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On profits

Profit and profit margin are two of the key measures of business. However, should they be important in this time? In classical economics, long-run profit = 0 in an efficient market. Clearly we are not turning towards a classical free market model in any way, shape, or form, but there’s a message in this idea we should pay attention to. While I am likely to be denounced as a socialist, perhaps what the market needs as part of this correction is an expectation of lower profit returns.

Way back in the halcyon days of the 20th century stocks were valued based on the cash that flowed out of them directly to shareholders. In other words, profits were returned to the shareholders regularly. However in recent times the number of stocks that return regularly dividends to shareholders has dropped. Profits are kept within the corporation; used for share buybacks or one-time dividends, investments, a hedge against downturns, empire building or maybe the occasional smart acquisition.

What happens now when the market dips (and let’s remember that there should be no profits in the mythical classic free market) that corporations lay off employees, reduce investments, or otherwise cut costs. Some of this is smart. No one would argue that GM and Ford have severe problems and are going to sell fewer cars in the future. But what about otherwise highly profitable companies?

The TechCrunch Layoff Tracker is littered with profitable and successful companies. Companies like Google, Electronic Arts, Microsoft, Citrix and hundreds more have been laying off hundreds of thousands of employees. I’m not soft-hearted enough to argue that every job needs to be maintained, or that there are underperforming workers that perhaps should have been let go years before. Perhaps the smart companies are the ones that make small cuts of right-sizing or business line closures to avoid the big ones. What I question is when the “market” demands moves to keep profits up. Why should companies expect to preserve historic levels of profitability in a recession? They shouldn’t. Managers and shareholders should ask that question the next time they look to cut their workforce.

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