Return on Capital

As we've been discussing, return on capital is one of the two core drivers of value creation. Yet it's surprising to us how often executives can't identify the one or two factors that most influence their company's ROIC—namely, what is the business's competitive advantage and how is it affected by the industry's structure and competitive behavior? These companies are likely missing value creation opportunities.

This chapter explores how competitive advantage, industry structure, and competitor behavior drive ROIC: why some companies earn 10 percent returns while others earn 50 percent returns. We also provide a historical context for ROIC trends, such as how they vary across industries and how they fluctuate or persist over time.

To illustrate, let's go back to the height of the tech boom with two newcomers at the time, eBay and Webvan, a California-based grocery delivery company. In November 1999, eBay's market capitalization was $23 billion, while Webvan's was $8 billion. eBay continued to prosper while Webvan disappeared. Analyzing the potential competitive advantage in their strategies would have shown that eBay was destined for success and Webvan was doomed.

Let's look at eBay's strategy. Its core business is online auctions that collect a small amount of money for each transaction between a buyer and a seller. The business requires little capital for managing its web site and facilitating transactions, needing just some computers but no inventories or ...

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