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08-Aug-2006
Degrees of Competitiveness, from Victor Niederhoffer

One of the key chapters in price theory books such as Price Theory and Applications by Peter Pashigian, is on the pricing policies and resulting profits for companies, which are based on the degree of competition they face, the elasticity of demand for their products, and their durability. One important conclusion is that the more differentiated a product is, and therefore less competition it has to contend with, the greater that company's profit margins. The basic theorem initially being that all firms price where the extra unit of revenue equals the extra cost incurred by the production of one more unit.

Other conclusions are that the lesser the degree of competition, the more inelastic is the region in which the company prices, i.e. demand will be less responsive to any given price increase. Increases in demand for firms that do not face much competition increases their profits in the short run, and may do even more so in the long term when plant size can change to accommodate the extra demand. Cost innovations are also very profitable for such firms.

Since profit margin serves as a proxy for how differentiated a company's products and processes are relative to its competitors, I thought it might be helpful to have a list of companies classified by profit margins. Note that the high profit margin companies all tend to trade at a much higher p/e than other companies, however, the basic economic model shows that companies that face many competitors will have their profits reduced to the point of the risk free return -- so this is to be expected. Any studies on profit margins versus stock market return would be interesting.

Thanks to Mr. Dude Pomada, who is soon to tie the knot, for the following calculations.

Here are the Dow 30 companies, based on the previous 12 months both operating margin & profit margin, sorted by profit margin:

DOW30    Oper Margin    Profit Margin
MSFT        37.20         28.45
INTC        31.46         22.31
KO          26.13         21.09
MRK         27.51         21.04
JNJ         26.47         20.61
C           24.46         20.44
PFE         29.90         15.76
AXP         18.68         15.39
MO          25.14         15.14
MMM         23.66         15.11
PG          19.42         12.73
MCD         19.52         12.72
GE          15.07         11.05
XOM         14.93         11.01
T           14.06         10.91
JPM         19.40         10.62
VZ          19.02          9.85
AIG         20.82          9.62
IBM         10.29          8.71
DIS         12.86          7.93
CAT         10.41          7.85
DD           8.07          7.71
UTX         12.13          7.18
HD          11.49          7.16
HON          8.97          5.98
AA           8.15          4.71
BA           4.02          4.69
WMT          4.90          3.59
HPQ          5.72          2.77
GM          -7.30         -5.49