When Businesses Need Little or No Capital  475
R&D expenses among high-tech hardware manufacturers provided similar 
shifts in perceived performance levels and rankings (see the bottom portion 
of Exhibit 24.7).
Capitalizing intangibles can provide a better financial perspective on com-
petitive positions. Think of comparing current budgets on brand advertising 
between incumbents and new entrants in personal or household products. 
The comparison is not very useful if the incumbent brands have been built by 
many years of marketing efforts. Incumbents’ current advertising budgets will 
then underestimate the investments required by new entrants to reach similar 
levels of brand awareness among customers. A capitalized investment base 
can provide a more accurate estimate.
While insights from capitalizing resources are valuable, companies must 
take care. Left unchecked, managers could have an incentive to classify all 
expenses as investments, even those with no long-term benefits, because this 
will maximize reported short-term performance. They could also be reluctant 
to write off investments that prove worthless after they have been capitalized. 
For instance, a distribution channel may be kept open merely to avoid a write-
down on the manager’s economic balance sheet.
When Businesses Need Little or No Capital
Some businesses do not require significant amounts of capital—for example, 
those in the professional services sector, but also consumer electronics com-
panies with outsourced manufacturing. Because of these companies’ low or 
even negative capital base, ROIC can become less meaningful. In such cases, 
we recommend using economic profit as the key measure of value creation.
Capital-Light Business Models and ROIC
Examples of businesses with an inherently low need for capital include ac-
counting, legal counseling and other professional services, and real estate and 
other forms of brokerage services. Businesses such as software development 
and services have limited fixed capital needs, and customer license prepay-
ments and supplier financing often bring their overall invested capital close 
to zero. In these cases, capital is very low relative to earnings generated, and 
ROIC accordingly is high. Modest changes in an already small invested-capi-
tal base can lead to very large swings in ROIC, making ROIC in any particu-
lar year hard to use for performance management or financial planning and 
target setting.
Let’s illustrate with a stylized example of TradeCo, whose financial state-
ments are summarized in Exhibit 24.8. TradeCo is a trading company in 
plumbing supplies and tools. It has offices and a warehouse in a low-cost 
location. Inventories are kept to a minimum: except for those items with the 

476  Measuring Performance in Capital-Light Businesses
highest turnover, supplies and tools are purchased on customer order. Be-
cause TradeCo pays its suppliers after receiving payment on its own customer 
invoices, working capital is negative.
As Exhibit 24.8 shows, revenues, earnings, and free cash flow are fairly 
stable on a year-by-year basis. But as the graph in Exhibit 24.9 shows, ROIC 
fluctuates wildly and is even unmeasurable in some years, despite stable earn-
ings margins and healthy cash flows. The reason is that TradeCo’s invested 
capital is very small and sometimes even negative, mainly because of move-
ments in working capital. ROIC is not meaningful in 2015 and 2017 because 
the company had negative invested capital. ROIC is numerically negative, 
but it lacks any economic interpretation.8 Looking at the bottom of Exhibit 
24.8, we see that economic profit was positive in 2017, clearly indicating value 
creation. The movements in ROIC could mislead your assessment of perfor-
mance. For example, ROIC increased from 316 percent in 2019 to 632 percent 
EXHIBIT 24.8  TradeCo: Financial Statements
$ million
NOPAT
2015
2016
2017
2018
2019
2020
Revenues
200.0
209.0
212.1
216.4
214.2
212.1
Cost of goods sold
(160.0)
(165.1)
(169.7)
(175.3)
(171.4)
(170.7)
SG&A
(20.0)
(20.9)
(21.2)
(21.6)
(21.4)
(21.2)
Operating taxes
(7.0)
(8.0)
(7.4)
(6.8)
(7.5)
(7.1)
NOPAT
13.0
14.9
13.8
12.7
13.9
13.1
Invested capital
2015
2016
2017
2018
2019
2020
Net working capital
(12.0)
(8.4)
(10.6)
(2.2)
(4.3)
(6.4)
Net PP&E
10.0
9.5
9.1
9.0
8.7
8.4
Invested capital 
(2.0)
1.1
(1.5)
6.8
4.4
2.1
Free cash flow
2015
2016
2017
2018
2019
2020
NOPAT
13.0
14.9
13.8
12.7
13.9
13.1
Net investments
(2.0)
(3.1)
2.6
(8.3)
2.4
2.3
Free cash flow
11.0
11.9
16.3
4.4
16.3
15.4
Key value drivers, %
2015
2016
2017
2018
2019
2020
NOPAT/revenues
6.5
7.2
6.5
5.9
6.5
6.2
Invested capital/revenues
(1.0)
0.5
(0.7)
3.1
2.1
1.0
ROIC
N/M1
1,371
N/M
186
316
632
Economic profit
2015
2016
2017
2018
2019
2020
NOPAT
13.0
14.9
13.8
12.7
13.9
13.1
Capital charge2
0.2
(0.1)
0.1
(0.7)
(0.4)
(0.2)
Economic profit
13.2
14.8
13.9
12.0
13.5
12.9
1 Not meaningful.
2 Cost of capital equals 10%.
8 Mathematically, ROIC still ties perfectly with cash flow and value, following the fundamental logic 
described in Chapter 3.