Who Really Profits?

A new index opens a small window into the profitability of global operations.
Nikos ValanceOctober 1, 2000

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.

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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.”

Gestrin adds that in some cases there is almost a strategic paralysis that takes over once huge resources are committed to a foreign operation. “Thirty years later,” says Gestrin, ” [the company] is still trying to justify the investment on strategic grounds.” In other cases, the fixed costs of the global investment are too huge to just pull out. “In operational terms, it doesn’t matter if the company is bleeding,” explains Gestrin. “It doesn’t make sense to shut down.”

Among the 10 companies registering the biggest declines, half are American multinationals: FedEx, General Motors, Monsanto, McKesson HBOC, and TRW. “That’s not what you’d expect,” says Raymond Mataloni, an economist with the U.S. Department of Commerce’s Bureau of Economic Analysis. Mataloni recently studied the reasons for low rates of return among foreign-owned companies doing business in the United States. He believes that his findings would likely apply to U.S. companies doing business overseas.

“Generally speaking, what we found,” says Mataloni, “is that the higher the market share, the better a company should do. Also, the longer a company has been in a particular market, the better it should be doing.” Mataloni agrees with Gestrin that translating core competencies may have been what hindered GM and TRW’s performances, while Gestrin adds that in the case of the automotive industry, cyclical demand factors may also play a part.

Of the U.S. multinationals, only FedEx accepted an invitation to discuss the index with CFO. And FedEx has a sharply critical view. “This analysis is flawed, misleading, and incompetent,” says Alan Graf, FedEx’s chief financial officer. “It is ludicrous to exclude income to offshore entities that have a U.S. origin. This is a global network, and it has to be analyzed on a total global basis.” Adds FedEx spokesperson Greg Rossiter: “The Templeton Index is a surprisingly superficial way to look at overseas profitability.”

The primary point of contention for FedEx is the exclusion of U.S. exports from foreign operations in the calculation of overseas profitability. Graf further claims that the Templeton analysis of FedEx was done on the basis of a Securities and Exchange Commission­ required tax footnote in the annual report that talks about the pretax income and losses of offshore entities. “FedEx,” says Graf, “does not report the international profit-and-loss segment of its operations publicly. It’s a flawed and misleading analysis because the tax books and the accounting books are different.”

Gestrin acknowledges that although many kinks have been worked out in the methodology, the index is not exact. “It’s still quite difficult to gain a precise picture of a multinational’s foreign operating profits,” he says. “The performance measurements that can be generated with the existing data are primitive.”

Getting To The Numbers

Analysis of foreign operating profits has typically been complicated by two factors. One is the lack of consistent international reporting regulations. The other is the reluctance of companies to provide information too transparently. However, more and more foreign corporations have adopted U.S. reporting standards, the most transparent in the world, mainly in an effort to attract U.S. capital. On the other hand, as some U.S. corporations have globalized, they’ve taken advantage of SEC regulations that require companies to report on a management basis. Some companies have stopped disaggregating and now report on a global management basis. “It’s a double-edged sword,” says Gestrin. “If companies are making money somewhere, they don’t want to raise a flag and say ‘come on in.’ But they do want to report their profitability to stakeholders. Regulators are sensitive to this.”

Despite the company’s contention that its global network should be analyzed on a global basis, FedEx acknowledges that its own data indicates that the company’s international network will be more profitable this fiscal year. Wall Street agrees. “FedEx took a hit on foreign earnings due to the Asian currency crisis,” says Jeffrey Kauffman, an analyst at Merrill Lynch who follows FedEx. “Traffic growth rates slowed, and freight flows changed. It’s a strong company, though, and its foreign revenues will come back soon.” Indeed, Graf also acknowledges that the company suffered start-up losses in Asia as a result of the currency crisis. FedEx intends to further erase the distinction between foreign and domestic profits by reporting global data for the company as a whole.

Can the Index Be Improved?

With companies reporting only in the aggregate, it is unlikely that any index can do much better at capturing real global performance for an individual company. But given a few more iterations, the rankings provided by the Templeton Index should be an increasingly useful benchmark for analysts of global profitability.

Anita McGahan, professor of strategy and management policy at Boston University School of Management, says that the index’s three-year average covers too short a period to correct for the volatility of the business cycle. “The very big companies that lead their industries will often absorb shocks from their industry over time,” she explains. McGahan also suggests that the methodology could be improved by separating out financial services firms from companies in operating industries. “The ratios used to calculate the index have very different meaning in the financial services industries and in operating industries,” she says.


The top 20 companies in the Templeton Global Performance Index.

This Year’s TGPI Rank Previous  Rank Company Industry* Country TGPI Score
1 NA  Nortel Networks  Electronics Canada 45.5
2 2 Glaxo Wellcome Pharmaceuticals Britain 37.6
3 3 Coca- Cola  Beverages United States 32.5
4 16 Merck Pharmaceuticals United States  29.8
5 33 Pfizer Pharmaceuticals  United States 28.5
6 NA Lilly (Eli) Pharmaceuticals  United States 28.2
7 38 Occidental Petroleum Petroleum United States 27.5
8 NA Great Universal Stores  Retail  Britain 27.3
9 51 Novartis Pharmaceuticals Switzerland  27.0
10 23 Cable & Wireless Telecommunications Britain 26.6
11 28 Schlumberger Miscellaneous United States 25.3
12  5 Microsoft  Computers United States 25.0
13 NA Gap Retail United States  24.9
14  151 Lehman Bros. Holdings Banking United States 24.7
15 12 Dell Computer Computers  United States 24.6
16  24 Compaq Computers United States  24.2
17 22 Phillips Petroleum Petroleum United States 23.2
18 NA Bank of Nova Scotia Banking Canada 21.5
19  139 Royal Bank of Canada Banking Canada 21.5
20 11 Bristol-Myers Squibb Pharmaceuticals United States 21.2

*Based on the industry classifications used in the Fortune Global 500 rankings. 

Source: Templeton Global Performance Index


The 10 biggest declines in global performance.

Ranking Company TGPI Score This Year’s Rank Previous Rank Change in Rank
1 Royal Philips Electronics 1.2 177 29 – 148
2 Marks and Spencer  -3.3 209 63 -146
3  Monsanto  1.5 174 41 -133
4 McKesson HBOC 1.9 164 34 -130
5 FDX -0.5  195  75 -120
6 NEC -3.9 211   91 -120
7 General Motors 1.7 172 56  -116
8 TRW 4.8 126  17 -109
9 Veba Group 0.5 189 81 -108
10  BCE 5.6 112 18 -94
Average 0.9 172.9 50.5  – 122.4

Source: Templeton Global Performance Index