When Businesses Need Little or No Capital  479
Because ROIC is multiplied by invested capital, economic profit auto-
matically corrects for any distortion in ROIC for business models with ex-
tremely low capital intensity. The TradeCo example in Exhibit 24.8 illustrated 
this. ROIC shows very large fluctuations over the years, even becoming un-
measurable in some years. In contrast, economic profit is fairly stable, just 
as TradeCo’s cash flows are stable and consistently positive over the years. 
Economic profit is a much better reflection of TradeCo’s underlying business 
economics. It provides more accurate insights into its historical performance 
and a useful basis for predicting s future performance.
As economic profit is a measure of return on capital in absolute terms, it is 
very useful for understanding whether value creation in a particular business 
has increased from one year to the next. But it is harder to use for interpreting 
differences in economic profit generated by businesses of different sizes. Take, 
for example, DiversiCo in Exhibit 24.11. DiversiCo is a diversified industrial 
company with business units in software, hardware, hardware services, and 
supplies. The business units are very different in size and economics. Hard-
ware, for example, has annual revenues of $2.5 billion, dwarfing the $100 mil-
lion in revenues generated by software development. The software business 
has negative invested capital, thanks to customer prepayments, whereas hard-
ware requires $1 billion in capital, mainly for manufacturing and distribution 
facilities and inventories. ROIC is meaningless for comparing performance 
across DiversiCo’s businesses, because software and hardware services have 
little or negative capital. Economic profit provides an accurate picture of value 
creation, but comparisons among businesses of such different sizes are diffi-
cult. Economic profit is lowest for the software business (at $25 million), not so 
much because of the business’s performance, but because of its size.
To better compare the value creation of DiversiCo’s businesses, scale eco-
nomic profit by revenues, turning it into a measure of value creation per dol-
lar of sales.10 As graphed in the final column of Exhibit 24.11, it now becomes 
clear that DiversiCo’s software business generates the highest value per dollar 
EXHIBIT 24.11  DiversiCo: Economic Profit Scaled by Revenues
25
17
10
4
25
43
73
103
n/m2
438
38
19
Invested
capital
Economic profit/
revenues,1 %
Economic
profit1
Software
Hardware
services
Supplies
Hardware
(5)
10
250
1,000
NOPAT
25
44
94
188
NOPAT/
revenues, %
25
18
13
8
Revenues
ROIC, %
100
250
750
2,500
1 Cost of capital equals 8.5%.
2 Not meaningful.
10 See M. Dodd and W. Rehm, “Comparing Performance When Invested Capital Is Low,” McKinsey on 
Finance (Autumn 2005): 17–20.

480 mEasuring pErformanCE in Capital-light BusinEssEs
of revenues, and its hardware business the lowest. Driving revenue growth in 
software development would therefore be most benefi cial for shareholders. 11
Scaling economic profi t in this way provides DiversiCo’s management with 
a better yardstick for decisions on resource allocation and portfolio strategy. 
 In the same way, the ratio of economic profi t over revenues can help in 
benchmarking performance with peers of different size and capital intensity. 
Consider the example of a branded-consumer-goods company, which we refer 
to as ReturnCo, in Exhibit 24.12 . ReturnCo is generating a ROIC of 105 per-
cent, far above its international peers’ ROIC levels of around 30 to 40 percent. 
But this does not necessarily mean that ReturnCo creates more value and that 
it has some source of competitive advantage over its peers. Following our 
rule of thumb, ROICs above 50 percent should be interpreted with caution 
and carefully analyzed. In this case, it turns out that ReturnCo provides its 
customers with aggressive discounts for early payment. The discount pushes 
its earnings margins below peer levels, but the early payments make its net 
working capital negative and reduce its invested capital. The net result is an 
exceptionally high ROIC. Comparing its ROIC with those of its peers is point-
less because of this difference in capital intensity, and absolute economic profi t 
will of course differ with the size of the competitors. Instead, an analysis of 
 11 Note how economic profi t over revenues is almost identical to NOPAT margin for capital-light busi-
nesses, such as software and hardware services in this example. This is easily explained by examining 
Equation 24.2 : when invested capital is 0, the capital charge is 0, and economic profi t is equal to NOPAT.
 EXHIBIT  24.12 Better Performance Comparison with Economic Profi t over Revenues 
%
Return on invested capital (ROIC)1
Peer 1
Peer 2
Peer 3
Peer 4
Peer 5
Peer 6
Peer 7
Peer 8
ReturnCo
Peer 9
Peer 10
22
29
25
29
28
28
33
32
105
34
39
Economic profit/revenues1
7.3
7.9
7.9
8.9
9.4
9.5
9.7
10.0
10.1
10.3  
15.3
1 Excluding goodwill and acquired intangibles.
 Source: Capital IQ, Corporate Performance Analytics by McKinsey.