Simple Mathematical Laws Govern Corporate Financial Behavior: A Brief Compilation of Profits-Revenues Data

Some Examples of Corporate Financial Behavior
A Brief Analysis of some 2012 Fortune 500 companies based on simple mathematical laws describing the financial world
1. Summary
The main purpose of this document is to provide an ongoing analysis of the profits and revenues data for various companies, operating in different sectors of the economy, in different countries, under different tax laws, under different social, political, and economic climates, to show that, nonetheless, simple mathematical laws describe the behavior of all companies worldwide. This is due the same type of statistical averaging process that takes place at the microscopic level, in the world of physics, but which, nonetheless, leads to simple, testable, mathematical laws at the macroscopic level.
For example, the classical breakeven analysis for the profitability of a company, making and selling N units of a product, implies a simple linear law, y = hx + c, relating revenues x and profits y. Indeed, three types of linear behavior, called Type I, Type II, and Type III are observed in the real world. A company exhibits Type I (h > 0, c < 0) or Type II (h > 0, c > 0) behavior if profits increase with increasing revenues. It exhibits Type III behavior (h < 0, c > 0), if profits decrease with increasing revenues (or if profits increase with decreasing revenues, yes, some
Page 1 of 63
companies seem to do it). Transitions from Type I to Type II to Type III behavior are seen with several companies studied. A more complex behavior is the nonlinear power law or the power-exponential law. Type III behavior usually seems to be accompanied by the appearance of a maximum point on the profits-revenues graph. Type III behavior, and the appearance of the maximum point, in particular, call for URGENT action. Ford Motor Company, Verizon Communications, Yahoo and Kroger are four examples (revealed to date in this study) of companies which appear prominently in the Fortune 500 list that reveal this maximum point (dubbed Mount Profit). Another small company, currently ranked number 2 in the Fortune Small Business 100, also reveals the Type III behavior. Yahoo exhibits an interesting variant of the Type III behavior (profits increasing with decreasing revenues) and is operating past its maximum point. Ford Motor Company, the biggest of them all, is also operating past the maximum point. The methods of financial data analysis advocated here have served the physical and engineering sciences very well over the centuries. The times may be ripe to extend them to business, economics, and management sciences. The quest to understand the appearance of a maximum point in the blackbody radiation spectrum changed physics forever. Now, we must try to understand the maximum point in the profits-revenues curve whose existence is as yet largely UNKNOWN! Finally, as we will see, the financial data for each company studied here, all of which appear in the Fortune 500 list for 2012, tells a little story. If we can understand this story, we can also understand how to turn the company into a profitable one and get its Profits Engine all revved up. Revenues Costs
Thermodynamics
Profits
From an understanding of Heat Engines to an understanding of Profits Engines

Page 2 of 63
Table of Contents
Topic No. Topic Page No.
Summary 1 1 Introduction 4 2 Hewlett Packard, HP 8 3 Verizon Communications 11 4 International Business Machines, IBM 14 5 Microsoft 17 6 Yahoo! 24 7 Delta Air Lines 28 8 Apple 33 9 Kroger 37 10 PepsiCo 41 11 Coke vs Pepsi 45 12 Procter & Gamble: The Perfect Type I Company 52 13 Lessons learned and Conclusions 53 14 Companies make decisions based on so-called market forces. These decisions affect many lives in a very significant way. It is to be hoped that the analysis presented here will help management see the BIG PICTURE and improve strategic decision making. The following is the simplest explanation for what we observe when we study the financial data for various companies. Revenues, R = pN where p is unit price and N is the number of units sold Costs = Fixed Costs + Variable costs = a + bN Profits, P = Revenues Costs = (p b) N a = [(p b)/p] R a Thus, the classical breakeven analysis for a company making and selling N units of a single product, implies a linear law relating revenues x and profits y. y = hx + c where, Slope h = (p b)/p = 1 (b/p) : Unit price b and variable cost b Intercept c = - a : Fixed cost Of course, nonlinearity is also observed and this gives rise to the maximum point on the profits-revenues graph as shown here for four companies.
Page 3 of 63
2. Introduction
We can think of money in economics as being just like energy in physics. Hence, the power-exponential law, see equation 1 below, with x being revenues and y being profits, may be thought of as a generalization of Plancks blackbody radiation law that can be extended from physics to economics with a simple reinterpretation of the meaning of the various mathematical symbols. y = mxn [ e-ax/(1 + be-ax) ] + c (1)
This law with (c = 0 and b = - 1) was first derived by Max Planck in a paper presented to the German Physical Society in December 1900 paper (and published in January 1901). Planck, who had despised statistical and probabilistic arguments all of his professional life (since this line of reasoning, first advanced by James Clerk Maxwell, with his famous creature called the Maxwells demon, leads to a potential violation of the second law of thermodynamics at a microscopic level), finally, and in an act of desperation, as he puts it, decides to uses some rather simple and straightforward statistical arguments (from the elementary theory of permutations and combinations) to derive the above law. This law can, therefore, be readily extended beyond physics to economics and the financial world using the same statistical arguments, if we invoke the analogy of energy in physics = money in economics. This can be appreciated if one studies the example given by Boltzmann, in a paper published in 1877, where he shows how to distribute a fixed amount of energy between seven different molecules. This is also the starting point for Max Planck when he developed quantum physics in 1900. The many different ways (W) of distributing a fixed amount of energy (among many molecules of a gas, for example) gives rise to what is known as entropy S. The formula relating S and W is S = k ln W where the proportionality constant k is now called the Boltzmann constant. Instead of energy distribution, we can use the exact same example given by Boltzmann to understand distribution of money (or revenues) between N different people (in a social context), or N different products of a company, and so on (in the financial, or economic context). http://www.scribd.com/doc/95728457/What-is-Entropy
Page 4 of 63
Plancks blackbody radiation law, i.e., equation 1 above, was derived using the general formula for entropy S and the energy distribution (P units among N entities) given in this 1877 paper by Boltzmann. This is, perhaps, the simplest explanation that can be advanced for extending Plancks law from physics to economics and beyond. Consider now the following, even more simple, argument. In his famous 1905 paper (which fetched him the Nobel Prize), Einstein starts with a simpler version of Plancks law (with b = 0) to explain certain puzzling aspects of the photoelectric effect that were not fully understood 100 years ago (see Neuenschwander at http://www.spsnational.org/radiations/2004/elegant_connections_f04.pdf also http://web.ihep.su/dbserv/compas/src/einstein05/eng.pdf ). Einstein first re-derives the expression for the entropy of light. This expression for the entropy is then used to show that light can be thought of as being made up of imperceptibly small particles (now called photons), each having a fixed energy hf where f is the frequency of light and h is a constant, now called the Planck constant. Hence, when light falls on the surface of a metal, the photon transfers some of its energy to the metal and knocks out an electron from within it surface. The maximum kinetic energy K of the electron is given by K = (hf W) where W is the energy that must be expended to eject the electron. The photoelectric law is a simple linear y = hx + c, which is a special case of equation 1 above. The graph of K versus f is a straight line with a slope h and an intercept c = - W. The photoelectric law is also very similar to the law Profits = (Revenues Costs) that describes the behavior of the financial world. Not all of the revenues appears as profits. Some of it must be given up. Only a small part of the total energy of a photon, hf, appears as the energy of the electron, K. Likewise, only a small part of the revenues appears as the profits. Just like K depends on the nature of the metal, specifically the work function W, the profits produced depends on the nature of the company, specifically its cost structure. Indeed, the linear law, y = hx + c, relating profits y and revenues x may be shown to be a consequence of the classical break even analysis for profitability of a company and has been discussed in earlier articles. Imagine a company producing and selling N units of a product. If a is the fixed and b the unit variable cost, the total cost C = a + bN is the sum of the fixed cost
Page 5 of 63
and the total variable cost bN. If p is the unit price, the total revenues R = pN. Hence, the profits P = R C = pN a bN = (p b)N a. Eliminating N = R/p, we get, P = [(p b)/p]R a which implies a simple linear relation between profits P and revenues R. Unfortunately, it appears that the wider implications of this law have not yet been appreciated. Several types of companies that follow three types of linear laws (depending on the relative values of h and c, positive or negative) and nonlinear laws (depending on the numerical value of the index n, which may less than or greater than unity, n < 1 or n > 1), can be conceived based on equation 1 above. The most dramatic idea, however, is the maximum point on the graph of profits versus revenues, implied by equation 1. This maximum point has now been observed in the graph of profits versus revenues for Ford Motor Company for the years 1990-2011. Further details may be found in the documents listed below. 1. http://www.scribd.com/doc/94325593/The-Future-of-Facebook-I The Future of Facebook, Published May 21, 2012. 2. http://www.scribd.com/doc/94647467/Three-Types-of-Companies-FromQuantum-Physics-to-Economics Three Types of Companies: From Quantum Physics to Economics, Published May 24, 2012. 3. http://www.scribd.com/doc/95140101/Ford-Motor-Company-Data-RevealsMount-Profit Maximum point on profits-revenue curve revealed by Ford Motor Company, Published May 29, 2012. 4. http://www.scribd.com/doc/95329905/Planck-s-Blackbody-Radiation-LawRederived-for-more-General-Case Published May 30, 2012. The main purpose of this document, which will be frequently updated, is to show that the simple linear relation between profits and revenues holds when we consider the behavior of various companies from the real world, from many different sectors of the economy. In what follows, we will begin with a tabulation of the profits and revenues, obtained from publicly available financial data (with a logo of each company) and follow it with the x-y plot(s) of profits versus revenues to illustrate the simple mathematical laws that apply, regardless of the many different complexities that seemingly govern corporate behavior. The same complexities also apply in the
Page 6 of 63
physical world as well. As discussed by physicists, when the kinetic theory of gases was first conceived (by Rudolf Clausius, in the mid 1800s, and then greatly extended by James Clerk Maxwell and Ludwig Boltzmann in the latter part of the 19th century), there are zillions of microscopically small particles within a gas, moving chaotically in all directions, colliding with each other and with the walls of the container (and obeying Newtons laws of motion, sometimes even relativistic arguments have been advanced for very high velocity molecules). At any given instant, the particles are moving at many different velocities. Nonetheless, there is a statistical averaging process that describes the velocity (and hence the kinetic energy, or more generally just energy, distribution). The Maxwell-Boltzmann velocity distribution, which gives the number of particles with a given velocity v, is also a special case of the mathematical law given above as equation 1. The maximum point on the velocity distribution curve gives the most probable state. The average energy is usually less than this most probable energy. Likewise, using the analogy between energy and money proposed here, we can begin to make progress to understand the chaos or the entropy that seems to govern the financial world and the economy as a whole. The arguments are really quite simple and have been discussed in some detail in the references cited above. We will now consider some of the leading companies in the annual Fortune 500 list to illustrate the three basic types of companies by considering the annual profits-revenues behavior. The following link gives the Fortune 500 list for 2012. http://money.cnn.com/magazines/fortune/fortune500/2012/full_list/ A quick listing of companies (to date) showing the different types of behavior predicted theoretically using the mathematical law given by equation 1 above. Linear law Type I: HP, Verizon, IBM, Microsoft, Yahoo! Delta, Apple, Kroger Linear law: Type II: Microsoft, PepsiCo, Coca Cola Linear law: Type III: Verizon, Yahoo! (two types) Maximum point on Profits-Revenue curve: Ford, Verizon, Yahoo, Kroger
Page 7 of 63
3.
Rank 10 in Fortune 500 List published in 2012
Investor Relations > Financial Information
Fundamentals - Annual Income Statement

http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irol-fundIncomeA Year Revenues, x $, millions 39,330 42,371 45,226 48,870 56,588 73,061 79,905 86,696 91,658 104,286 114,552 118,364 126,033 127,245 Profits, y $, millions 2,678 3,104 624 3,561 -903 2,539 3,497 2,398 6,198 7,264 7,660 8,329 8,761 7,074 Profit margin, y/x
1998 1999 2001 2000 2002 2003 2004 2005 2006 2007 2009 2008 2010 2011
0.068 0.073 0.014 0.073 -0.016 0.035 0.044 0.028 0.068 0.070 0.067 0.070 0.070 0.056
The x-y graph for HP, see Figure 1, reveals a simple linear trend, with profits increasing as revenues increase. Of course, there is a lot of scatter in the graph but the upward trend is unmistakable. Notice also the best-fit line (deduced using classical linear regression analysis), obviously does NOT pass through the origin of the (x, y) plot here but makes a finite positive intercept on the revenues (x) axis. In other words, revenues must exceed a certain minimum value before the company can report a profit. This is called Type I behavior, see Ref. [2] above. Many companies exhibit this Type I behavior (for example ExxonMobil, which heads the Fortune 500 list, discussed in Ref. [2].) However, as companies grow and mature, this Type I behavior gives way to Type II and eventually Type III behavior. The maximum point on the graph of profits versus revenues revealed for
Page 8 of 63
Ford Motor Company represents this transition from Type I to Type II to Type III behavior.
12,000 10,000
Profits, y [$, millions]
8,000
6,000 4,000 2,000 0
x0
-2,000 0 25,000 50,000 75,000 100,000 125,000 150,000
Revenues, x [$, millions] Figure 1: The Profits-Revenues graph for Hewlett Packard (1998-2011) revealing Type I behavior, y = hx + c =h(x x0) with x0 = - c/h, with x0 > 0 and c < 0. The equation of the best-fit line y =0.079x 2075.35. The constant h = 0.079 is the marginal rate of increase of profits (MRP) and is similar to the marginal tax rate in tax law. A fixed increase in the taxable income always leads to the same fixed increase in the taxes owed. Likewise, it appears that a fixed increase in revenues always yields the same fixed increase in profits. The constant value of h 0.08 is also supported if we consider individual (x, y) pairs such as the 2007 and 2008 data which yields h = 0.076, or the 2006 and 2010 data, which yields, h = 0.07. The earlier data, for 1998 and 2000, yields h = 0.093 and suggests, perhaps, an increase in costs as revenues have increased over the last decade. Hopefully, companies, like HP in this example, will be able to draw and benefit from such lessons that can be gained from such as analysis of the profits-revenues data.
Page 9 of 63
Leo Apothekar, President and CEO HP Annual Report 2010

For the year we delivered:
Net revenue of $126 billion, up 10% year-over-year. GAAP Operating Profits of $11.5 billion, up 13% yearover-year.
Notice that revenues have grown steadily and more than doubles since 1998, the first year for which data has been compiled here. The revenues were nearly $40 billion in 1998 and had more than doubled to $86.7 billion in 2005 (eight year period) and have continued to grow since then. The revenues were nearly 50% higher in 2011 compared to 2005. Profits have nearly tripled between 2005 and 2011. But, in the earlier period, from 1998 to 2005, profits did not register the same behavior although the general trend of increasing revenues with increasing profits is revealed by the x-y graph. The simple analysis here actually reveals the importance of the nonzero intercept c, which is related to the fixed costs of operation. Hence, the familiar profit margin y/x used to analyze corporate performance is essentially a misleading one. If the law relating profits and revenues is y = hx + c, the profit margin y/x = h + (c/x) can either increase or decrease in unpredictable ways depending on the nonzero c, or the fixed costs. The slope h, or the marginal rate of increase of profits (MRP) is a much better indicator of corporate profitability and performance. For HP, only about 8% of the increase in revenues, on the average, appears as profits, i.e., h is quite low. Like the work function W in Einsteins photoelectric equation, each photon of energy hf is only able to produce an electron with the kinetic energy K since an amount W must be given up. Likewise, for HP, for every $1 billion increase in the revenues, about $920 million must be given up and only $80 million appears as profits. Only a reduction in the work function (which is related to its cost structure) for HP will yield a long term increase in profitability and increase in the slope h (or MRP); see example of IBM, Fig. 4.
Page 10 of 63
4. Verizon Communications Inc. Fortune 500 List, Rank 15 in 2012

http://www.gurufocus.com/financials.php?symbol=VZ http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/2773.html The second-largest U.S. telecommunications group saw profits buoyed by surging smartphone sales, but its success last year
Year 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002
Revenues, x $, millions 110,875 106,565 107,808 97,354 93,469 88,144 75,112 71,283 67,752 67,625
Profits, y $, millions 2,404 2,549 3,651 6,428 5,510 5,480 7,397 7,261 3,509 4,575
Profit margin, y/x 0.022 0.024 0.034 0.066 0.059 0.062 0.098 0.102 0.052 0.068
Comments Type III Behavior from 2008 to 2011
Type I Behavior 2002-2004
The most striking and noticeable trend, and unfortunately not a very pleasant one, is the consistent decrease in the profits, between 2008 to 2011, with a significant increase in the revenues. Revenues, x, increased from $97.35 billion in 2008 to $110.9 billion in 2011 but profits, y, decreased from $6.43 billion in 2008 to $2.4 billion in 2011. This has been called the Type III behavior (see Ref. [2]) and has also been observed in some other cases of profitable companies, most notably Universal Insurance Holdings, Inc. (Rank 2 in the recent Fortune Small Business FSB 100 List) and also Ford Motor Company. This has been discussed in Refs. [2] and [3] above and is also observed here with Verizon, Figure 2.
Page 11 of 63
A TRUER CONNECTION
Lowell McAdam Chairman and Chief Executive Officer Verizon Communications We see expanding opportunities to build truer connections with our customers and communities by using our unique platforms to meet crucial needs across America and the world. Verizon will create new and more effective products, solutions and processes that will make us an even more valuable partner to our customers, communities and shareowners.
10.0
9.0 8.0
Profits, y [$, billions]
7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 80 85 90 95 100 105 110 115 120
Revenues, x [$, billions] Figure 2: Type III behavior revealed by the profits-revenues data for Verizon Communication, Inc. for 2008-2011. The arrow indicates the direction of time. The straight line connecting the (x, y) pairs for the years 2008 and 2011 has the
Page 12 of 63
equation y = -0.296x + 35.23 where revenues x and profits y are in billions. Slope h = (y2 y1)/(x2 x1) = (2.4 3.7)/(110.9 107.8) = - 0.296. Once slope h is determined, the intercept c = 35.23 is obtained from y1 = hx1 + c = y2 = hx2 + c. Type III behavior usually suggests that the company has gone past the maximum point on its profits-revenues curve and is now operating to the right of the curve, in the region where profits decrease with increasing revenues. This was also suspected with Ford Motor Company when recent data revealed a Type III behavior. The existence of the maximum point on the profits-revenues graph was then later confirmed by considering data for earlier years, from 1990-2011. We see the same trend here with Verizon Communications. Verizon must take immediate steps to address its costs structure responsible for this Type III behavior and the appearance of the maximum point, see Figure 3.
10 9 8
7 6 5 4 3 2 1 0 0 20 40 60 80 100 120 140 160
Revenues, x [$, billions] Figure 3: The profits-revenues graph for Verizon Communications, Inc., for the ten year period 2002-2011, reveals what appears to be a sharp maximum point. The Type III behavior, i.e., decreasing profits with increasing revenues is also revealed if we consider the (x, y) pairs for the years 2010, 2007, 2006, 2005. The company
Page 13 of 63
changes from Type I behavior, i.e., increasing profits with increasing revenues (2002-2004), to Type III behavior within an extremely narrow range of revenues. The appearance of a maximum point on the profits-revenues graph, and/or the Type III behavior, even with a company reporting profits, is not necessarily healthy and suggests the need to address the underlying costs structures that lead to this behavior. As with Ford Motor Company, Verizon Communications has also been struggling over the last few years to maintain profitability in the face of increasingly tough competition. The simple approach to financial data analysis outlined here helps identify the fundamental issues that must be addressed by a company to enhance its profitability. Verizon will soon start reporting losses, with increasing revenues, if the present trends continue and deeper issues associated with revenue enhancement methods are not addressed.
Page 14 of 63
5. FORTUNE 500 List: Rank 19 in 2012
International Business Machines

ftp://public.dhe.ibm.com/annualreport/2005/2005_ibm_annual.pdf http://www.ibm.com/annualreport/ http://www.ibm.com/investor/financials/ http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/225.html Virginia M. Rometty, President and CEO
The only IBM CEO not yet invited to become a member of the Augusta National Golf Club, in Augusta, Georgia. (The club has a male only membership policy. IBM has been a corporate sponsor for all major Augusta golf events. Hence, in the past, all IBM CEOs, were automatically invited to join the club. )
I am pleased to report that IBM had another strong year in 2011. Your company continued to outperform our industry and the market at large. We capped IBMs first century by achieving record revenue, profit, free cash flow and earnings per share. At the same time, we continued to deliver superior returns to you, and we are well positioned for future growth in a globally integrating economy. Revenue and income: Our revenue in 2011 was $107 billion, up 7 percent. We grew operating pre-tax income by 9 percent, to $21.6 billion, our highest ever. Margins: IBMs operating pre-tax income margin rose for the ninth consecutive yearto 20.2 percent, up 10 points since 2000. We achieved this by continuing to shift our business mix to more profitable segments and by driving productivity. More than 90 percent of our segment profit in 2011 was from software, services and financing. Earnings per share: We have continued to achieve strong EPS growth. Last year was another record, with diluted operating earnings per share of $13.44, up 15 percent. This marked nine straight years of double-digit EPS growth.
Page 15 of 63
30 25
20 15 10 5 0 -5 -10 0 20 40 60 80 100 120 140 160
x0
Revenues, x [$, billions] Figure 4: The profits-revenues graph for IBM for the years 2001-2011. A nice Type I behavior, with the best-fit equation, y = 0.474x 32.46 = 0.474 (x x0) where x and y are in billions, is evident here. The solid dot represents the cut-off revenues (related to the fixed costs, x0 = $72.5 billion) below which IBM will report a loss. Once revenues exceed this cut-off value, profits increase rapidly, as revealed by the high value of slope h = 0.474. This means that 47.4% of the additional revenues (above the cut-off) are converted into profits. Can IBM further improve its profitability? Yes, by increasing the slope h even further and by decreasing the cut-off revenue x0 = $72.5 billion to a much lower value.
Notice the emphasis on Profits, Revenues, and EPS in the Letter from the President and the CEO, in the Annual Reports. Hence also our focus here on developing a full and complete understanding of the fundamental mathematical law(s) relating profits and revenues for any company.
Page 16 of 63
6. FORTUNE 500 List for 2012
Rank 37. Microsoft
http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/3063.html http://money.cnn.com/quote/financials/financials.html?symb=MSFT http://investing.money.msn.com/investments/stock-incomestatement/?symbol=MSFT http://www.microsoft.com/investor/reports/ar99/highlights.htm http://www.microsoft.com/investor/reports/ar02/financials/item8_income.htm Revenues, x $, billions 69.94 62.5 60.4 58.44 57.6 51.12 44.28 39.79 36.84 32.19 28.37 25.296 22.956 19.747 15.262 11.936 9.05 6.075 Profits, y $, billions 23.15 18.8 17.7 14.6 14.6 14.07 12.6 12.25 8.17 7.53 7.829 7.346 9.421 7.785 4.49 3.454 2.195 1.453 Profit Margin, y/x 0.331 0.301 0.253 0.250 0.293 0.275 0.285 0.308 0.222 0.234 0.276 0.290 0.410 0.394 0.294 0.289 0.243 0.239 Shares diluted, billions 8.5 8.8 8.9 8.9 9.3 9.74
Year 2011 2010 2008 2009 2009 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995
EPS $2.69 $2.10 $1.62 $1.62 $1.87 $1.44
Page 17 of 63
As seen from the tabulated profits-revenues data, both profits and revenues have increased steadily for Microsoft with the profit margin varying between a low of 22.2% in 2004 to a high of 33.1% in 2011. However, as we will see shortly, the graphical representation of the same data provides additional insights that are NOT readily revealed with the tabular form of the data, or the ratio analysis, specifically the determination of the profit margin and the EPS. Notice also the increasing values of the EPS for the period 2007-2011. Although earning (i.e., profits) increased during this period, contributing to the increase in the EPS, the number of outstanding shares also decreased significantly during the same period. This also contributed to the increasing EPS. This is often overlooked. A graphical representation of the earnings versus shares is therefore required to fully understand the increasing EPS values. In most cases, however, the number of shares does NOT vary significantly. Hence, one is essentially relying on the absolute increase in profits (earnings), not just the profit margins, to increase EPS.
30.00
25.00
Earnings (Profits), y $, billions
20.00
15.00
10.00
5.00
0.00 8.00
8.50
9.00
9.50
10.00
10.50
Number of shares, x [billions]

Figure 5a: Just as the profit margin is the ratio of profits to revenues, the EPS is also a simple ratio. Hence, EPS increases with
Page 18 of 63
increase in earnings (i.e., profits). It will also increase if the number of outstanding shares decreases. This trend is revealed by the dashed straight line with the negative slope. The EPS is the slope of the ray(see Figure 5b) joining any point on such a straight line back to the origin (0, 0). The origin (0,0) is, of course, outside this graph which is draw to a greatly expanded scale. As we move down the dashed line (to increasing shares), the EPS will decrease because of a decrease in earnings and also because of the increase in shares. Conversely, moving up the line, as in the case of Microsoft between 2007 and 2011, with decreasing shares and increasing earnings, increases the EPS.
35.00
30.00 25.00 20.00 15.00 10.00 5.00 0.00 0 1 2 3 4 5 6 7 8 9 10 11 12 13
Earnings, E [$, billions]
Slope of the ray (dashed line) joining the point (S, E) to (0, 0) equals EPS = E/S = 23.15/8.5 = $2.72
Number of shares, S [$, billions]

Figure 5b: The slope of the ray joining the point with coordinates (S, E) on this diagram equals the EPS. Since a higher EPS is desirable from a financial performance standpoint, increases in the EPS rely primarily on the increase in the earnings (i.e., the absolute level of profits) since the number of shares does not usually change very significantly. In the case of Microsoft, the number of shares decreased along with
Page 19 of 63
the increase in earnings thus increasing the EPS even more. The three (S, E) points for 2009, 2010, and 2011, actually lie on a straight line with a negative slope as seen here. Hence, the rate of increase of earnings with decreasing shares is essentially constant. 40.00 35.00
Profits, x [$, billions]
30.00 25.00 20.00 15.00 10.00 5.00 0.00 -5.00 -10.00
y = 0.51x 2.28 = 0.51 (x 4.48)
y = 0.693x 25.3 = 0.693 (x 36.52)
10
20
30
40
50
60
70
80
90
100
Revenues, x [$, billions]

Figure 6: The profits-revenue graph for Microsoft for the period 1995-2011. Revenues have increased more than ten-fold during this period and profits have increased both nearly a factor of 12. Nonetheless, although both revenues and profits increased, there was a period of adjustment, from 2000 to 2007, when revenues increased with only modest increase in the profits, before the rapid rate of increase in profits began once again starting 2008. The upward sloping dashed straight line reveals the trend from 1995-2000 and the solid line the more recent trend. It is clear now that the familiar profit margin, the ratio y/x, provides a rather poor description of these very significant historical trends.
Page 20 of 63
Perhaps, even more significant are the conclusions that can be deduced from the simple mathematical equations for the two linear trends. These equations say it with numbers and were deduced by considering only two (x, y) pairs those for 1999 and 2000 for the earlier period - and those for 2009 and 2011- for the recent period. Both these straight lines capture the trend for the respective periods very nicely. (Hence, there is not much to be gained, for example, by considering a rigorous linear regression for these two periods.) Since the slope h is positive and the intercept c is negative, it follows that Microsoft exhibits Type I behavior during both these periods. However, there was a very large change in the value of the intercept c, which became significantly more negative, due to the post-2000 period of adjustment, which lasted for several years. In other words, the fixed costs have increased significantly for Microsoft although it is now operating on a straight line with a steeper slope. The current operating slope h = 0.693 means, once revenues exceed the cut-off, or breakeven value, profits increase very rapidly. Nearly 70% of the additional increase in revenues appears as profits, compared to only about 50% in the earlier period prior to 2000. This is a very significant and favorable development for Microsoft. One could use the same term work function used by Einstein to explain the photoelectric effect. Microsoft will be able to further increase its profits significantly if efforts are devoted to reduce this work function, or the fixed costs of operation. Now, let us consider what happened during the period of adjustment and the transition from one Type I behavior to the other. The simplest analysis of this situation is possible by simply joining the (x, y) pairs for two points on each of the Type I straight lines. The straight line joining the data for 1999 and 2009 provides such a simple solution, see Figure 7. The mathematical equation of this straight line is y = 0.176x + 4.31. The slope h = 0.176 is significantly reduced in the Type II mode. More importantly, the intercept c has changed from its negative value (which is characteristic of Type I behavior) to a positive value (characteristic of Type II behavior). The other data points for this transition period fall above and below this straight line. Perhaps, a linear regression would yield a better description but there is not much to be gained at this point from such an improvement in the quantitative analysis.
Page 21 of 63
50.00
40.00
Profits, x [$, billions]
30.00
20.00
10.00
0.00
Type II behavior y = 0.176x + 4.31 line joining 1999-2009

0 10 20 30 40 50 60 70 80 90 100
-10.00

Figure 7: The transition between the two Type I behaviors discussed earlier was accomplished with an intervening period of Type II behavior when profits increased at a much lower rate with increasing revenues. What is truly amazing, however, is that Microsoft was able to switch back from Type II behavior to Type I behavior after the falling into the Type II mode for an extended period of time. This suggests that significant efforts were made to accomplish revenues enhancements during the transition. This was accompanied also with the penalty of a higher work function (higher fixed costs). But, it is very significant that Microsoft has regained its Type I behavior. Companies can fall from Type I to Type II mode and then into the more adverse Type III mode and then rapidly descend into a crisis mode with profits decreasing even as revenues increase. (We see this now with Verizon which must get into the Type II mode and then regain its Type I behavior, see Figure 8.)
Page 22 of 63
It is hoped that the discussions provided thus far provide further convincing evidence for the efficacy of the analytical approach suggested here, based on the deduction of simple mathematical laws, aided by x-y graphs, to understand corporate financial behavior.
14,000 12,000
Profits, y [$, millions ]
10,000 8,000
6,000
4,000 2,000 0 0 40,000 80,000 120,000 160,000
Revenues, x [$, millions ]

Figure 8: Profits-revenue graph for Verizon Communications, with the additional data for 1996-2000. The upward sloping straight line with a positive slope (Type I behavior) describes the earlier data from 1996-2000, y = 0.399x 14,029.7 = 0.399 (x 35,150). Then, in 2001, Verizon suddenly reported its lowest profit of $389 million (the data point closest to x-axis). This was followed by a short period of rapid increase in profits with a very small increase in revenues (2002 to 2005), a sharp maximum point, followed a descent into Type III behavior (dashed line with negative slope), with profits decreasing with increasing revenues.
Page 23 of 63
7. 2012 Fortune 500 list Yahoo! Rank 483

http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/10867.html http://investing.money.msn.com/investments/financial-statements?symbol=YHOO Ten-year financial summary at above link.
Year
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Revenues, x $ billions
0.95 1.63 3.57 5.26 6.43 6.97 7.21 6.46 6.32 4.98
Profits, y $, billions
0.11 0.24 0.84 1.9 0.75 0.64 0.42 0.598 1.23 1.05
Comments
Revenues from 02 to 08 Profits reached a maximum in 05 and then Revenues from 09 to 11 but profits
The ten-year financial data for Yahoo! is summarized in the above table. As we will see shortly, the profits-revenues data for Yahoo! indicates a rather interesting variant of the Type III behavior in recent years. Between 2000 and 2008, revenues increased continuously, see Figure 9, and reached a peak value of $7.21 billion, and then started decreasing. The profits, however, reached a maximum of $1.9 billion in 2005 and then started decreasing with increasing revenues. Hence, Yahoo! indicates both Type I and Type III behavior in these two periods, see Figure 10. Between 2008 and 2011, however, Yahoo! illustrates a rather unusual Type III behavior. The profit-revenue graph has a negative slope, see Figure 11, but now profits increase with decreasing revenues.
Page 24 of 63
Revenues and Profits [$, billions]
8.0
7.0
Revenues, x
6.0
5.0 4.0 3.0 2.0
Profits, y
1.0 0.0 2000
2002
2004
2006
2008
2010
2012
Year
Figure 9: Profits and revenues for Yahoo! plotted versus time t in years. Profits increase with increasing revenues, between 2002 and 2005. While revenues continue to increase, profits start decreasing and then begin to increase again. Beyond 2008, revenues again begin to decrease but now profits begin to increase. The last period gives rise to an interesting variant of the Type III behavior.
Page 25 of 63
3.0 2.5
Profits [$, billions]
2.0 1.5 1.0 0.5 0.0 -0.5
Type I (2002-2005)
Type III (2005-2008)
-1.0
0.0 2.0 4.0 6.0 8.0 10.0

Figure 10: Profits-revenues graph for Yahoo! between 2002 and 2008. Profits reached a peak value of $1.79 billion in 2005 and then started decreasing with increasing revenues. Thus the graph reveals Type I behavior (positive slope h > 0, and negative intercept c < 0) until 2005 and then changes to Type III behavior (negative slope h < 0 and positive intercept c > 0) between 2005 and 2008. The peak is at the point (5.26, 1.9) for 2005. Arrows indicate the direction of time. Type I: y =0.46x 0.51 and Type III y = -0.76x + 5.89.
Page 26 of 63
3.0 2.5
Type III Behavior Decreasing Revenues Increasing Profits (2008-2011)

2005 (5.26, 1.9)
2011 (4.98, 1.05) 2008 (7.21, 0.424)
2.0 1.5 1.0 0.5
0.0
-0.5 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0

Figure 11: An interesting Type III profits-revenues behavior is revealed between 2008 and 2011. The solid line with the negative slope joins the (x, y) pairs for 2008 and 2011. Profits are actually increasing with decreasing revenues as Yahoo! moves up the downward sloping line to increasing profits. The arrows indicate the direction of time. The dashed line with the negative slope was followed from 2005-2008, also Type III behavior, with profits decreasing as revenues increased. The open diamond (data for 2010) is an exception and does not fall on this second Type III line (solid line) plotted here. It is to be hoped that Yahoo! will soon regain its Type I behavior and start its upward trek to higher profits with increasing revenue. The second Type III: y = -0.28x + 2.45.
Page 27 of 63
8. 2012 FORTUNE 500 Rank 83. Delta Air Lines
http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/2126.html http:/money.cnn.com/quote/financials/financials.html?symb=DAL Delta Air Lines (DAL) is an interesting example of a Fortune 500 company, ranked 83 in the 2012 list (previous rank was 88), with losses being reported for five of the eight years for which profits and revenues data has been compiled in the table below. It is also of interest to note that the number of shares (S), used to calculate the EPS, has been going up as well. The shares went up by 80% between 2008 and 2011. Hence, earnings (i.e., profits) must increase significantly just to keep the EPS constant. Year Revenues, x Profits, y ($, billions) ($, billions) 15.24 16.48 17.53 19.15 22.7 28.06 31.76 35.18 -5.2 -3.84 -6.21 1.61 -8.92 -1.24 0.59 0.85 Costs, z = (x y) (Revenues Profits) 20.44 20.32 23.74 17.54 31.62 29.3 31.17 34.33 Shares millions EPS
2004 2005 2006 2007 2008 2009 2010 2011
468 827 843 844
-$19.06 -$1.50 $0.70 $1.01
Since Profits = (Revenues Costs), it follows that we can estimate the costs from the available data. This is an overall or effective cost after taking into account all its obligations. This is given in the fourth column. Costs > Revenues when the company reports a loss and Costs < Revenues when it reports a profit.
Page 28 of 63
4 2
0 -2 -4 -6 -8 -10 0 10 20 30 40

Figure 12: Profits-revenues graph for Delta Air Lines for the period 2004-2011. Excluding the two outliers it appears that we can conclude that profits increase with increasing revenues. Notice that revenues have increased consistently each year and have more than doubled between 2004 and 2011. The (x, y) pairs for 2004 and 2007 yields a straight line with the highest positive slope h, whereas the (x, y) pairs for 2004 and 2011 also yields a straight line with somewhat lower positive slope. Consider, therefore, the graph of profits versus revenues in Figure 12. This seems to reveal no readily discernible pattern although it appears that DAL does exhibit Type I behavior based on the most recent data. Profits increased with increasing revenues between 2010 and 2011. The profits-revenues equation would be y = 0.0764x 1.831 if we consider only these two data points. However, as noted already, the data for 2004 to 2009 is less conclusive, with both losses and
Page 29 of 63
profits with increasing revenues. If we ignore the two outliers shown by the arrows (19.15, 1.61) for 2007 and (22.7, -8.92) for 2008, it appears that a case can be made for profits increasing with increasing revenues.
50 45
Costs, z = (x y) [$, billions]
40 35 30 25 20
z =(x y) = 0.721x + 9.28

15 10 5 0 0 5 10 15 20 25 30 35 40 45 50

Figure 13: Graph of costs z = (x y), deduced from the financial data, versus revenues. Since both costs and revenues are positive quantities, we expect to see a positive correlation. This is revealed here. From linear regression analysis, the best-fit line can be shown to have the equation z = (x y) = 0.721x + 9.28. This yields the profits-revenue relation y = (1 0.721)x 9.28 = 0.279x 9.28 which is a Type I relation as suspected. To test this hypothesis, let us consider the graph of Costs, z = (x y) versus Revenues, x. Both costs and revenues are positive quantities and we expect a
Page 30 of 63
positive correlation, see Figure 13. A nice upward trend is observed and the numerical value of the slope m = 0.721 is deduced using classical linear regression analysis. Notice that on the costs-revenues graph we again see the same two outliers but all the other data points follow the best-fit line very closely. Indeed, a reanalysis, after eliminating these two outliers from the regression, yields a slightly modified equation z = (x y) = 0.67x + 10.43 or y = 0.33x 10.43. The correlation coefficient is very high (denoted in statistics literature as r2 = 0.975). Thus, although the situation with Delta Airlines appears dismal, with the company operating close to its breakeven or cut-off revenue, the high positive value of the slope h = 0.33 deduced for profits-revenues equation implies that once past the breakeven or the fixed costs, nearly one-third (33%) of the additional revenues will appear as profits. In other words Delta Airlines must focus on reducing its Work Function as Einstein puts it in his explanation for the photoelectric effect. If a photon of energy E = hf strikes the surface of the metal, only a portion of this energy is seen as the kinetic energy K of the electron that is ejected, because some work W must be done to eject the electron. K = E W = hf W. This is the photoelectric equation, deduced after a lot of discussion of about entropy and energy of light (based on the power-exponential law given as equation 1). Reducing W, which is a characteristic property of the metal, increases K, the energy that appears in the electron. Likewise, each unit of revenue that is produced by a company does not appear as profits to the outside world. A big chunk of the revenue is absorbed in the form of costs. Costs are just like the work function W in the photoelectric law. The difference between a metal, with a fixed W, and a company is that efforts can be directed to reducing its work function, i.e., the costs. Then profits will appear. In the case of Delta Airlines, it is clear that the company is capable of converting 33% (one-third) of the revenues into profits, once it is past the breakeven point. It is to be hoped that Delta, and other companies in a similar situation, will benefit from such analysis and become profitable not just profitable consistently profitable and work like a Profits Engine to benefit the shareholders, the employees, the customers, and society at large.
Page 31 of 63
Finally, for completeness, we present the profits-revenues graph for Delta Airlines once again in Figure 14, with the Type I profits-revenue equation superimposed on to the data.
6 4
2 0 -2 -4 -6 -8 -10 0 10 20 30 40 50
y = 0.33x 10.43 = 0.33(x 31.64) x > x0 = 31.64 equals profits

Figure 14: Profits-revenues graph for Delta Airlines with the Type I profits-revenues equation superimposed on to the recent financial data. Once revenues exceed the breakeven value of x0 = $31.64 billion, Delta has the potential to convert one-third (33%) of the additional revenues into profits for its shareholders, with immense benefits to follow for its customers, employees, and to society at large. The simple analysis presented here shows how the airline can return to profitability and that too in a consistent manner and operate like a well-tuned Profits Engine.
Page 32 of 63
9. 2012 FORTUNE 500 Rank 17. Apple

http://money.cnn.com/quote/financials/financials.html?symb=AAPL http://investing.money.msn.com/investments/financialstatements?symbol=AAPL& Apple ranks 17 in the Fortune 500 list for 2012. This magazine named Apple the most admired US company in 2008 and also as the most admired in the world from 2008-2012. Its former Chairman and CEO, Steve Jobs, has been compared to none other than the automotive giant Henry Ford. The profits-revenues data for Apple, one of the most successful companies in modern corporate history, tells a story that matches and may be readily found at the links given above and has been summarized in the table below. Shares, S (millions) for EPS diluted 936.6 924.7 907.0 902.1 EPS (diluted)
Year
Revenues, x $, billions 108.6 65.1 36.3 32.5
Profits, y Profit margin, $, billions y/x 25.9 14.0 5.7 4.8 0.238 0.215 0.157 0.148
2011 2010 2009 2008
$27.68 $15.15 $6.29 $5.36
One can only wish that every company has such a sterling report card! Take the revenues. These have tripled between 2009 and 2011. But, look at the profits. Did they triple? They should also triple, shouldnt they, if we use the profit margin y/x as a measure of performance? If the denominator x goes up 3 times, the numerator y should also go up 3 times. This is what using ratios such as the profit margin, or the earning per share (EPS), implies. In the case of Apple, the profits have more than tripled, going up from $5.7 billion in 2009 to $25.9 billion in 2011 or by a factor of 4.54, i.e., they have more than quadrupled. This should be convincing proof that the profit margin might be misleading indicator of corporate performance. Why did the profits go up 4.54 times when the revenues went up 3
Page 33 of 63
times? As we will see shortly, the graphical representation of the same data, see Figure 15, yields some insights.
40.0 35.0
30.0 25.0 20.0 15.0
10.0 5.0 0.0

-5.0 -10.0 0 20 40 60
y = 0.278x 4.28 with r2 = 0.99985
80
100
120
140

Figure 15: The profits-revenues graph for Apple, Inc. reveals a nice linear behavior, as for a Type I company (h > 0 and c < 0), with all the four data points lining up almost PERFECTLY on a straight line. The equation for the best-fit line through these four points is y = 0.278x 4.28 = 0.278 (x 15.377). According to statistical theory, the linear regression coefficient r2 = +1.0 for a PERFECT positive correlation. Here we get r2 = 0.99985. This is as perfect as it can get in terms of a predictable relation between revenues and profits. Hence, at least in the short term, we can expect Apple to operate along this line. If revenues go up, profits will go up and should lie, no doubt, on an extension of this straight line. We should be able to confirm this with data for 2012 within the year. (Of course, one could test the same using quarterly data and check the predictions out on a quarterly basis.) It is clear that one cannot blithely use simple y/x ratios to assess the year-on-year performance of a single company or even compare different companies (within a
Page 34 of 63
sector of the economy, or across different sectors). This also means that we must tread cautiously even with the use of the ratios such as EPS. The number of shares used to determine the EPS are listed by Apple (following the lead taken in this regard by Microsoft, as well). The EPS has increased from $5.36 in 2008 to $27.68 in 2011, or more than 5 times. This is due to two reasons. First, the absolute level of profits (earnings) which appears in the numerator of this ratio has gone up for Apple. The earnings went up by 4.54 times, as already noted. Second, the number of shares, which appears in the denominator of the ratio, has also gone up. However, the rate at which profits are growing is far greater than the rate at which the shares are growing and this explains the rapid increase in the EPS. In other words, it is clear that one must consider rates of change rather than simple ratios. This is what calculus teaches us as already discussed in earlier articles (see Refs.[1] and [2] cited earlier in the introduction). Notice also that the profit margin y/x has been increasing year after year, whereas the rate of increase of profits, with increasing revenues, as given by the slope of the graph, is a constant. If revenues increase by an amount x, the profits will always increase by the same fixed amount y = hx. The slope h is the marginal rate of increase of profits (MRP) as revenues increase. (This is like the marginal tax rate and similar terms used in economics theory.) The reason for the increase in the profit margin y/x is also obvious if we look at the implications of the linear law y = hx + c = 0.278x 4.28. If profits The profit margin y = 0.278x 4.28 y/x = 0.278 (4.28/x)
The nonzero intercept c = - 4.28 explains why we see the profit margin y/x is increasing year-after-year. Since the second term is negative, the theoretical maximum profit margin is 0.278, or 27.8%. As revenues x increase, the second term will decrease and the profit margin y/x will go up. The higher the revenues x, the higher will be the ratio y/x and eventually y/x will reach its maximum value (mathematically known as the asymptotic value) of h = 0.278. Notice also that all the profit margins in the table given earlier are less than 27.8%.
Page 35 of 63
If the linear law applies, and the intercept c < 0, the slope h of the profits-revenues graph is also the theoretical maximum value of the profit margin, y/x. Fundamental operational changes will be required to increase the profit margin once this barrier is reached. Unfortunately, this aspect of the financial behavior of a company has NOT yet been understood.
While Apple has certainly benefited thus far from this perception of an ever increasing profit margin, the analysis presented here also serves as a cautionary note. Unless Apple does something dramatic (to increase the slope h of the graph, see box), it will soon be confronted with this theoretical barrier of 27.8% profit margin. Since the profit margin was 23.8% in 2011, and 21.5% in 2010, should it be expected to go up again by 10% (23.8% + 2.38%) to 26.18% or, better yet, go up 15% or 20% to (23.8% + 4.76%) 28.56%?
This is IMPOSSIBLE with the present operating profits-revenues equation. Such unreasonable expectations should NOT be encouraged and could destroy a company like Apple. (Of course, the Wall Street speculations will all be centered on the change of guard with the sad passing away of Steve Jobs, when Apple begins to hit such a brick wall in a couple of years by 2014 at the latest!) And, so it is, as noted earlier in the analysis of Facebook financial data (after its disastrous IPO), see Ref. [1], the superficial analysis of financial data, based on simple ratios such as the profit margin (y/x) or the EPS, should be shunned since such a misguided and simplistic analysis only ends up destroying companies in the long run (with a short term boost in the market place due to the wildly rising profit margins resulting from the negative intercept, c. (Microsoft also benefited from the same Type I behavior, a negative c, in the 1980s and 1990s.)
Page 36 of 63
In summary, the analysis of the financial data for Apple, Inc. presented here while revealing some very positive details also serves as a cautionary note against future wild speculations and expectations about how this companys profits and revenues will, or should, increase, in the near future. These should be tempered by a fuller understanding of the simple linear law relating profits and revenues. For Apple, this means a fixed h = 0.278 or MRP of 27.8% for the future increases in revenues. A more complete discussion of the ten-year financial data and the quarterly data for Apple may be found in a separate article uploaded on this website, see link http://www.scribd.com/doc/96228131/The-Perfect-Apple-How-it-can-be-destroyed
10. 2012 FORTUNE 500 Rank 23. Kroger

http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/2291.html http://money.cnn.com/quote/financials/financials.html?symb=KR
Annual Profits-Revenues data for 2005-2012

Revenues, x Profits, y Comments $, billions $, billions 60.553 0.958 Between 05 and 09 2005 66.111 1.115 both x and y 2006 70.235 1.181 increase in tandem 2007 70.261 1.209 (Type I behavior) 2008 76.063 1.249 2009 Sudden drop in 76.609 0.07 2010 profits for 2010. 82.049 1.116 Revenues increase 2011 82.049 1.193 but profits decrease 2011 adj 90.374 0.602 after 2010 (Type III) Jan 28, 2012 The fiscal year ends in January each year for Kroger. Values here are for 12 month period in January each year.
Page 37 of 63
Year
2.0
1.5
Type I behavior (2005-2009) y = 0.0188x 0.178
1.0
0.5
0.0
2010 drop in profits
-0.5 0 10 20 30 40 50 60 70 80 90 100 110 120

Figure 16: Profits-revenues data for Kroger (2005-2009) illustrating Type I behavior. The general trend is described by the straight line joining the (x, y) pairs for 2005 and 2009, with the equation y = 0.0188x -0.178 = 0.0188(x -9.49). Hence, revenues must exceed a minimum of $9.5 billion before Kroger can report a profit. However, the slope h = 0.0188 is very small only about 2% of the additional revenues appears as profits. The Type I behavior continued with revenues increasing to about $80 billion but the additional $70 billion in revenues (beyond breakeven) did NOT result in significant profits. It is clear that Kroger must address its cost structure in a determined way to become more profitable (at least h = 0.05 as the short term management goal).
After following this Type I behavior, with profits increasing with increasing revenues, Kroger suddenly reported a huge drop in profits for 2010 after which it has been in the Type III mode with profits decreasing even as revenues have increased between FY 2009 and FY 2012. This sudden transition to Type III behavior is illustrated in Figure 16.
Page 38 of 63
2.0
1.5
Type III behavior (2009-2012) y = -0.071x + 7.02
1.0
0.5
0.0
-0.5
10
20
30
40
50
60
70
80
90
100 110 120

Figure 17: Profits-revenues data for Kroger (2009-2012, FY ending on Jan 28, 2012) illustrating a sudden to Type III behavior, with profits decreasing even as revenues increased after 2009. There was a sudden drop in profits in 2010, followed by a return to profitability but at a lower level of profits and with increased revenues. Since then the trend is described by the straight line with the negative slope. The equation of the straight line joining the (x, y) pairs for 2011 (adj) and 2012 is y = -0.071x + 7.02.
Page 39 of 63
1.4
1.2
1.0 0.8 0.6
0.4
0.2 0.0 0 10 20 30 40 50 60 70 80 90 100

Figure 18: The Type I and Type III behaviors observed during the two successive time period implies the existence of a maximum point on the profits-revenues graph for Kroger, as illustrated here. The dashed curve is an attempt to fit the data and is NOT based on mathematical calculations. However, as discussed already (introduction), the power-exponential law can be used to explain this behavior the appearance of the maximum point. This is now the fourth example of a company exhibiting such a maximum point on the profits-revenue graph the others being Ford Motor Company, Verizon Communications and Yahoo. All these companies seem to go directly from Type I to Type III without an intervening Type II mode. (Microsoft is a good example of a company which went from Type I to Type II mode and then has reverted back, in recent years, to the Type I mode.)
Page 40 of 63
11. 2012 FORTUNE 500 Rank 41. PepsiCo

http://money.cnn.com/magazines/fortune/fortune500/2012/full_list/ http://money.cnn.com/quote/financials/financials.html?symb=PEP http://www.gurufocus.com/financials.php?symbol=pep Ten year data PepsiCo is a unique example of a rather mature Fortune 500 company with a worldwide presence. On a hot day, everyone likes to reach out for a nice cold Pepsi (or is it ok, lets not get too smart now!) Hence, PepsiCos profits and revenue performance in recent years is of great interest. As we see from the table below, revenues have been growing and have more than doubled from $32.6 billion in 2005 to $66.5 billion in 2011. The profits and profits margin, on the other hand, tell a different story and we will now take a look at that more closely. Year 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 Revenues, x $, billions 66.504 57.838 43.232 43.251 39.474 35.137 32.562 29.261 26.971 25.112 Profits, y $, billions 6.443 6.320 5.946 5.142 5.658 5.642 4.078 4.174 3.494 3.313 Profit Margin, y/x 0.097 0.109 0.138 0.119 0.143 0.161 0.125 0.143 0.130 0.132 Profit Margin % 9.7 10.9 13.8 11.9 14.3 16.1 12.5 14.3 13.0 13.2
Take the period 2005 to 2011. Profits went up by 58% (1.58 times), from $4.1 billion to $6.43 billion with more than a doubling of revenues. Now, take a look at the more recent performance between 2009 and 2011. Revenues went up by 54% (1.538 times) from $43.2 billion to $66.5 billion. But, profits went up by less than 10%, from $5.95 billion in 2009 to to $6.44 billion in 2011. This is a significant slowing down in the profits-revenues space and suggests the first example that
Page 41 of 63
we encounter in our analysis of what has been called Type II behavior. Profits increase with increasing revenues but at a much lower rate than when the revenues were lower. In other words, as the company has grown its costs have actually increased at a higher rate than the rate of increase of revenues. This is also evident if we study the profit margin behavior. The profit margin has decreased overall between 2002 and 2011, with occasional fluctuations to higher values. This is more readily understood if we look at the data using the simple mathematical laws that have been advocated here.
10.000
8.000
6.000 4.000 2.000 0.000 -2.000 -4.000 0 10 20 30 40 50 60 70 80 90 100
Type II behavior h > 0, c > 0 y =0.0256x + 4.745 = 0.026 (x + 185.8) Type I behavior h > 0, c < 0 y = 0.232x 2.52 = 0.232 (x 10.85)

Figure 19: The transition from a Type I behavior (h > 0, c < 0) at low revenue levels to a Type II behavior (h > 0, c > 0) at higher revenue levels is illustrated here by the profits-revenue data for PepsiCo over the last ten years (2002-2011). Profits increase with increasing revenues in both periods, but the profits increase at a much lower rate.
Page 42 of 63
This qualitative assessment can be quantified by the change in the value of the constant h, the slope of the graph, from h = 0.232 to h = 0.026, almost a factor of ten reduction in the slope. Correspondingly the intercept c made by the graph on the profits axis increases and becomes positive. Thus, Type I and Type II behavior are distinguished by the change in the sign of the constant c and by the reduced value of the constant h. Now, let us consider the overall trend performance during this ten-year period. Perhaps, this is more significant aspect of the ten-year performance.
9.0 8.0
7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 0 20 40 60 80 100
Type II behavior h > 0 and c > 0 y = 0.075x + 2.02 r2 = 0.752
Positive intercept c = 2.02

Figure 20: The overall trend for the ten-year period is considered here while ignoring what appears to be a significant slowing down in the growth of profits with increasing revenues since 2009. The best-fit line through the data points has the equation y =0.075x + 2.02 = 0.075 (x + 26.88). The linear regression coefficient r2 = 0.752 is quite high suggesting a statistically significant positive correlation for the years 2002-2011.
Page 43 of 63
If the linear law applies, and the intercept c >0, the slope h of the profits-revenues graph is also the theoretical minimum value of the profit margin, y/x. It cannot fall below this value. Fundamental operational changes will be required to increase the profit margin and return to Type I behavior. It is not enough to seek revenue enhancements alone. The work function (positive c) must also be reduced. This aspect of the financial behavior of a company has NOT yet been understood.
A straightforward statistical analysis, using linear regression, yields the profits-revenues equation y = 0.075x + 2.019 = 0.075 (x + 26.875). The slope h = 0.075 is positive but the intercept c = 2.019 is also positive, indicating an overall Type II behavior, although the slope h is now higher than the Type II slope deduced earlier. (The Type II slope is, however, still lower than the Type I slope deduced earlier.). As noted earlier with the discussion of Apples data, If y = hx + c,
Profit margin y/x = h + (c/x) Hence, profit margin can either increase or decrease as revenues x increases depending on the numerical value of the constant c. For Apple, c < 0, and the profit margin will keep on increasing until it hits the maximum value h. It cannot increase any further, unless fundamental changes are made. Now we see the opposite situation with PepsiCo. With the intercept c > 0, the profit margin y/x will just continue to decrease, year-after-year, as the revenues x increase. This is what we observe with PepsiCo. If we study the financial data in our table, we see that all profit margins are higher than the theoretical minimum value given by the slope h = 0.075 or 7.5%. The good news is that unless there are serious disruptions in PepsiCo operations, or revenue streams, the profit margin will NOT fall below 7.5%. But, serious efforts must now be made to address the positive c (or excessive work function, see discussion in http://www.scribd.com/doc/96228131/The-Perfect-Apple-How-itcan-be-destroyed .
Page 44 of 63
12. Comparison of the Profits-Revenues data

for PepsiCo and Coca Cola (2002-2011)
Year 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002
Revenues, x $, billions PepsiCo 66.504 57.838 43.232 43.251 39.474 35.137 32.562 29.261 26.971 25.112
Profits, y $, billions PepsiCo 6.443 6.320 5.946 5.142 5.658 5.642 4.078 4.174 3.494 3.313
Revenues, x $, billions Coca Cola 46.542 35.119 30.99 31.944 28.857 24.088 23.104 21.962 21.044 19.564
Profits, y $, billions Coca Cola 8.572 11.809 6.824 5.807 5.981 5.080 4.872 4.847 4.347 3.976
At the lowest revenue level in the above table, about $25 billion, PepsiCo reported profits of $3.3 billion in 2002. Its worldwide competitor in the same sector of the economy, Coca Cola, on the other hand, reported higher profits, about $6 billion with about the same revenue ($24 billion) in 2006. Also, Coca Cola reported higher profits, with lower revenues, for all of 2002-2005. This is also true for the most recent three years, 2009-2011. With revenues of $66.5 billion, PepsiCo reported profits of $6.44 billion whereas Coca Cola reported profits of $8.6 billion with revenues of only $46.5 billion. These differences are more readily understood by considering the graphical representation of the same data, along with the relevant best-fit equations for each company. For Coca Cola: For PepsiCo: y = 0.164x + 1.061 y = 0.075x + 2.02 r2 = 0.944 Excludes 2010 data r2 = 0.752
Page 45 of 63
Thus, both companies exhibit Type II behavior (h > 0 and c > 0) with a small positive intercept on the profits axis. This means that if we consider historical data, prior 2002, we would more likely find Type I behavior (h > 0 and c < 0) as is usually the case when Type II behavior is observed. This is already evident with PepsiCo if we break up the 2002-2011 into two time periods. Both companies have grown and matured and enjoy high revenues levels than in earlier years, and also have more of a global presence, which means that costs have inevitably gone up. This leads to the transition from Type I to Type II behavior.
18.0 16.0
14.0 12.0 10.0
y = 0.164x +1.061
8.0 6.0 4.0 2.0 0.0 0 10 20 30 40 50 60 70 80
y = 0.075x + 2.02

Figure 21: Comparison of the profits-revenue data for PepsiCo and Coca Cola with the relevant best-fit equations for each company. The blue dots represent the data for PepsiCo whereas the red diamonds are the data for Coca Cola. The slope h, the rate of increase of profits with increasing revenues, for Coca Cola is more than double the value for PepsiCo. This also yields the smaller positive intercept for Coca Cola compared to PepsiCo. For every additional $1 billion in revenues, Coca Cola is able to convert $164 million into profits whereas PepsiCo
Page 46 of 63
is only able to convert $75 million into profits. Actually, both companies have high costs and more of the additional revenues should appear as profits. (Compare this with Microsoft or Apple, both companies with a high value of h.)
The Suspected Transition to Type I Behavior for PepsiCo at lower Revenues

As discussed in the previous section, both PepsiCo and Coca Cola currently seem to display the Type II behavior (h > 0, c > 0) with profits increasing with increasing revenues but at a somewhat low rate, as revealed by the small numerical value for the constant h. For PepsiCo, h = 0.075 and for Coca Cola, h = 0.164. This suggests, as seen earlier with Microsoft, see Figure 7 (and with other companies that I have studied over the last 10+ years) that PepsiCo might reveal the Type I behavior if we consider data for earlier periods when revenues were lower. Indeed, historical data for PepsiCo, going back to 1986, extracted from various annual reports confirm this suspected trend. There are some discrepancies between the numbers for the revenues and profits (all obtained from PepsiCos annual reports), as highlighted below in the tabulated data but Type I behavior was definitely observed, between 1986-1996 and also between 1995-2002. For 1986-1996 Data source: http://www.pepsico.com/Annual-Reports/1996/selecteddata.html Type I behavior with y = 0.0669x 0.146 (see Figure 22) For 1996-2002
Data source: http://www.pepsico.com/Investors/Annual-Reports.html

The 1998 Annual Report has 1996-1998, the 2000 Annual Report for 1999 and 2000 and the 2002 Annual Report for 2000, 2001 and 2002. The Ten year data 2002-2011 from http://www.gurufocus.com/financials.php?symbol=pep
Page 47 of 63
2.5
2.0
1.5
1.0
0.5
0.0
-0.5 0 5 10 15 20 25 30 35 40

Figure 22: The profits-revenues data for the eleven-year period 1986-1996 is plotted here, see data source cited. The slope and intercept for the straight line is fixed by the (x, y) pairs for 1986 and 1994, which yields h =0.0669 and c = -0.1455. The slope h is actually slightly lower than h = 0.075 obtained for 2002-2011 but the intercept is now negative. This means, if we combine the data sets in a single graph, the data would fall on roughly parallel line, one with a positive intercept and the other with a negative intercept. A significantly higher slope, with a negative intercept is observed for the later period 1995-2002. Linear regression was not used, firstly, because of the discrepancies observed in the numbers from the different annual reports, and secondly, because the objective here is merely to reveal the suspected trends and the transition from Type I to Type II behavior as revenues increase. For 1986, (x1, y1) = (9.017, 0.458) and for 1994 (x2, y2) = (28.351, 1.752). Hence, the slope h = (y2 y1)/(x2 x1). The intercept c is fixed once the slope h is determined using these values, c = y1 = hx1 = y2 hx2.
Page 48 of 63
5.0 4.5 4.0
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 0 5 10 15 20 25 30

Figure 23: The profits-revenues data for the period 1995-2002 is plotted here, see data source cited. The slope and intercept for the straight line superimposed here are fixed by considering the (x, y) pairs for 1996 and 2002 which yields h =0.496 and c = - 9.156. These data for 1995 was significantly different in the two reports cited. The lower revenue is plotted here and the higher value in Figure 22. Again linear regression was not used because of these discrepancies but the trend is unmistakable. A composite plot combining the two data sets considered in Figures 22 and 23 has been prepared in Figure 24 without the two straight lines. If we neglect the outliers at the higher revenues (with low profits), one sees a general upward trend of rising profits with rising revenues. The more quantitative analysis and the classifications proposed into Type I, Type II, and Type III behaviors help us understand these general trends and seek innovative solutions for improving profitability.
Page 49 of 63
3.5 3.0
2.5 2.0 1.5 1.0 0.5 0.0 0 5 10 15 20 25 30 35

Figure 24: Composite plot of the profits-revenues data for PepsiCo from 1986-2002. As seen in the table following discrepancies between the various annual reports were observed. Hence, only simple trends are deduced without invoking regression analysis.
Page 50 of 63
Summary of the Profits and Revenues data for 1986-2002 Extracted from various PepsiCo Annual Reports
Year
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1995 1996 1999 2000 1997 1999 2000 1998 2001 1998 2002 1993 1994 1999 2000 2000
Revenues, x $, billions
9.017 11.018 12.381 15.049 17.516 19.218 21.885 24.935 28.351 30.255 31.645 19.067 20.337 20.367 20.438 20.917 22.183 22.337 22.348 23.512 24.605 25.112 15.706 17.984 25.093 25.479 20.438
Profits, y $, billions
0.458 0.595 0.762 0.901 1.077 1.08 0.374 1.588 1.752 1.606 1.149 1.422 0.942 2.05 2.183 1.491 2.505 2.543 1.993 2.662 2.278 3.313 1.152 1.363 2.505 2.543 2.183
Comments
Low profits
Revenues discrepency in different Reports
The data listed in blue here was also obtained from different reports.
The following Type I equations can be deduced by considering extreme points. The Type I slopes are generally higher than the Type II slopes. PepsiCo is now operating in the Type II mode. 1986 and 1994: 1986 and 1988: 1993 and 2001: 1988 and 1994: y =0.067x 0.1455 y =0.091x 0.357 y = 0.0927x 0.303 y = 0.177x 0.357
Page 51 of 63
13. FORTUNE 500 2012 Procter & Gamble, Rank 27

The Perfect Example of Type I Company (1990-2011) with a transition from one Type I mode to another with a higher profitability
16
14
12 10 8
6
4 2 0
-2
-4 0 20 40 60 80 100 120

Figure 25: Profits-Revenues data for Procter & Gamble for two periods. The squares represent data for 1990-2001 and the diamonds for 2002-2011. The linear regression equations are y = 0.171x 2.425 (solid line) for 2002-2011 and y = 0.154x 2.421 for 1990-2001 (dashed line). Here we have a slowtransition from one Type I behavior to another which means more of the revenues (beyond the breakeven) are being converted to profits.
Page 52 of 63
14. Lessons learned and Conclusions

Let us first summarize the results of our study here of 10 leading Fortune 500 companies using the mathematical law y = mxn [e-ax/(1 + be-ax)] + c. For n = 1 and a = b = 0, this general law (which can be deduced by extending the statistical arguments used Planck to develop quantum physics to economics and other problems) reduce to the simple linear law y = mx + c or y = hx + c. Company Slope h Hewlett Packard 0.079 -0.296 Verizon Comm 0.399 0.474 IBM 0.51, 0.693 Microsoft 0.176 0.46 Yahoo! -0.76, -0.28 0.33 Delta Airlines 0.278 Apple 0.02 Kroger -0.07 0.075 PepsiCo 0.164 Coca Cola 0.154, 0.171 P&G -0.078 Ford Motor Intercept c Negative Positive Negative Negative Negative Positive Negative Positive Negative Negative Negative Positive Positive Positive Negative Positive Comments Type I but very low value of h Type III, Profits with Revenues Type I, then transition to Type III Type I Type I transition from Type I to II Type II between the two Type I Transition from Type I to Type III Type III with Profits Revenues Type I with losses for 5 of 8 years Type I, Near PERFECT correlation Type I Type III, Sudden transition Type II, early years was Type I Type II Type I to Type I transition Type III is dominant mode for recent years (annual and quarterly), with a maximum point. Type I, Ref. [3] Type I, Ref. [4] Type I, Ref. [3] Type II, Ref. [3]. Analysis of Quarterly data reveals Type I.
Google Facebook ExxonMobil Universal Insurance Holdings, Inc.
0.274 0.315 0.112 -0.32
Negative Negative Negative Positive
Page 53 of 63
Verizon Communications, Yahoo, and Kroger, clearly reveal a maximum point on the profits-revenues graph which can be explained by invoking the more general nonlinear power-exponential law (a generalized of Plancks blackbody radiation law). Ford Motor Company, discussed in a separate article is another example of a very important Fortune 500 company showing such a maximum point. The data for Facebook and Google has been analyzed in the article, with link given below.
1. As noted in earlier articles (see links and bibliography at the end of this section), the discussion here should be viewed more like the observations on the positions of the various planets, or the motion of various galaxies, that were presented by astronomers which eventually led to deeper insights and the enunciation of simple laws that are now universally accepted. Likewise, there is no theory being presented here about the business world, only a mathematically compact way of explaining the large masses of financial data that are now being tabulated regularly. As we have seen here, simple mathematical laws can be used to describe these observations. The preponderance of the data can be explained using the linear law y = hx + c. 2. Three types of linear behavior can be conceived, depending on the numerical values of the constants h and c. This gives rise to the Type I, Type II, and Type III behaviors discussed. Profits increase with increasing revenues for both Type I and Type II. However, the slope h is greater (corresponding to a negative intercept c) for the Type I company. As revenues increase, the rate of increase of profits, with increasing revenues, decreases and there is a transition from Type I to Type II behavior. These transitions, of course, mean that nonlinearity is definitely being observed. However, it is more convenient to look at the situation in terms of simple linear laws, rather than nonlinear laws (which can yield either extremely bullish or bearish predictions which may be wholly unwarranted, given the many complexities inherent in the problem being studied). 3. The transition from Type I to Type II is not entirely surprising and certainly not wholly undesirable. It simply reflects the realities of a growing and maturing company with increasing revenues and concomitant profits.
Page 54 of 63
However, the transition from Type I straight to Type III, with or without an intervening Type II mode, is cause for alarm and calls for URGENT action to restore the companys profitability. A company can continue to operate for some time with decreasing profits and increasing revenues, (or vice versa, as with Yahoo!) but this cannot be sustained in the long term. 4. The appearance of a maximum point on the profits-revenues graph is shown to be a rather common occurrence (observed with 4 of the 13 Fortune 500 companies studied). This is actually the reflection of the nonlinear behavior described by the power-exponential law, y = mxn [e-ax/(1 + be-ax)] + c which can be thought of as a generalized statement of Plancks blackbody radiation law. As was the situation when Planck first proposed this law (to mark the birth of what we now call quantum physics), the mathematical law is merely as heuristic point of view which explains the empirical observations on blackbody radiation and also the photoelectric effect to which these ideas (Plancks quantum) were later extended by Einstein. The deeper meaning the energy quantum was a matter of friendly debate and disagreements between Planck and Einstein, for years after they proposed their respective theories. Likewise, the analysis here also represents a heuristic point of view and calls attention to certain universal trends that are being observed when we study the financial data for several companies. 5. The significance of the slope h (also called the MRP, marginal rate of increase of profits) is easily understood. The slope h = 1 (b/p) if we consider a company making and selling N units of a single product, with p being the unit price associated with revenue generation and b the unit variable cost. Once revenues exceed the breakeven value, a high slope h means that more of the additional revenues are converted into profits. 6. The intercept c in the linear law is like the work function in Einsteins photoelectric law. Some of the energy of the photon must be given up to produce an electron with energy K. Likewise, some of the revenues generated by a company must be given up and will not appear as profits. This is the cost, or the fixed cost, when we consider the simple case of single product. Similar results seem to apply with multiple revenue streams.
Page 55 of 63
7. The classical breakeven analysis gives us three parameters (a, b, p), associated with costs and revenues, that can be controlled to increase profits. The linear law implied by this fundamental triplet (a, b, p) of control parameters is also seen to hold when we consider real companies with many different products and revenue streams. As we understand the meaning of the slope h (or the MRP) and the intercept c (costs or the work function), we will, hopefully, learn how to build a real Profits Engine, with companies being able to operate consistently in a profitable manner and deliver a rated profits level, like heat engines today can deliver a rated horsepower. 8. Finally, it is conceivable that successful companies could use the graphical representation of profits and revenues data suggested here as valuable marketing tools and exploit them in advertising campaigns to boost their individual brands.
Bibliography of Internet articles to date posted at this website, since the Facebook IPO on May 18, 2012. 1. http://www.scribd.com/doc/95140101/Ford-Motor-Company-Data-RevealsMount-Profit Ford Motor Company graph illustrating pronounced maximum point, Published May 29, 2012. 2. http://www.scribd.com/doc/95329905/Planck-s-Blackbody-Radiation-LawRederived-for-more-General-Case Generalization of Plancks law, Published May 30, 2012. 3. http://www.scribd.com/doc/94647467/Three-Types-of-Companies-FromQuantum-Physics-to-Economics Basic discussion of three types of companies, Published May 24, 2012. Examples of Google, Facebook, ExxonMobil, Best Buy, Ford, Universal Insurance Holdings 4. http://www.scribd.com/doc/94325593/The-Future-of-Facebook-I Facebook and Google data are compared here. Published May 21, 2012. 5. http://www.scribd.com/doc/94103265/The-FaceBook-Future Published May 19, 2012 (the day after IPO launch on Friday May 18, 2012).
Page 56 of 63
6. http://www.scribd.com/doc/96228131/The-Perfect-Apple-How-it-can-bedestroyed Detailed discussion of Apple Inc. data. Published June 7, 2012. 7. http://www.scribd.com/doc/95728457/What-is-Entropy Discussion of the meaning of entropy (using example given by Boltzmann in 1877, later also used by Planck to develop quantum physics in 1900). The example here shows the concepts of entropy S and energy U (and the derivative T = dU/dS) can be extended beyond physics with energy = money, or any property of interest. Published June 3, 2012. 8. http://www.scribd.com/doc/95906902/Simple-Mathematical-Laws-GovernCorporate-Financial-Behavior-A-Brief-Compilation-of-Profits-RevenuesData Current article with all others above cited for completeness, Published June 4, 2012 with several revisions incorporating more examples.
Page 57 of 63
Appendix 1: Fortune 500 Rank 102 MMM or 3M: Company in transition

http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/284.html
http://www.gurufocus.com/news/174058/3m-company-reports-operating-results-10q
From their website: A Global Innovation Company

http://solutions.3m.com/wps/portal/3M/en_US/3MCompany/Information/AboutUs/WhoWeAre/ 3M is a global innovation company that never stops inventing. Over the years, our innovations have improved daily life for hundreds of millions of people all over the world. We have made driving at night easier, made buildings safer, and made consumer electronics lighter, less energy-intensive and less harmful to the environment. We even helped put a man on the moon. Every day at 3M, one idea always leads to the next, igniting momentum to make progress possible around the world. As we will see from our study of the profits-revenues data for the company, this is now clearly a company in transition from a Type I company to possibly a Type II. Or, can it revert back to its Type I behavior with corrective action based on the information just revealed? Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Revenues, x $, billions 16.332 18.232 20.011 21.167 22.923 24.462 25.269 23.123 26.662 29.611 Profits, y $, billions 1.974 2.403 2.99 3.234 3.851 4.096 3.46 3.193 4.085 4.283 Comments
First drop in profits with revenues Both profits and revenues Resume increasing revenues and profits two years in a row
Page 58 of 63
We see the first drop in profits, with increasing revenues in 2008 followed by a drop in both revenues and profits in 2009. This has been followed by an increase, once again, in both the revenues and profits in 2010 and 2011.
35
Time, t [in years] Revenues, x [$, billions] Profits, y [$ billions]

30 25 20 15 10 5 0 2000
Revenues, x
Profits, y
2002
2004
2006
2008
2010
2012
Figure 26: Revenues and profits have been on an upward trend since 2002. However, after the drop in revenues, for the first time between 2008 and 2009, revenues seems to be increasing at a higher rate ($ per year). Profits have also recovered and are rising again although no significant acceleration in profits growth is evident (even after plotting profits separately using an expanded scale). The profits-revenues (x-y) graph, however, reveals an interesting trend and yields some additional insights into how this transition to higher revenues and profits is proceeding after the short period of decline in both profits and revenues.
Page 59 of 63
Profits, y [$ billions]
x0
-2
-4 0 5 10 15 20 25 30 35 40
Revenues, x [$ billions]
Figure 27: The profits-revenues graph for 3M (2002-2011) tells a different story. The company is in Type I mode but is undergoing a transition. The (x, y) pairs for 2002 and 2007 yield the relation y = 0.261x 2.289 = 0.261 (x 8.77). This describes the data quite well. Once revenues exceed the cut-off value of $8.77 billion, about 26% of the additional revenues are converted into profits (slope h = 0.261). However, the situation following the first drop in profits, and then both profits and revenues, is still evolving. The company could fall into a Type II mode. This is suggested by the fact that both profits and revenues increased at a much lower rate in 2010 and 2011. For this period x = (29.611 26.662) = 2.949 and y = (4.283 4.085) = 0.198 and the rate h = y/x = 0.067. Using the changes between 2005 and 2010 as a measure, a higher rate h = y/x = 0.851/5.495 = 0.154 is estimated but this too is lower than the Type I slope of h = 0.261. These predictions can, no doubt, be tested over the next few years, if companies continue to operate as they today, without any lessons being learned from such analyses.
Page 60 of 63
Appendix 2: Fortune 500 Rank 308 Stryker: A Solid Type I Company

http://money.cnn.com/magazines/fortune/fortune500/2012/snapshots/1090.html http://money.cnn.com/quote/financials/financials.html?symb=SYK http://www.gurufocus.com/news/161395/stryker-corp-reports-operating-results-10k http://www.gurufocus.com/financials.php?symbol=SYK#is Stryker is one of the worlds leading medical technology companies and is dedicated to helping healthcare professionals perform their jobs more efficiently while enhancing patient care. The Company offers a diverse array of innovative medical technologies, including reconstructive, medical and surgical, and neurotechnology and spine products to help people lead more active and more satisfying lives.
2.5 2.0
1.5 1.0 0.5 0.0
Type I y = 0.212x 0.333 = 0.212 (x x0) r2 = 0.9746
x0 = 1.572
-0.5 0 2 4 6 8 10 12

Figure 28: Profits-revenues graph for Stryker revealing Type I behavior for the period 2002-2011.
Page 61 of 63
About the author V. Laxmanan, Sc. D.

The author obtained his Bachelors degree (B. E.) in Mechanical Engineering from the University of Poona and his Masters degree (M. E.), also in Mechanical Engineering, from the Indian Institute of Science, Bangalore, followed by a Masters (S. M.) and Doctoral (Sc. D.) degrees in Materials Engineering from the Massachusetts Institute of Technology, Cambridge, MA, USA. He then spent his entire professional career at leading US research institutions (MIT, Allied Chemical Corporate R & D, now part of Honeywell, NASA, Case Western Reserve University (CWRU), and General Motors Research and Development Center in Warren, MI). He holds four patents in materials processing, has co-authored two books and published several scientific papers in leading peer-reviewed international journals. His expertise includes developing simple mathematical models to explain the behavior of complex systems. While at NASA and CWRU, he was responsible for developing material processing experiments to be performed aboard the space shuttle and developed a simple mathematical model to explain the growth Christmas-tree, or snowflake, like structures (called dendrites) widely observed in many types of liquid-to-solid phase transformations (e.g., freezing of all commercial metals and alloys, freezing of water, and, yes, production of snowflakes!). This led to a simple model to explain the growth of dendritic structures in both the ground-based experiments and in the space shuttle experiments. More recently, he has been interested in the analysis of the large volumes of data from financial and economic systems and has developed what may be called the Quantum Business Model (QBM). This extends (to financial and economic systems) the mathematical arguments used by Max Planck to develop quantum physics using the analogy Energy = Money, i.e., energy in physics is like money in economics. Einstein applied Plancks ideas to describe the photoelectric effect (by treating light as being composed of particles called photons, each with the fixed quantum of energy conceived by Planck). The mathematical law deduced by
Page 62 of 63
Planck, referred to here as the generalized power-exponential law, might actually have many applications far beyond blackbody radiation studies where it was first conceived. Einsteins photoelectric law is a simple linear law, as we see here, and was deduced from Plancks non-linear law for describing blackbody radiation. It appears that financial and economic systems can be modeled using a similar approach. Finance, business, economics and management sciences now essentially seem to operate like astronomy and physics before the advent of Kepler and Newton.
Acknowledgements With sincere thanks to many Internet sources that have been used to compile this document as evident by all the corporate logos and various photographs used here to make the presentation more interesting.
Page 63 of 63

Simple Mathematical Laws Govern Corporate Financial Behavior: A Brief Compilation of Profits-Revenues Data

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Simple Mathematical Laws Govern Corporate Financial Behavior: A Brief Compilation of Profits-Revenues Data

Uploaded by

Copyright:

Available Formats

Some Examples of Corporate Financial Behavior

From an understanding of Heat Engines to an understanding of Profits Engines

Rank 10 in Fortune 500 List published in 2012

Investor Relations > Financial Information

Fundamentals - Annual Income Statement

Profits, y [$, millions]

Leo Apothekar, President and CEO HP Annual Report 2010

4. Verizon Communications Inc. Fortune 500 List, Rank 15 in 2012

Comments Type III Behavior from 2008 to 2011

Type I Behavior 2002-2004

Profits, y [$, billions]

Profits, y [$, billions]

7 6 5 4 3 2 1 0 0 20 40 60 80 100 120 140 160

5. FORTUNE 500 List: Rank 19 in 2012

International Business Machines

Profits, y [$, billions]

20 15 10 5 0 -5 -10 0 20 40 60 80 100 120 140 160

6. FORTUNE 500 List for 2012

Rank 37. Microsoft

EPS $2.69 $2.10 $1.62 $1.62 $1.87 $1.44

Earnings (Profits), y $, billions

Number of shares, x [billions]

Earnings, E [$, billions]

Number of shares, S [$, billions]

Profits, x [$, billions]

30.00 25.00 20.00 15.00 10.00 5.00 0.00 -5.00 -10.00

y = 0.51x 2.28 = 0.51 (x 4.48)

y = 0.693x 25.3 = 0.693 (x 36.52)

Revenues, x [$, billions]

Profits, x [$, billions]

Type II behavior y = 0.176x + 4.31 line joining 1999-2009

Revenues, x [$, billions]

Profits, y [$, millions ]

Revenues, x [$, millions ]

7. 2012 Fortune 500 list Yahoo! Rank 483

Revenues and Profits [$, billions]

Profits [$, billions]

2.0 1.5 1.0 0.5 0.0 -0.5

Type III (2005-2008)

Revenues, x [$, billions]

Type III Behavior Decreasing Revenues Increasing Profits (2008-2011)

Profits [$, billions]

2.0 1.5 1.0 0.5

Revenues, x [$, billions]

8. 2012 FORTUNE 500 Rank 83. Delta Air Lines

2004 2005 2006 2007 2008 2009 2010 2011

468 827 843 844

-$19.06 -$1.50 $0.70 $1.01

Profits [$, billions]

Revenues, x [$, billions]

Costs, z = (x y) [$, billions]

z =(x y) = 0.721x + 9.28

Revenues, x [$, billions]

Profits [$, billions]

y = 0.33x 10.43 = 0.33(x 31.64) x > x0 = 31.64 equals profits

Revenues, x [$, billions]

9. 2012 FORTUNE 500 Rank 17. Apple

Revenues, x $, billions 108.6 65.1 36.3 32.5

2011 2010 2009 2008

$27.68 $15.15 $6.29 $5.36

Profits, y [$, billions]

30.0 25.0 20.0 15.0

10.0 5.0 0.0

y = 0.278x 4.28 with r2 = 0.99985