3 ways to use capital efficiency as a guiding principle3 ways to use capital efficiency as a guiding principle
Here's what entrepreneurs should know about using capital efficiency to become more nimble and resilient.
July 9, 2021
This article is a continuation of a series on the traits of a Tardigrade brand. In my last article, I provided an overview of each of the critical characteristics. In this one, I want to explore in greater detail the foundational aspect of capital efficiency.
Those of you who are regular readers of these articles or listeners to the TIG Talk podcast know that 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 of the contra-revenue tied to its generation. For example, COGS, trade spend, freight, broker commissions, etc. The second axis, time, is simply the distance between capital deployment and when it returns as contribution margin.
Therefore, a highly capital-efficient brand sees every dollar deployed returning 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 by sales channel. We will examine each of these below.
A great place to examine capital efficiency at a transactional level is e-commerce. Along the vertical axis, starting with 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 e-commerce transaction.
I recommend reviewing 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.
3. Sales channel
Sales channels group similar customers or transactions by type and might include retail grocery, food service, e-commerce 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 section, I recommend plotting the different channels you serve on a graph. Doing so will help you identify which of those channels are the most or least capital efficient, helping you make more informed decisions as to where to invest capital and other resources.
There is a reason that this is the first of the Tardigrade traits I discuss; in my experience and opinion, there is nothing that will make a brand more nimble and resilient than being highly capital efficient.
Elliot Begoun is the Principal of The Intertwine Group, a practice focused on helping emerging food and beverage brands grow.
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