Aug 5, 2024 | Management, Operations
A phrase I am hearing a lot in conversation with my networks is: ‘this business model is capital light‘. It seems to most aspiring entrepreneurs this is preferable to ‘Capital heavy’, for the obvious reason that the upfront cash at start-up is less. However, while useful, it also is only one way of looking at a business model and its associated strengths and weaknesses.
Capital-intensive businesses have high fixed costs compared to variable costs, making them vulnerable to a slowdown, as they are very volume sensitive. Their breakeven point is higher than businesses less capital intensive. However, once they reach that break-even point, most of the rest is profit.
The obvious contrast is between an oil refinery or steel-making plant, to an accounting or law practice. The former needs considerable capital deployed before there is any consideration of the labour, management, and raw material required for conversion. The latter requires just offices and capable personnel.
In effect, Capital Intensity is a measure of how many dollars of capital are required to generate a dollar of sales?
Capital intensity requires that the assets be procured in order to be operational. This can be a mix of cash retained from earnings, or available from shareholders, loans, or ‘outsourcing’ manufacturing to a contractor who has, or will add, capacity for ‘rent’. An additional source is from suppliers so long as your debtor days are less than your creditor days, in which case, your creditors are in effect adding to the funding of your business.
Often you will see the term ROCE or Return On Capital Employed in financial reports. This is simply the ratio of profit to capital. If you generate $1 in profit for every dollar of capital, you will have a capital efficiency ratio of 1:1.
It is a useful macro measure of the efficiency of the capital used in the business, just as it is a valid calculation of the efficiency of a machine: Revenue/Capital cost of the machine.
Successful businesses use capital to generate revenue and profits, the more successful you are, the better you have used the capital deployed.
How much capital is required to generate your profits?
How to Calculate Capital Intensity
The capital intensity formula is:
Capital Intensity = Fixed Assets / Total Revenue
Example
Imagine a company has $100,000 in fixed assets and $1,000,000 in total revenue. The company’s capital intensity would be: $100,000 / $1,000,000 = 0.1
This means that the company needs 10 cents of capital to generate every dollar of revenue.
Increasingly, the capital required early in the life of a business is reducing as digital technology evolves, removing the capital requirement as a barrier to entry to many industry segments. This is leading to a transfer from capital intensive to ‘technology intensive’, which is in turn becoming increasingly complex and expensive as technology evolves at an accelerating rate, and the business cycles become shorter.
As the old saying goes, there is never a free lunch!
Jul 30, 2024 | AI, Leadership
Increasingly, we must distinguish between ‘content’ created by some AI tool, masquerading as thought leadership and advice, and the genuine output of experts seeking to inform, encourage debate and deepen the pool of knowledge.
I’m constantly reminded as I read and hear the superficial nonsense spread around as serious advice, of the story Charlie Munger often told of Max Planck and his chauffeur.
Doctor Planck had been touring Europe giving the same lecture on quantum mechanics to scientific audiences. His constant chauffeur had heard the presentation many times, and had learnt it by heart. One night in Munich, he suggested that he give the lecture while Doctor Planck acting as the chauffeur sat in the audience, resting.
After a well received presentation a question from a professor was asked to which the chauffeur responded, ‘I am surprised that in an advanced city like Munich, I get such an elementary question. I am going to ask my chauffeur to respond’.
It is hard at a superficial level to tell the difference between a genuine expert, and someone who has just learned the lines.
To tell the difference between those two you must
- Dig deeper to determine the depth of knowledge, where it came from. Personal stories and anecdotes are always a good market of originality.
- Understand how the information adjusts to different circumstances, and contexts. An inability to articulate the ‘edge’ situations offers insight to the depth of thinking that has occurred.
- Look for the sources of the information being delivered. Peer reviewed papers and research is always better than some random Youtube channel curated for numbers to generate ad revenue.
- Consider the ‘tone of voice’ in which the commentary is delivered. AI generated material will be generic, bland, average. By contrast, genuine originality will always display the verbal, written and presentation characteristics of the originator.
- Challenge the ‘expert’ to break down the complexity of the idea into simple terms that a 10 year old would understand.
These will indicate to you the degree of understanding from first principles, the building blocks of knowledge, that the ‘Guru’ has.
The header is a photo of Max Planck in his study, without his chauffeur.
Jul 22, 2024 | AI, Strategy
Our brains work on 3 levels.
At the most basic is the ‘reptilian brain.’ This is the ancient wiring that is common with every other animal. It monitors and manages the automatic things that must happen for life. Our instincts, temperature control, heart rate, respiration reproductive drives, everything necessary for the survival of the animal.
The limbic system. This manages our emotional lives, fear, arousal, memories, it is where we store our beliefs. It in effect provides the framework through which we look to make sense of the world.
The Neo cortex, the newest part of our brain that differentiates us from other animals. It is where we make choices, it controls our language, imagination, and self-awareness.
This three-part picture is a metaphor. The parts of the brain do not act independently, but in an entirely integrated manner, each having an impact on the others, and receiving input from the others.
Consider the parts of this complex interconnected and interdependent neuro system that is replaceable by AI. There is not all that many of them, beyond the extrapolation of language and imagery from what is in the past.
Despite the hype, we have a long way to go before artificial sentience will be achieved, if it is possible. (Expert opinion varies from ‘Within the decade’ to ‘Never’).
However, who cares?
The productivity gains from AI are present in some form in every current job, and the numbers of new jobs that will emerge are huge. Nobody had conceived of the job of ‘prompt engineer’ 3 years ago!
These new jobs in combination with the renewal of those currently available, will deliver satisfaction, and a standard of living out kids will thank us for.
Sadly, there is always a flip side. In this case it is the dark downsides we all see emerging from social media, which will also be on steroids, and the social dislocation that will occur to those on the sharp end of the changes in jobs.
How we manage that balance will be the challenge of the 2030’s.
Image by Canva.com
Jul 17, 2024 | retail, Strategy
The pile-on to Coles and Woolworths as protagonists in the ‘cost of living crisis’ and accusations of gouging, is somewhat akin to the ‘burning of witches’ in Salem in 1692. (in fact, most of the 16 executed were hanged, but never let a good story get in the way of a fact). The population just needs a victim to blame for their poor fortune, anyone will do, never mind their lack of guilt.
If there was any guilt involved in the lead up to the current ‘crisis’ it would have been allayed by a factual examination of the supply chains in use by retailers, and the drivers of those chains.
It is true that Coles and Woolworths are amongst the most financially successful retailers in the world. This is a position evolved from a long history of take-overs and mergers in the supermarket industry, endorsed by those with the power to stop them. Coles and Woolworths have by this process, as well as their own efforts to attract and keep consumers, have accumulated the scale that enables them to deliver superior returns their shareholders, a group that includes every Australian with superannuation. Had they not performed in this way, the boards of these businesses would have relieved be MD’s of their role. On occasions over the last 40 years I have been watching, there have been a number of MD’s so sent on gardening duty.
So, where should the blame be laid, if there is to be any laid?
None of the various reports have laid bare the mechanics of the supply chains at work. At best they refer to them in passing. However, the antidote to the unreasonable exercising of power back through a supply chain, which is the hypothesis of all the proponents of the gouging story, is transparency.
It is true that Coles and Woolworths can be brutal with their suppliers. Not every supplier is treated equally, and dumb, insensitive, and even discriminatory choices are made, but that situation exists in every walk of life. You do not address these shortcomings by regulation, you address them with transparency.
I used the two dimensional scale in the header to score Coles and Woolworths based on my experiences over 45 years. Despite the current voluntary code of conduct, seemingly about to be made mandatory, the transparency scores for both retailers are concentrated on the bottom left of the scale.
The first three ‘transparency milestones’ get a tick, as 1 or 2 out of five. They are present but only to ensure some level of quality and to protect the retailers from litigation.
The ‘supply chain scope’ measures for both give solid scores in the internal operations, a pass for direct suppliers, but nothing beyond a passing interest in the final two.
Divestiture will not change any of that. It would simply add cost to the supply chains previously wrung out by scale.
A break-up requires a party willing and able to stump up the capital to complete a transaction. To generate a return on that investment it would be necessary to rise prices to accommodate the increased costs. It is unlikely any domestic group would be a buyer, which just leaves an international chain being handed a stepping stone, which is equally unlikely to reduce process in any way.
If the authorities were really interested in adjusting the profitability of the retailers in favour of their suppliers, who have been scrambling for scale for as long as the retailers have, they need to throw the divestiture story into the bin marked ‘stupid idea’ and consider mechanisms that address the core of the problem: measures that favour those with capital at the expense of those who do not.
Divestiture makes a good headline in populist press, but like many good headlines, has absolutely no substance.
Header: courtesy of HBR ‘How transparent is your supply chain ‘ August 2019 Bateman & Bonanni
Jul 15, 2024 | AI, Governance, Leadership
In a world dominated by discussions around AI, electrification to ‘save the planet’ and its impact on white collar and service jobs, the public seems to miss something fundamental.
All this scaling of electrification to replace fossil fuel, power the new world of AI, and maintain our standard of living, requires massive infrastructure renewal.
Construction of that essential electricity infrastructure requires many skilled people in many functions. From design through fabrication to installation, to operational management and maintenance, people are required. It also requires ‘satellite infrastructure’, the roads, bridges, drivers, trucks, and so on.
None of the benefits of economy wide electrification and AI can be delivered in the absence of investment in the hard assets.
Luckily, investment in infrastructure, hard as it may be to fund in the face of competing and increasing demands on public funds, is a gift we give to our descendants.
I have been highly critical of choices made over the last 35 years which have gutted our investment in infrastructure, science, education, and practical training. Much of what is left has been outsourced to profit making enterprises which ultimately charge more for less.
That is the way monopoly pricing works.
When governments outsource natural monopolies, fat profits to a few emerge very quickly at the long-term expense of the community.
Our investment in the technology to mitigate the impact of climate change is inherently in the interests of our descendants. Not just because we leave them a planet in better shape than it is heading currently, but because we leave them with the infrastructure that has enabled that climate technology to be deployed.
Why are we dancing around short-term partisan fairy tales, procrastinating, and ultimately, delivering sub-standard outcomes to our grandchildren?
Header illustration via Gemini.ai
