Return on Invested Capital Notes
Ch 4: Return on Invested Capital
1. Drivers of Return on Invested Capital
ROIC = (1-Tax Rate)*((Price per Unit-Cost per Unit)/Invested Capital per Unit)
A company with a competitive advantage will have a higher ROIC because it either can charge a premium price or can produce at a more efficient cost.
The structure-conduct-performance (SCP) framework is the strategy model that underlies our thinking about what drives competitive advantage and ROIC.
The structure of an industry influences the conduct of the competitors, which in turn drives the performance of the companies in the industry.
The intensity of competition in an industry is determined by (Porter’s 5 forces):
Threat of new entry
Pressure from substitute products
Bargaining power of buyers
Bargaining power of suppliers
Degree of rivalry among existing competitors
The industry structure and competitive behavior aren’t fixed; they’re subject to shocks of technological innovation, changes in government regulation, and competitive entry.
2. Competitive Advantage
Sources of Competitive Advantage:
Price Premium – offer any business the greatest scope for achieving an attractive ROIC, but is harder to achieve than cost efficiencies.
Innovative products
Quality
Brand
Customer lock-in
Rational price discipline
Cost and Capital Efficiency
Innovative business method
Unique resources
Economies of scale
Scalable product/process
3. Sustainability of Return on Invested Capital
In a perfectly competitive economy, ROICs higher than the WACC get competed away.
Whether a company can sustain a given level of ROIC depends on:
Length of Product Life Cycle
The longer the life cycle of a company’s businesses and products, the better its chances of sustaining its ROIC.
Persistence of Competitive Advantage
If a company cannot prevent competition from duplicating its business, high ROIC will be short-lived.
Advantages that rise from brand and quality on the price side and scalability on the
1. Drivers of Return on Invested Capital
ROIC = (1-Tax Rate)*((Price per Unit-Cost per Unit)/Invested Capital per Unit)
A company with a competitive advantage will have a higher ROIC because it either can charge a premium price or can produce at a more efficient cost.
The structure-conduct-performance (SCP) framework is the strategy model that underlies our thinking about what drives competitive advantage and ROIC.
The structure of an industry influences the conduct of the competitors, which in turn drives the performance of the companies in the industry.
The intensity of competition in an industry is determined by (Porter’s 5 forces):
Threat of new entry
Pressure from substitute products
Bargaining power of buyers
Bargaining power of suppliers
Degree of rivalry among existing competitors
The industry structure and competitive behavior aren’t fixed; they’re subject to shocks of technological innovation, changes in government regulation, and competitive entry.
2. Competitive Advantage
Sources of Competitive Advantage:
Price Premium – offer any business the greatest scope for achieving an attractive ROIC, but is harder to achieve than cost efficiencies.
Innovative products
Quality
Brand
Customer lock-in
Rational price discipline
Cost and Capital Efficiency
Innovative business method
Unique resources
Economies of scale
Scalable product/process
3. Sustainability of Return on Invested Capital
In a perfectly competitive economy, ROICs higher than the WACC get competed away.
Whether a company can sustain a given level of ROIC depends on:
Length of Product Life Cycle
The longer the life cycle of a company’s businesses and products, the better its chances of sustaining its ROIC.
Persistence of Competitive Advantage
If a company cannot prevent competition from duplicating its business, high ROIC will be short-lived.
Advantages that rise from brand and quality on the price side and scalability on the