The ROI “Problem”

More than once, I’ve been critical of the business model that can be described as “maximizing profit at any cost, particularly when you can foist off as many costs as possible on someone or something else” [like the environment and/or public health].

This is scarcely new in the United States. For almost fifty years, big oil promoted cheap gasoline enhanced by tetraethyl lead, with adverse health impacts, particularly for the children of low income families who lived in cities filled with automotive exhaust. Big tobacco did the same with cigarettes… and still is.

For almost a century and a half, businesses just dumped wastes of all sorts into the nearest waterway, making most of the large rivers little more than toxic sewers. Even now, pesticide run-off from factory farms has created and continues to increase a massive area in the Gulf of Mexico that’s has little or no oxygen and almost no fish of any kind.

Big and small business have attempted to do the same with the minimum wage, keeping it as low as politically possible, and business continues to wonder why millions of people who have any option at all refuse to take many minimum wage jobs, even though it’s statistically and economically impossible to live on that wage in almost any city in the U.S.

But the profit/greed instinct runs strong in the human animal, as does the need to quantify how much more profit your business is making than are your competitors – or how much less, meaning that you have to cut costs to be “competitive.”

The standard measurement tool is ROI [Return on Investment]. The form is simple. Divide the gain from an investment by the amount of the initial investment. The result is ROI.

Right now, U.S. gross corporate profits, net corporate profits, and profit rates (i.e., ROI) are at an all-time high. In three industry sectors – information technology, real estate and financials – the average profit rate is above 20%. In big pharma, a Bentley University study found a gross profit margin of over 70%. But thanks to creative accounting, often high gross profits mysteriously turn into more modest numbers.

The problems involved with using ROI as a metric for business success are close to innumerable. First, how do you isolate/account for outside factors? The state of the national economy has an effect on all businesses. The same is true about state and federal laws and regulations. So does the amount and nature of competition. External economic factors also affect ROI, particularly interest and inflation rates.

Corporate internal factors also affect the return on investment. Have bad managers been replaced by good ones [and are higher salaries required by better management factored into the investment costs] or good ones by those less able?

For all these problems and difficulties, addressed time and time again in industry and scholarly articles over the past several decades, all too many corporations use simplistic or slanted versions of ROI that serve their purpose, either to boast or to show regulators how little profit they make. There are literally scores of articles on different forms of ROI, but in the end it’s all about how to maximize output from inputs and processes to keep costs low and profits high.

All that seems to matter is to meet the minimum regulatory standards, keep wages as low as practicable, products as cheap and shorted-lived as customers will tolerate, dividends or stock prices just high enough to retain investors, while maximizing ROI and upper executive pay.

Seldom does one see a different calculus, such as how can a business remain solvent, produce good products, satisfy customers, and fairly pay its employees and stockholders. It’s far simpler to trot out the single magic term – ROI – as if that explains and justifies everything.

And for U.S. business, that seems to suffice.

14 thoughts on “The ROI “Problem””

  1. R. Hamilton says:

    I think minimum wage has always been wrongheaded; and if people can’t live off of what they’re offered, they need to move, learn new skills, or do without with whatever consequences that implies.

    Employers should NOT be social programs nor instruments of policy; their ONLY job is to stay in business (which requires over time if not EVERY quarter, a profit) preferably without violating the law. The more requirements are levied on them (although SOME but not every ideologue’s environmental and other requirements might be reasonable), the more difficult it is for them to do so, and the less they have left on the off chance they want to either invest or VOLUNTARILY do something oh-so-bighearted.

    That said, if it’s politically impossible to get rid of minimum wage entirely, then it should probably be scaled for local cost of living rather than the same everywhere – and there needs to be a sub-minimum wage for those under 18, presumably still living at home. What one can’t live off of in NYC or LA, one can live off of in at least modest comfort in various places esp. in the south or southwest (excluding southern California!) that are NOT big cities. Twain’s “A Connecticut Yankee In King Arthur’s Court” managed to describe inflation and different costs between cities and rural areas, although the unenlightened Middle-Age audience the title character spoke to didn’t understand at all.

    The needs of big city dwellers are NOT the needs of the rest of the nation. They need the rest of us more than we need them.

    1. Postagoras says:

      Shrug. Once again you respond to Mr. Modesitt’s thoughtful post by trotting out the same old, same old.
      Instead of endlessly repeating your magic solutions, why don’t you try something really hard? How about responding with a suggestion that is politically possible?

      1. R. Hamilton says:

        In one sense we already have regional minimum wages insofar as state or local governments can (and some do) set their own higher than the federal government. Perhaps the federal law should be altered to phase in a change whereby a lower minimum may be passed by a state or locality IF it satisfied a standard cost-of-living formula for that jurisdiction. Done right, nobody would take a cut (that could be a provision of it), but over time, it would allow for the difference between inexpensive and expensive localities.

        But what do think I am, an idea factory? I do NOT want ANY idea that would please leftists unless it would also please libertarians or conservatives or at least centrists. Leftists have nothing to offer except more red tape, more collectivism, less liberty.

        1. Postagoras says:

          Sigh. Yes, you’re not an idea factory. That’s kind of the problem.
          No matter what Mr. Modesitt posts, you respond with the same points, over and over and over and over. The same magic solutions.
          And you make it clear that you aren’t interested in compromise, and you disdain more than half the voters of America.

          I have to ask, why do you bother?

    2. Ryan Jackson says:

      “if people can’t live off of what they’re offered, they need to move, learn new skills, or do without with whatever consequences that implies.”

      Congrats, they’re doing that, and people are losing their mind because places can’t keep open, or have slow business, or no one wants to work for them.

      1. R. Hamilton says:

        The last resorts are not minimum wage or government programs, but private charity or Darwin Awards, either of which accomplish more (improving character, or eliminating public burdens; not to mention having some discretion where finite resources might be best applied; and as inflation demonstrates, even government resources are finite, and there are consequences if that’s ignored; there is NO magic free stuff without consequences) than a government program could.

        Outcomes are not central – we’re not important as individuals except to those who know us personally, or because of our accomplishments. Maximizing the number of unproductive undead (but not living full lives!) at the expense of liberty (not even counting expense in taxes) is not a constructive use of government.

        1. Your stance on the minimum wage is based on the assumption that businesses and employers accurately price the value of workers’ skills and labor, when their interest is not in offering fair compensation, but in keeping wages as low as possible in order to maximize profit. The world and the U.S. have already tried unregulated minimum wages, and they didn’t work all that well for anyone but the business. Seeing as there are a lot more workers than businesses, over time in any society that is not a dictatorship or a commercial oligarchy, the people are going to push for what they believe is their fair share, or at least enough money to live on. From a societal point of view, it actually doesn’t make much sense to pay people who do an honest day’s full time work less than they can live on, because (1) you waste human potential; (2) you get lots of malnourished and ignorant (if not stupid) people, because poor childhood nutrition lowers intelligence and creates poorer health; (3) you create more and more anger that feeds unrest and sometimes results in revolutions (which are costly to everyone); and (4) you eventually lose out to more egalitarian cultures because they more effectively harness human potential.

        2. Ryan Jackson says:

          I am curious. As you stand here posting again and against how nothing is more important than personal freedom. That your personal freedom is more important than the lives of thousands…

          How are you a fan of Mr. Modesitt’s work? It’s not a fun question but I’m genuinely curious. The Protagonists again and again act for the good of the many over the good of the one or themselves.

          Take it a step further and every time law or justice comes up it becomes very apparent the outlook and best results are an even system that’s as fair as it can be but ultimately steps on “personal freedom” in ways every time.

          How can you enjoy reading about heroes who fight for things you find to be anathema?

  2. Corwin says:

    What I don’t understand is this, America is one of the wealthiest nations in the world and can’t afford a decent minimum wage yet here in Australia a much smaller country, we have a minimum wage of over $20 an hour for every job. If we can do it and afford it, why can’t YOU?

    1. Tom says:

      TAXABLE INCOME TAX RATE Australia
      $0 – $18,200 0%
      $18,201 – $37,000 19%
      $37,001 – $80,000 $3,572 plus 32.5%
      $80,001 – $180,000 $20,797plus 37%
      Over $180,000 $54,097plus 45%

      TAXABLE INCOME TAX RATE USA
      $0 – $9,275 10%
      $9,276 – $37,650 15%
      $37,651 – $91,150 25%
      $91,151 – $190,150 28%
      $190,151 – $413,350 33%
      $413,351 – $415, 050 35%
      Over $415,051 39.6%

      Any questions?

      1. Tom says:

        Answer?

        The tax rates in Australia are among the highest in the world. Compared to the US, high earners will be paying far higher rates on much lower incomes. However, compared to the UK, Australia’s tax rates are on par, or slightly lower.

        In Australia it seems that “The report also revealed: Overall job satisfaction: 38% of Australian workers are unsatisfied with their current job. Issues with salary or pay (41%), job security (37%), and uninteresting work (33%) were identified as the main drivers for workplace dissatisfaction.” 2019 Poll.

        In the US its seems that “In 2002, about 12% of respondents said they were very dissatisfied or a little dissatisfied with their work, a figure that barely changed in subsequent surveys through 2018. In 2021, a tad over 16% said they weren’t satisfied—an increase, but not a big one.” 2021 Poll.

        So perhaps if the worker is “happy” they will work at a lower wage! The griping is standard human behavior; just as is the greed.

  3. Corwin says:

    Those tax rates are not quite current, but don’t forget, we don’t have state taxes on top of those as you do in many of the US states. I still don’t understand why America can’t pay a decent living minimum wage while we can. How do our federal tax rates affect what companies pay, especially if they are higher than yours?

    1. Tom says:

      The US minimum wage was designed to create a minimum standard of living to protect the health and well-being of employees. The federal minimum wage is set by the Fair Labor Standards Act (FLSA) (that is the US Congress) and enforced by the U.S. Department of Labor (DOL). Although the federal minimum wage rate is subject to change, it has not increased since 2009.

      Australia’s national minimum wage is set each year by an expert panel of the Fair Work Commission (FWC). The panel receives submissions from a wide range of organisations and conducts research to inform its decisions. Increases to the minimum wage are based on objectives enshrined in law. These refer to different factors, including business competitiveness, employment growth, and the needs of the low paid. There is no specific mention of poverty in the current objectives. Nor is there a fixed relationship with any other measure of living standards.

      The government determines the opportunity for the sovereign citizen to create the level of the quality of their life. The behavior of each party is determined in part by their history and specifically the culture of their society.

      The US could pay more but chooses not to do so.

  4. wayne kernochan says:

    A couple of minor reinforcing points. Very briefly:

    First, in my business experience in the ’80s and ’90s, despite what my business school told me, most (at least non-service) companies were using payback period, not ROI, to determine investments. Compared to ROI, payback period had all the flaws you’ve mentioned plus the additional flaw of overemphasizing minimizing costs as opposed to maximizing profits (or anything else).

    Second, in my view, ROI has a major additional flaw: it only considers typically a 4-5 year period in the future. It does so because (a) ROI uses “discounting” (the notion that a dollar a year from now is worth less than a dollar now), making ROI beyond 4-5 years much smaller, and (b) the fact that many products are superseded by new versions in about that time frame. The flaw is best explained by an example: suppose you chose between two products, one with a smaller ROI over 4-5 years and one containing asbestos with the side effect that after 20 years many of your customers and employees will die. ROI tells you to choose the second option.

    This obviously applies to pollution such as strip mining and carbon emissions due to climate change. The effect of mine tailings on employees’ health (not to mention people downstream) can be and is ignored using ROI.

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