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Capital investment as a driver for growth

Executive summary

Introduction

Capital investment is one of the key resource constituents for SMEs.

Typical deployment of capital investment is found in:

  • Plant and machinery

The typical source of capital investment is either from reinvestment of internal accruals or leveraging.

Some commonly found industries employing capital investment as the primary driver for growth are:

  • Plastics
  • Rubber
  • Chemicals
  • Packaging material
  • Paper
  • Infrastructure
  • Electronics

Product and Customer characteristics

Products are usually intermediates or accessories in the end customer’s own product or delivery.

The customers are characterized as follows:

  • Organized buyers
  • With technical expertise
  • High focus on cost
  • Defined quality parameters

Coexisting drivers

The product categories and customer characteristics lead us to usually find the following drivers to coexist with capital investment as the key driver:

  • Input purchase efficiency
  • Customer relationship management

The owner(s) usually take on the mantle of leading these drivers, be it managing customer relationships or hands on purchase decision making.

Strengths

The fundamental strength of companies leveraging capital investment as the key driver is the owner(s) involvement. The owner(s) involvement ensures that every decision has complete ownership.

Weaknesses

The strength of owner(s) involvement becomes a weakness, as it inhibits scalability.

The scalability is inhibited not only in numeric terms but also in an inability to handle complexity. We have therefore seen that companies leveraging capital investment usually participate in simple, single line product categories, both in the input and output stages.

Opportunities

Wherever, owner resources are available as in next generation or other members, we have seen opportunities being leveraged primarily through inorganic growth. Typically new capital infusion is used to start an additional business line.

Threats

Most product categories led by capital investment as a driver exhibit a low entry barrier.

The opportunity to ring fence the business either from a revenue or profit dimension seems limited.

Strategic options

We see several strategic options for companies leveraging capital investment as a driver.

The base line option is to “settle” for a “decent” ROCE model. In fact some companies said to us that they are satisfied with 18 to 24 % return on capital employed.

A more aggressive value building option we see is to combine the drivers of differentiated product or service and people competence along with capital investment.

We have seen this successfully done in businesses like electronics.

Imperatives

The so-called “vanilla” option of a decent ROCE will entail a continuous source of “cheap” capital as also a continuing commitment of time and attention by the owner.

This option also forces succeeding generations to participate in the same business, with less opportunity seen to professionalize.

The more aggressive option of combining new drivers entails exercising a choice of product category or more specifically deciding where in the customer’s value chain do you want to engage.

This option also entails professionalizing whether in people resources or in business processes.

Conclusion

In conclusion we observe that companies leveraging capital investment as a key business driver almost always entail the owner(s) to participate in base operations as also to take ownership of associated drivers of purchase efficiency and customer relationships.

While the entry barriers to such businesses are low, this can viewed as a threat for existing players as also placing a cap on the ROCE.

We recommend companies to focus on combining new drivers along with capital investment as a strategy to move up the value chain of engagement with customers thereby leading not only revenue but also profitability growth.

 

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