Return on Invested Capital (ROIC) is one of the most important financial metrics for CEOs aiming to maximize long-term shareholder value. ROIC measures how efficiently a company uses its capital to generate profits. It answers the fundamental question: “Are we getting the best possible returns for the capital we’ve invested in the business?” For CEOs of mid-size companies, understanding and improving ROIC can make the difference between stagnation and sustainable growth.
This article explores seven key strategies for maximizing your ROIC and positioning your business for lasting profitability.
1. Improve Operational Efficiency
Operational efficiency plays a crucial role in maximizing ROIC. By improving the processes that drive day-to-day operations, companies can increase their profitability without having to raise a lot of additional capital. The goal is to generate more output (revenue) with the same or fewer resources.
Actionable Strategies:
- Automate Processes: Implementing technology to automate routine tasks reduces labor costs and increases productivity. Whether through AI, machine learning, or process automation tools, streamlining operations can lower operating expenses.
- Optimize Supply Chains: Identify inefficiencies in the supply chain and negotiate better terms with suppliers. Shorter lead times, bulk purchasing, and renegotiating contracts can improve cost structures, boosting ROIC.
Key Takeaway: Every percentage point gained in efficiency increases returns without needing additional capital. Focus on incremental gains in productivity and cost management, in order to improve ROIC.
2. Focus on Capital Efficiency
Capital efficiency is about ensuring that every dollar of invested capital yields maximum returns. This requires careful evaluation of how capital is deployed across the business and whether certain investments are yielding diminishing returns.
Actionable Strategies:
- Cut Unprofitable Projects: Regularly review the profitability of ongoing projects. If a project isn’t meeting your minimum ROIC target, redirect that capital to higher-performing areas.
- Manage Working Capital: Improve your working capital by reducing Days Sales Outstanding (DSO) and inventory levels, while optimizing payment terms with suppliers. Effective working capital management ensures that less capital is tied up in day-to-day operations, freeing it for higher-return activities.
Key Takeaway: Efficiently managing capital ensures that it is directed toward the most profitable areas of the business, boosting overall ROIC.
Pricing power refers to a company’s ability to raise prices without losing customers. Firms with strong pricing power are able to charge premium prices, which directly impacts margins and, therefore, ROIC. Improving your company’s pricing strategy can be a game changer.
Actionable Strategies:
- Differentiate Your Products: By offering unique, value-added features, businesses can justify premium pricing. Customer-focused innovation that sets your product apart from competitors can allow for price increases without sacrificing demand.
- Implement Dynamic Pricing: Use data to adopt a dynamic pricing strategy that allows your company to adjust prices based on real-time demand, supply, and customer segments.
Key Takeaway: Strong pricing power increases profitability without additional capital investment, driving up ROIC.
4. Invest in High-Return Growth Opportunities
While improving operational efficiency and cutting costs are important, growth investments are key to maximizing ROIC. The challenge is to identify opportunities that generate high returns on invested capital and align with your strategic objectives.
Actionable Strategies:
- Expand in High-Growth Markets: Identify high-growth sectors or geographic regions where your products or services have strong demand. For example, mid-size firms expanding into emerging markets often experience higher returns due to less competition and higher market growth potential.
- Acquire Complementary Businesses: Mergers and acquisitions (M&A) can be a powerful tool to improve ROIC if managed properly. Acquiring companies that enhance your product offerings or operational efficiency can lead to synergies and improved capital returns.
Key Takeaway: Growth investments should focus on areas that promise high returns. Always conduct due diligence and evaluate potential opportunities with a strong ROIC lens.
5. Reduce Cost of Capital
The cost of capital plays a significant role in determining ROIC. The lower the cost of capital, the higher your return on invested capital. For CEOs, reducing the cost of capital means managing debt effectively and securing lower-cost financing options.
Actionable Strategies:
- Optimize Debt Financing: When managed carefully, debt can be a cheaper form of financing compared to equity. Mid-size companies can maximize ROIC by refinancing debt at lower interest rates or utilizing debt for projects with guaranteed high returns.
- Improve Creditworthiness: By improving your company’s financial health (e.g., maintaining healthy profit margins, positive cash flow, and manageable debt levels), you can secure more favorable loan terms from lenders.
Key Takeaway: Reducing the cost of capital through debt optimization and improved creditworthiness directly enhances ROIC by increasing profitability relative to capital costs.
6. Enhance Asset Utilization
Maximizing asset utilization is another effective way to boost ROIC. This strategy involves ensuring that the company’s existing assets (like equipment, facilities, or intellectual property) are being used to their full potential to generate higher returns.
Actionable Strategies:
- Leverage Underutilized Assets: Conduct regular audits to identify underperforming or underutilized assets. For example, leasing excess office space or selling unused equipment can increase asset utilization.
- Outsource Non-Core Functions: Outsourcing non-core business activities such as IT services, logistics, or customer support can free up resources and reduce the capital invested in non-strategic areas.
Key Takeaway: Effective asset utilization allows businesses to generate more revenue without additional investment, driving ROIC improvements.
7. Measure and Monitor ROIC Regularly
Maximizing ROIC isn’t a one-time effort; it requires continuous monitoring and adjustment. Regularly measuring ROIC provides insights into which areas of the business are delivering the most value and which need improvement.
Actionable Strategies:
- Establish ROIC Benchmarks: Set clear ROIC targets for the entire business and individual projects. Hold teams accountable for achieving these targets, and make adjustments when they fall short.
- Conduct Regular ROIC Reviews: Schedule periodic reviews to evaluate the impact of capital allocation decisions on ROIC. This ensures that the company remains agile and can pivot as necessary.
Key Takeaway: Ongoing measurement and accountability ensure that capital is consistently deployed in ways that maximize returns.
Conclusion
Maximizing ROIC is a vital strategy for CEOs aiming to drive sustainable growth and profitability. By improving operational efficiency, managing invested capital more effectively, leveraging pricing power, and investing in high-return opportunities, CEOs can increase their company’s ROIC and overall value. Additionally, reducing the cost of capital and optimizing asset utilization are key levers that mid-size companies can pull to boost their financial performance.
Ultimately, ROIC is not just a financial metric; it’s a reflection of how well a company is using its invested capital to generate growth and shareholder value. For CEOs, maintaining a laser focus on maximizing ROIC can lead to long-term success.