8Return on Invested Capital
As Chapter 3 explains, the higher a company can raise its return on invested capital (ROIC), and the longer it can earn a rate of return on that capital greater than its cost of capital, the more value it will create. So it is critical to every strategic and investment decision to be able to understand and predict what drives and sustains ROIC.
Why do some companies develop and sustain much higher returns on capital than others? Consider a classic example from the days of the tech boom at the turn of the millennium. Two newcomers at the height of the boom in 2000 were the companies eBay and Webvan. In November 1999, eBay’s market capitalization was $23 billion, while Webvan’s was $8 billion. Over the years that followed, eBay continued to prosper, reaching a market capitalization of more than $70 billion in 2015, when it spun off its subsidiary PayPal. By mid-2018, the combined market capitalization of eBay and PayPal was more than $160 billion. Webvan, in contrast, disappeared into bankruptcy and liquidation after just a few years. To understand why, we can look at what these companies’ underlying strategies meant for their respective returns on invested capital.
The core business of eBay is an online marketplace that collects a small amount of money for each transaction between a buyer and a seller. The business needs no inventories or accounts receivable, and it requires little invested capital. Once the service started and a growing number of ...
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