142  Return on Invested Capital • There are large variations in rates of ROIC within industries. Some com- panies earn attractive returns in industries where the median return is low (e.g., Walmart), and vice versa. • Relative rates of ROIC across industries are generally stable, especially compared with rates of growth (discussed in the next chapter). Industry rankings by median ROIC do not change much over time, with only a few industries making a clear aggregate shift upward or downward. These shifts typically reflect structural changes, such as the widespread consolidation in the defense and airline industries over the past two decades and the maturing of the biotech industry. Individual company returns gradually tend toward their industry medians over time but are generally persistent. Even the 2008 financial crisis did not upset this trend. ROIC Trends and Drivers Relatively stable ROIC levels from the early 1960s to the early 2000s are evi- dent in Exhibit 8.3, which plots median ROIC between 1963 and 2017 for U.S.- based nonfinancial companies.7 In that exhibit, the measure of ROIC excludes goodwill and acquired intangibles, which allows us to focus on the under- lying economics of companies without the distortion of premiums paid for acquisitions (discussed later in the chapter). 7 The numbers in this section are based on U.S. companies because longer-term data for non-U.S. companies are not readily available. EXHIBIT 8.3  ROIC of U.S.-Based Nonfinancial Companies, 1963–2017 ROIC excluding goodwill, % 5 10 0 15 20 25 30 35 40 45 1st quartile Median 3rd quartile 2000 2005 2010 2015 1995 1990 1985 1980 1975 1970 1965 Source: Corporate Performance Analytics by McKinsey. An Empirical Analysis of Returns on Invested Capital  143 Until the 2000s, the median ROIC without goodwill was about 10 percent. Furthermore, annual medians oscillated in a tight range, with higher returns in high-GDP-growth years and lower returns in low-growth years. Since the 2000s, however, median ROIC without goodwill has increased to what appears to be a new level of about 17 percent in 2010 and beyond. Notice also that the spread between the first and third quartiles has widened. The first-quartile company earned around 5 to 7 percent during the entire period, while the third- quartile company’s return has increased from the midteens to over 35 percent. In fact, the entire distribution of ROIC has widened as more and more companies earn high returns on capital. Exhibit 8.4 shows the distribution of ROICs over different eras. In the 1965–1967 period, only 14 percent of com- panies earned more than a 20 percent ROIC, compared with 45 percent in 2015–2017. At the same time, the share of companies earning less than 10 per- cent has declined from 53 percent to 30 percent. One factor powering the shift in the median ROIC is the steady increase of operating margins across sectors since the mid-1990s. As shown in Exhibit 8.5, the median operating margin (NOPAT over sales) has risen by two percent- age points. When higher margins combine with improved capital productivity (lower invested capital over sales), returns on capital rise. The U.S. economy’s changing industry mix serves as an even more powerful driver and helps to explain the widening dispersion of returns. Among U.S.-based nonfinancial companies, the share of operating profits from companies in the life science and technology sectors increased from 19 percent of total operating profits in 1995 to 38 percent in 2017.8 This impressive increase has been driven by the EXHIBIT 8.4  Distribution of ROIC % of companies with given annual ROIC excluding goodwill, by time period 0 10.0 5.0 15.0 20.0 25.0 30.0 35.0 40.0 45.0 50.0 0–5 <0 5–10 20–25 15–20 10–15 40–45 35–40 30–35 25–30 45–50 >50 ROIC range 1995–1997 1965–1967 2005–2007 2015–2017 Source: Corporate Performance Analytics by McKinsey. 8 We defined life science and technology sectors to comprise pharmaceuticals, biotechnology, health- care equipment and supplies, information services and software, and technology hardware, storage, and peripherals.