Return on invested capital

A company s ROIC can be disaggregated so the root causes for key drivers in ROIC can be identified. ROIC can be expressed as  

ROIC = (I - Operating cash tax rate) x (EBITDA/Revenues) x (Revenues/Invested capital) 

Profits = (Price x Volume in units) - Fixed costs - (Variable cost per unit X Volume in units) 

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Although numerous cases have been documented where petroleum refineries have simultaneously reduced pollution outputs and operating costs through pollution prevention techniques, there are often barriers to their im-plementation. The primary barrier to most pollution prevention projects is cost. Many pollution prevention options simply do not pay for themselves, or the economics often appear marginal. Corporate investments typically must earn an adequate return on invested capital for the shareholders and some pollution prevention options at some facilities may not meet the requirements set by company policies. 

We therefore chose to examine the performance of chemical companies in relation to some easily measurable dimensions of their corporate activity - such as product portfolio, scale, geography, market position, and product focus. By classifying companies this way, we were able to test a number of hypotheses about what drives the creation of value, measured by total return to shareholders (TRS), market-to-book value, and pre-tax return on invested capital (ROIC). Data from the last full commodity cycle (1992 to 2003) generated surprising insights.5 ... 

The first finding for the commodity segment is that size does matter. Larger companies had less cyclical (though not higher) returns on invested capital, and the less cydical returns correlated, albeit mildly, with higher total returns to shareholders. These companies were not only able to cut their production costs, but also had suffidendy diversified offerings - and therefore sufficiently stable cash flows - to weather cycles for individual products. 

Depending on the answers to these questions, companies must shape a leading edge portfolio in which the corporation is the best owner across all of its businesses. Our studies show that focused specialty players can boast a higher return on invested capital. Companies with too diverse a portfolio and a lack of critical mass vis-a-vis customers and suppliers will increasingly suffer from competitive... 

The industrial gases industry routinely manages to earn attractive return rates. From 1992 to 2004, the average annual return on invested capital (ROIC) before tax was 13.6 percent. The industry s profitability was thus between that of specialty chemicals (17.8%) and commodities (12%), but more stable. In 2004, industrial gases almost came out on top of specialties, due to the latter s declining profitability in the second half of the 90s (Fig. 11.2).3) Air, its main raw material, is free , and its products are probably the purest commodities from a chemical point of view. In any case, the industrial gases industry has managed to deliver better and less volatile returns than the commodity chemicals sector. 

Since the mid-nineties, more and more chemical companies have come to realize the importance of shareholder value, and it is crucial for this development to continue. In such a capital-intensive industry, the lack of focus on value creation (and the use of ROS as the key ratio) will typically lead to relatively low returns on invested capital. Ultimately this creates a situation in which even successfuF players do not generate value and, in some cases, actually destroy it the typical spread (i.e., the difference between return on invested capital and capital costs) for chemical companies lies between -3 percent and -f5 percent, with only a few exceptions. 

This development resulted in a relatively satisfactory stock performance in comparison with other basic materials industries such as steel and, in general, was more or less in line with the market as a whole until the mid 1990s (Fig. 3.3). The Asian crisis, however, proved quite a setback - wiping an estimated USD 25 billion off the industry s economic profit (return on invested capital minus WACC times invested capital) for Asian companies alone. The recovery of the Asian markets saw no matching improvement in the perception of the chemical industry by... 

It is vitally important to translate the various outward-looking perspectives into measurable and concrete technical targets for production managers and front-line personnel. Detailed value-driver trees are an excellent tool for establishing a direct link between financial indicators at the corporate level - such as Return on Invested Capital - and hands-on technical indicators that mean something to a production unit, such as tonnes of steam per tonne of product (Fig. 12.3). 

While the third type of classification is in line with a global trend in the food industry (and well beyond the food industry), it still falls short of a real consumer-centric approach. In order to spot real business opportunities, food companies are today in a process to better understand the (unsatisfied) needs and motivations of their actual and potential costumers, to whom they want to offer profitable solutions. For which needs a company decides to offer solutions depends on what the company considers as its core - markets, brands, categories, (proprietary) technologies, know-how - as well as on metrics related to short and long-term expectations on return on invested capital (ROIC), so as to focus the efforts entirely on it. 

Rank Company Sales (millions) Net income (millions) Profit margin (%) Return on invested capital (%)... 

Economic surplus (ES) = (return on invested capital (roic) % - weighted average cost of capital (wacc) %) x invested capital (ic)... 

We aren t just talking about reducing costs either we are talking about implementing projects that add value to our companies, projects that drive revenue growth, deliver positive cash flow well into the future, and deliver satisfactory levels of return on invested capital (ROIC). 

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