their gains to society to mitigate those threats. John Micklethwait and Adrian Wooldridge in their 2003 history, The Company, quote Henry Mills, a Unitarian minister, who said the establishment of company towns in the 19th century was prompted by “the sagacity of self-interest” – in other words, it made business sense for companies to provide their workers with a minimum of shelter and education.

Friedman himself wrote in his 1970 article that “in the present climate of opinion, with its widespread aversion to ‘capitalism’, ‘profits’, the ‘soulless corporation’ and so on, [corporate social responsibility] is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest.”

For the largest groups, this judicious corporate selfishness, which used to be focused on individual communities where companies had their factories, has extended across the globe, into areas far beyond the direct housing and feeding of employees. Cross-border mergers and globalisation may mean that profits are reaped from around the world. But protest remains mainly local. Individual “stakeholders”, to use 21st-century corporate-speak, read about and react to record earnings while worrying about the price of petrol at the pump in Minnesota, the fate of metalworkers in Luxembourg, or the fees charged on a loan from their bank in Yorkshire. They need placating.

There is another good reason why highly profitable companies try to offset accusations of profiteering, extortion and monopolistic tendencies with good works: it is much more difficult to get across the message that the bottom line is not the be-all and end-all of corporate performance.

As the British Banking Association puts it: “There is a general perception that the fact that any company makes large profits (not just in banking, but in any other sector) must in some way mean that these are being earned unfairly from the public.”

Christian Pilichowski, in charge of international relations for the Federation des Travailleurs de la Metallurgie, the French metalworkers’ union, says the hunt for ever-higher profits has an “infernal logic”. Even when companies are reporting record results, he says, managers claim that competition is getting more and more severe and press for further cost cuts: “For the moment, there isn’t a single example of a company that’s saying, ‘OK, we’ve made the profit we wanted to, so we’ll distribute a bit more.'”

It may be idealistic to expect companies to hold back. But the corporate scandals of the early part of the decade – in part the consequence of a damaging fixation on short-term profit targets – and subsequent developments in international accounting did seem to offer a route away from the tyranny of short-term profit targeting.

When he worked at Thomson Financial/ First Call, the financial analysis group, Chuck Hill, a former US Naval Reserve commander, earned the soubriquet “the dean of earnings”. As head of research, his views on whether companies were hitting, missing or surpassing Wall Street’s estimates of quarterly earnings were often quoted as the stock market bubble inflated. The focus on such figures arguably helped contribute to a culture of short-termism. Now, having founded his own independent consultancy, Veritas et Lux, Hill is a critic of the quarterly obsession. “The profit numbers are more realistic than they were in the 1990s,” he says. “But I’m dismayed that, given all the moaning and groaning about how the investment community and the media focus on short-term results, the companies aren’t doing more themselves to diminish it.”

“The fact that you have record profits means nothing,” points out Jeffrey Diermeier, a former chief investment officer at UBS Global Asset Management and head of the CFA Institute, which represents investment analysts and the wider investment community. “The message [from companies] should be: ‘We’re very lucky, we’re earning a wonderful profit and we’ll invest that profit right now for the future.'”

That is roughly what Exxon has tried to do. Far from crowing about its 2005 record, Exxon took out advertisements in leading US newspapers on the day of its full-year results in January, pointing out that margins (the profit made on each sale, expressed as a percentage) in other industries such as pharmaceuticals, banking and semiconductors were higher. The ad urged Americans to “take a second look” at the figures. Judging from the tone of popular debate about petrol prices and profiteering, it is doubtful many did.

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