Discussion PaperBy Chris Bradley, Wonsik Choi, Jeongmin Seong, Ben Stretch, Oliver Tonby, Patti Wang, and Jonathan Woetzel

Corporations in Asia have grown in scale but lag behind the global average on profits, and the Covid-19 crisis poses new challenges.

The Covid-19 crisis is an unprecedented global challenge in the post–World War II period. The pandemic has proven to be not only a public-health crisis but also a major disruption to supply chains, which may permanently change long-standing business practices in the next normal. But Asia has come through crisis periods before and emerged stronger for it—and there is reason to believe it can do so again.

The dynamism, speed, and agility of companies in Asia have given the region resilience, enabling it to achieve macroeconomic stability in a volatile world. Corporations in Asia have grown rapidly and risen to global prominence over the past decade.

However, bigger has not always meant better for economic profit (net of the cost of capital), a measure of value creation and companies’ ability to beat the market. As a group, companies in Asia lag behind their counterparts in the rest of the world.

An external shock of the magnitude of the Covid-19 pandemic may accelerate the widening of the gap between underperforming and outperforming companies.

There are many opportunities for corporations in Asia to build their ability to sustain long-term growth in what will be a more volatile context in the wake of the Covid-19 shock.

Corporations can accelerate digital adoption and thereby unlock productivity, build scale by exploring M&A and continued regionalization, and be bold and agile in the management of portfolios. In addition, business leaders need to manage for multiple time horizons, putting in place plan-ahead teams.

Corporate Asia has added scale; however, it has underperformed in economic profit

Over the past decade, $1 of every $2 in new global investment went to companies in Asia, enabling them to scale up.

Today, they account for 43 percent of the world’s largest companies by revenue. However, growth in scale and revenue has not, overall, translated into higher economic profit.

Globally, returns have fallen because of an abundance of cheap capital. Around the world, economic profits fell, from $726 billion in 2005–07 to a loss of $34 billion in 2015–17. Asia experienced a swing in economic profits from $150 billion to a loss of $207 billion. This was more than half the global deterioration.

Three main factors explain Asia’s declining economic profitability over this period. The largest factor, accounting for 44 percent of the decline, was a cyclical downturn in energy and materials.

One-third of the drop can be attributed to the allocation of capital to value-destroying sectors, particularly in China. The remainder of the decline was because of the underperformance of companies in Asia relative to their global peers.

The performance of individual companies matters

McKinsey research on the power curve (the relative performance of companies in generating economic profit) found that the top and the bottom are pivotal spots for any company to occupy, since those are where most value is created and destroyed. The middle of the curve is the broad flatland where the majority of companies do not create or destroy economic profit.

The research mapped all companies in the Global 5000 (G5000) list on the power curve by country and sector. Overall, Asia is underrepresented at the top—the so-called superstar companies.

Among the top quintile of global companies, only 16 percent are Asian, while 24 percent are North American. Companies in Asia are also overrepresented in the bottom quintile of global companies, making up 24 percent (versus 17 percent in North America). In short, Asia has a higher concentration of companies that destroy economic value and a lower share of companies that create it.

Patterns of strength and weakness depend on individual companies and the sectors in which they operate:

• Superstar companies in Asia outperform in finance. The top 10 percent of financial-service firms in Asia outperform those in the rest of the world. Overall, companies in Asia generated $43 billion in economic profit, in contrast with the $52 billion loss in the rest of the world. The significant economic profit generated by financial-services firms in Asia was achieved despite the fact that the region has only half as many companies in the sector as the rest of the world. China’s four largest banks alone contributed almost half the entire economic profit generated by all financial institutions in Asia.
• Superstar companies in Asia underperform in consumer and knowledge-intensive sectors. The biggest gap in economic-profit performance between large companies in Asia and those in the rest of the world is found in high-value consumer sectors, technology, and pharmaceutical and medical products. Although Asia is well represented in these three sectors in sheer numbers, the top 10 percent of companies in the rest of the world substantially outperform the top 10 percent in Asia, generating three to 20 times more economic profit.
• Energy and materials companies in Asia tend to match the global average in performance. Companies in the energy and materials sector face the challenges of cyclicality and overcapacity globally. Asia’s leaders in this sector perform similarly to their counterparts in the rest of the world. Companies in these sectors in Asia’s emerging economies stand out: they only represent 30 percent of companies in these sectors in the region but generated about half the economic profit created.
• Asia has strong top performers in domestic services and capital goods but a long tail of underperformers. In those sectors, the gap between the top 10 percent of companies in Asia and their peers in the rest of the world is smaller than in other sectors—but Asia also has many underperforming companies. Its bottom 10 percent of companies in capital goods lost $79 billion, 2.2 times more than those in the rest of the world.

Companies in Asia have a track record of resilience

Cyclicality, capital allocation, and underperforming companies may have eroded economic profit in Asia, but the region has proved its resilience in the face of short-term volatility, which could help companies emerge with relative strength from the Covid-19 pandemic.

The nations and companies of Asia have weathered multiple crises and come out stronger once they passed. McKinsey Global Institute (MGI) research on developing economies around the world singled out 18 long-term and recent outperformers, in part for their resilience and consistent growth—and Asia dominates the list.

Even countries in Asia that were hit hard by the financial crisis of 1997–98, such as Indonesia, Malaysia, South Korea, and Thailand, returned to positive per capita GDP growth within a year or two. In contrast, middling and underperforming economies and regions, such as some Latin American countries and Russia, were laid low by events such as external debt shocks, currency fluctuations, and commodity slumps.

Their recoveries were slower, marked by prolonged periods of fiscal instability and high inflation.

Companies in Asia are resilient, in part, because they have to be. They operate in highly dynamic markets that are growing rapidly—all against a backdrop of digital disruption and rapidly evolving consumer demands. Indeed, contested leadership in Asian markets is a vital piece of the puzzle that explains the success of the region’s large companies in outperforming economies and, by extension, the success of the economies themselves.

Today, Asia is being challenged to navigate through the Covid-19 crisis and its economic fallout. The outbreak began in Asia but so have containment strategies and new protocols.

At the time of writing in May 2020, Asia’s response to the Covid-19 pandemic appears to have been relatively successful in reducing transmission and cases of infection in China and South Korea, although peak impact has not yet been reached in India or Southeast Asia. 

In both optimistic and pessimistic scenarios, McKinsey sees China returning to growth faster than the rest of the world.

A shock the magnitude of the current crisis has the potential to change business, society, and the global economic order in multiple ways. In only around two months in early 2020, several well-established supply chains and business practices were completely disrupted.

Some may recover and return broadly to the way they operated before the pandemic; others may have been changed for good. Contactless commerce, for example, could become the permanent norm for consumers.

The pandemic may well be a proving ground that tests whether businesses can become more resilient to shocks, more productive, and better able to deliver to customers.

As Asia’s corporate sector continues to mature, expand internationally, and push ahead with digital innovation, the ability of the region’s companies to adapt to whatever the postpandemic world brings could be enhanced.

Asia could unlock $440 billion to $620 billion in economic profit

The corporate ecosystems operating in Asia today will be tested by the extent of the Covid-19 shock, which could accelerate the destruction of value—but could also offer new opportunities for outperformers to pull further ahead. In order to ascertain how corporate Asia might generate greater economic profit, we explored two levers. Combining the two, companies in Asia could potentially unlock $440 billion to $620 billion in economic profit.

The first lever is improving performance at the company level. More companies in Asia at the bottom of the power curve need to move up, and more need to move into the top quintile or solidify their position in it. In other words, more troubled companies need to turn around, while middle and even top performers need to unleash more of their still-unrealised potential.

If Asia were to match North America’s power-curve distribution, our simulations show that it could boost economic profit by $440 billion—a substantial prize.

But to do so, about 200 companies in Asia would have to move from the bottom to the middle quintiles to create $180 billion in economic profit, and another 250 companies would need to move from the middle quintiles to the top, which would generate $260 billion. That will prove challenging, given Asia’s highly competitive corporate environment.

The second lever is investing in value-creating sectors. The source of capital for that could be net new or it could come from rebalancing away from value-destroying sectors or companies to value generators.

Where companies play matters. Across Asia, capital continues to flow into value-losing sectors. If we assume that Asia matches the capital-allocation mix of North America, that would imply $3 trillion to $4 trillion of capital to be invested in value-creating sectors. It could be net new capital or capital that is shifted from value-losing to value-creating sectors. That could yield additional economic profit of about $180 billion, mostly in IT and in pharmaceutical and medical products.

Simply reallocating capital toward sectors that generate higher economic profit is not sufficient if the companies within them are inefficient.

For example, despite the fact that the consumer sector generates substantial global economic profit globally, reallocating capital to that sector alone would generate only $10 billion in incremental economic profit, since companies in Asia in those industries generate lower economic profit than their Western peers. The entire corporate ecosystem needs to be healthy and sustainable if corporate Asia is to be able to weather current and future shocks effectively.

Companies in Asia can make significant performance improvements in five sectors

Corporate Asia may underperform in measures of economic profit on aggregate. But that should not obscure the many bright spots in various sectors across the region, with resilient, outperforming companies facing an opportunity to define the next normal in a postpandemic world.

A detailed look at five key sectors reveals significant opportunities for companies in Asia to improve performance. To do so, they will need to address some significant performance gaps:

• Pharmaceuticals. Asia is already the second-largest pharmaceutical market in the world, but the region’s pharmaceutical companies have yet to increase their share of global value. Around the world, the pharmaceutical industry generates net positive economic profit in all regions analyzed, combining for a total of $105 billion in 2015–17. However, Asia accounted for only 6 percent of that, suggesting considerable opportunities for improved performance and value creation. Advanced Asian economies and China have the research capabilities to compete with Western incumbents, while companies in emerging Asia, frontier Asia, and China can meet the need for low-cost healthcare delivery in their countries and simultaneously lead globally in digital health solutions.
• Consumer goods. Asia is becoming the world’s center for consumption as rising incomes across the region boost spending power, but it accounts for only 10 percent of the economic profit generated by G5000 consumer-goods companies around the world. Companies can take advantage of rising consumption from an expanding middle class across Asia, scale up through programmatic M&A, build global brands, and extend their reach through digital platforms.
• Energy and materials. Asia accounts for a very large and increasing share of global energy demand, propelling rising scale for large companies in the sector. Companies in Asia account for 43 percent of the G5000 list in energy and materials, up from 35 percent in 2007. However, the commodity supercycle ended, and companies in Asia are feeling the effects of overcapacity. In 2015–17, Asia’s losses in the energy sector were $62 billion (30 percent of global losses in economic profit); in materials, companies in Asia posted economic losses of $50 billion (almost two-thirds of global losses). Nevertheless, companies in Asia can lead the global transition to a cleaner future by strengthening their lead in renewable energy and electrification and by expanding into rapid-growth areas, such as liquefied natural gas.
• Real estate. Between 2015 and 2017, real estate globally posted a loss of $69 billion. Nevertheless, some investors still favor the Asian real-estate sector, which is buoyed by the region’s continuing urbanization. Real-estate companies will, however, need to develop new competencies in managing diverse portfolios and use technology to achieve end-to-end process improvement.
• Banks. Asia has been the world’s largest regional banking market for a decade. The banking sector is likely to continue growing as incomes rise and the middle classes expand. Forward-looking indicators suggest that many banks will be under pressure because of a combination of low growth, thinning margins, potentially higher costs related to risk, and the need for scale efficiencies. Asia’s banks may need to embrace consolidation to add scale and deepen their use of digital technologies.

Corporate Asia needs to position itself for a postpandemic world

There is no question that corporations in Asia will come under more stress. While corporate Asia has been resilient overall, there are huge variations in the performance of individual companies in Asia. They tend to be more capital intensive, with heavier balance sheets, which can be a burden in periods when liquidity is tight and demand shrinks well below its expected trajectory. Companies in Asia will need to address the challenges related to survival in the short term.

Companies in Asia will also need to explore opportunities ahead, building capabilities to sustain long-term growth in a more volatile context. Three priorities stand out:

• Innovation and digitisation: accelerating digital adoption and leveraging technology to unlock productivity. Whether it’s the emergency of digital health solutions, such as telehealth, or unlocking productivity gains through robotics and automation for energy companies, digitisation is a key lever in all sectors. In the context of the Covid-19 pandemic, digital capabilities have proven to be even more critical, and there was an acceleration in digital adoption.
• Scale, scale, scale: exploring M&A opportunities and continued regionalisation. The demand and supply shocks caused by the COVID-19 crisis could facilitate consolidation and restructuring at the global level, potentially creating opportunities for companies in Asia to explore. McKinsey research showed that companies that proved to be resilient during turbulent times tended to have prepared their balance sheets before crises hit and then were more acquisitive once the pressure eased. Those resilient companies tended to shift to M&A and to use their superior cash levels to acquire assets that less well-prepared companies were selling off in order to survive. Overall, resilient companies were about 10 percent more acquisitive than nonresilient companies early in the recovery. In addition to opportunities for M&A, there may be a shift toward regionalization and localization. Previous MGI research anticipated the possibility that the next phase of globalisation could be regionalisation; the Covid-19 pandemic may accelerate that trend.
• Portfolio management: making bold moves and staying agile. Companies in Asia have already proven to excel in dynamically reallocating resources. However, they also need to start diversifying and scaling their portfolios in new ways, especially in response to the Covid-19 crisis.

Companies in Asia will doubtless spend a great deal of time on crisis management, but they also need to look further out, planning how to deal with the challenges ahead in order to tap successfully into the opportunities for long-term growth that are clearly still on offer. All companies could consider taking two steps: launching a plan-ahead team and ensuring that the team works across multiple time horizons.