Labor Squeeze: Auto and Airline Deals Drive US Margin Challenges

Recent labor agreements in the auto and airline industries spotlight the profitability conundrum facing US companies—and equity investors.

Pricing power and cost containment are essential ingredients for companies looking to expand profit margins. We’ve seen this clearly in 2023, when some of the best-performing US firms maintained their pricing power amid higher inflation, while boosting profitability on the strength of disciplined expense management.

But recent union labor contracts could upend this balance, making it more difficult for investors seeking consistent growth in a slower economy. As companies face more earnings and margin pressure (Display), we believe that equity investors should pay especially close attention to spending trends and corporate pricing power in 2024.

US Earnings and Profitability Remain Challenged

Tech Firms Doing the Pivot

First, let’s look at two companies that have proactively managed expenses: Microsoft and Amazon. Microsoft’s expansion of its cloud business over the past few years was accompanied by high expense growth. As revenue growth slowed in fiscal 2023, expenses didn’t come down as quickly, and the company experienced a couple of quarters of margin compression. But Microsoft pivoted by prioritizing its spending and putting a lid on expenses—just as revenue growth began to accelerate again. This combination drove operating margins higher over the last couple of quarters.

Amazon has experienced lower margins in both its core retail business and Amazon Web Services unit as capacity expansions ran into slowing revenue growth. Like Microsoft, Amazon eventually clamped down on spending, which helped it expand its operating margins from 2% to 7.8% in the third quarter.

This isn’t to say that cost cutting is easy or that all forms of spending are misguided. Companies must spend and invest to foster growth, but there occasionally needs to be some garden-weeding. Active equity investors must determine which companies do this most effectively.