In a recent article, I provided an overview of each critical characteristic. In this one, I want to explore the foundational aspect of capital efficiency in greater detail.
Those of you who are regular readers of these articles or listeners to the TIG Talk podcast know I miss very few opportunities to preach the gospel of capital efficiency. However, I recognize that I might not be operationally defining it in an actionable fashion. So, let’s take the time to do just that below.
Capital efficiency is measured along two axes. The first is contribution margin, and the second is time. The contribution margin is computed by taking gross revenue and subtracting all contra-revenue tied to its generation—for example, COGS, trade spend, freight, broker commissions, etc. The second axis, time, is the distance between capital deployment and when it returns as contribution margin.
Therefore, a highly capital-efficient brand sees every dollar deployed return a favorable contribution margin quickly. It is that simple!
So, how do you use capital efficiency as a guiding principle? That is not quite as simple. I suggest its use in three ways. The first is transactional. The second is by the customer, and the third is by sales channel. We will examine each.
Transactional
A great place to examine capital efficiency at a transactional level is eCommerce. Along the vertical axis, starting with the selling price and backing out COGS, pick, pack, ship, acquisition spend, platform fees, and any other direct expense, you arrive at the contribution margin per transaction. On the horizontal axis, you look at days sales of inventory (DSI) plus days sales outstanding (DSO) minus days payables outstanding (DPO). The three combined are the time elements of capital efficiency. With this information along both axes, you now have the information required to determine the capital efficiency of each eCommerce transaction.
Customer
Review the capital efficiency of each new key customer you plan or hope to bring on. The process is not much different from the above, but rather than transaction by transaction, you look at the aggregate transactions over an annualized period. For example, if you anticipate the annual revenue to be X, starting with the contribution margin, subtract all the contra-revenue associated with its generation. Contra-revenue items could include COGS, freight, trade spend, broker commission, etc. Next, you layer in the time axis, identifying the DSI, DSO, and DSP attached to serving this customer. I will risk being a total nerd and suggest plotting this on a graph and comparing it to other customers. Doing so will help you compare the value of one customer to the other as measured by capital efficiency.
Sales channel
Sales channels group similar customers or transactions by type and might include retail grocery, food service, eCommerce, and more. The process needed to examine the capital efficiency of a channel is, for all intents and purposes, the same as the process employed for the customer. You are simply aggregating more data points. At the channel level, you look at annual revenue minus all contra-revenue. Then, you will layer in DSI, DSO, and DSP. Just like in the above, I recommend plotting the different channels you serve graphically. Doing so will help you identify the most or least capital-efficient channels, helping you make more informed decisions about where to invest capital and other resources.
There is a reason that this is the first of the Tardigrade traits I discuss. Nothing will make a brand more nimble and resilient than being highly capital-efficient. I hope digging a bit deeper into this article was helpful. I’d love to hear your thoughts and field your questions. Please don’t hesitate to reach out.
