Who Really Profits?

It is a truth universally acknowledged that in a global economy, international operations are a key indicator of a company's strength. It is also universally acknowledged that reliable information on the profitability of these operations is almost impossible for outsiders to obtain.

The Templeton Global Performance Index provides a start. Created by Michael Gestrin, Rory Knight, and Alan Rugman, of Templeton College at Oxford University, the index is an attempt to show just how well multinational companies are doing on their overseas investments.

Using 214 companies from the Fortune Global 500 as its sample, the index ranks a corporation's international profitability by calculating the return on foreign assets and foreign operating profit margins using data obtained from annual reports. (The first rendition of the index, published in 1998, used only the former calculation, creating a bias toward capital-
intensive industries.) Return on foreign assets is calculated as pretax foreign profit divided by foreign assets, while the foreign operating profit margin is calculated as pretax foreign profit divided by foreign revenues.

Unlike other assessments of foreign-subsidiary performance, the index does not include exports from the U.S. base to foreign markets in its analysis. By excluding these exports, the authors argue, they can analyze the profitability of the investment independent of the obvious revenue flow from the home country. They argue that this exclusion is consistent with what most corporations would want to see for themselves. "There's zero international risk associated with an export," says Gestrin, the lead author of the index. "Nobody can expropriate an export, but they can expropriate an investment."

While the index cannot explain why a particular company is performing poorly overseas, and is too simple for strategic discussions at the company level, it does offer a useful tool for analyzing trends, sectors, and geography. Given the limitations of generally available data, the index offers a window into major shifts in global business performance.

Winners And Losers
The most striking finding of the index is that although some companies certainly profit from their international operations, many do not. Seventeen companies in the index achieved rates of return on their foreign assets that were more than double what they earned from their domestic operations. On the other hand, 21 of the 214 companies lost money on their foreign operations in 1998­99. "This is a remarkable percentage when you think about it," says Gestrin. "The index calculates both a one-year and a three-year number [as well as an average of these measurements]. So for these companies, it's a fairly consistent losing record. It could lead to the companies in question becoming targets for takeovers."

Of the top 20 companies in the index, 13 are U.S. multinationals, 3 are British, 3 are Canadian, and 1 is Swiss. Six companies from the 1998 top 20 (Glaxo Wellcome, Coca-Cola, Merck, Microsoft, Dell Computer, and Bristol-Myers Squibb) have maintained their place among the best global performers despite the methodological change. The absence of Asian multinationals and, in particular, Japanese companies, from the top rankings is a trend that has carried over from the first rendition of the index.

A number of companies jumped in the rankings relative to their performance on the first index. Apple Computer Inc., which increased its position from 203 last year to 55 this year, showed the biggest improvement, due in large part to the restructuring program begun in the second quarter of 1996. Toys "R" Us also dramatically improved its foreign performance after its disastrous foray into the European market in the early 1990s, which resulted in the sell-off of 50 international outlets in 1998, mostly in Europe.

Banks make up 6 of the top 10 companies with improved global performance. To a large degree, this is a consequence of the methodological change between the first and second surveys. Banks typically show very low pretax returns on assets, although they earn higher operating profit margins. The inclusion of the latter data in the second index helped improve banks' scores considerably.

A Big Leap
But not all of the improvement by banks is due to the methodological change. For example, Lehman Bros. Holdings increased its foreign operating margins from 11 percent in 1997 to 28 percent in 1999, indicating improvement in its "real" global performance. CFO David Goldfarb attributes the company's overseas success to its strategy. "We developed a strategic plan for the firm years ago, a big part of which was to grow with Europe. So we moved resources of the firm into our European business, especially investment banking and equities." It was a calculated risk that paid off. "What took place, we projected," he says. "Increases in initial public offerings, increases in privatization, and increases in consolidations."

At this point, it would be foolish to use the index to reach any firm conclusions about individual companies. Not enough time has passed to discount the impact of long- term investment strategies or short- term cyclical shocks. Nonetheless, Gestrin has some ideas about why companies may perform poorly in foreign markets. "What you're looking at," says Gestrin, "is the fact that strong core competencies are not guaranteeing international success."

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