Take community
care facilities, the worst of the bunch with a -7.2% average pretax
margin. This sector includes residential care facilities that also offer
nursing assistance or other health services. Not only is the overhead
overbearing, there's a shortage of nurses worldwide, pushing up wages.
Pricing power is limited, too: In the United States, these facilities
get paid by Medicare and Medicaid, a relatively stingy twosome.
A hodgepodge of support services is next on the loser
list. These struggling outfits do everything from organizing trade shows
and conferences to labeling and wrapping gifts--not exactly quantum
physics. These functions have low barriers to entry and plenty of
competition. Coordinator-types also have to pay out subcontractors,
gobbling what little profit they hope to make. Average margin: -2.6%.
The next three groups also traffic in commodity
products: beverage makers (-2.2%), real estate services (-2.1%), and
bakeries and tortilla makers (-0.9%). Small food manufacturers really
get squeezed in the value chain--trapped between suppliers, with whom
they have little leverage relative to larger players, and massive retail
chains with lots of buying power. "The only people making money in the
food chain are big corporations, because scale is the only driver of
profits in that industry," says James Nolen, finance professor at the
McCombs School of Business at the University of Texas at Austin.
To be fair, these numbers are something of a snapshot,
as the profitability of any industry ebbs and flows, at least somewhat,
with the overall economy. "In [the early 1980s], the U.S. moved from a
retail economy to a service-based economy," says Nolen. "In the late
1990s, [it] moved largely to a knowledge-based economy. You can sell
[those skills] at a higher rate."
But there are other factors at play. Temporary jolts,
such as high fuel costs, a weak U.S. dollar, collapsing real estate
prices and a credit crunch, can turn winners into losers, and visa
versa. Take small banks and credit unions, the tenth most profitable
businesses on our list (margin: 13.6%). Small lenders have been more
insulated from the credit crisis than the big guys, like Citigroup
and Bank of America,
though who knows for how long.
On the other hand, U.S. liquor retailers haven't fared
particularly well--not only because they don't have much pricing power
with distributors, but because the weak dollar means they have to pay a
lot more for imported alcohol these days.
Size matters too--even within the small-company
universe. Tiny shops may not require a lot of overhead, but at some
point--say, around $3 million in revenues--the relative level of
overhead spikes, crimping margins. Generally speaking, economies of
scale don't kick in until a business hits the $10 million in revenue
range, says Nolen.
Business models and industry dynamics matter, but they
aren't everything, says Sara Sarasvathy, associate professor of business
administration at the Darden Business School at the University of
Virginia. She conducted a study of 45 "expert
entrepreneurs"--individuals who have built, and taken public, at least
one company. Her hopeful conclusion: Entrepreneurs who profit in a given
industry can see new opportunities where others can't, and are willing
to bet on them.
"Philosophically, [expert] entrepreneurs don't think
of the world as a given," says Sarasvathy. "They see everything as
transformable."
Maybe--but then, data often speak louder than dreams.
This article first appeared
here.
