These businesses or companies suffer misfortunes or losses at first yet over the long run, these companies or businesses acquire higher profits. But the gamble or risk included in such industries is additionally higher, thus the competition is impressively low. Return on Capital Employed (ROCE) measures profitability and the efficiency of capital use. It is calculated by dividing earnings before interest and taxes (EBIT) by capital employed, which includes shareholders’ equity and debt liabilities. For instance, a company with $50 million in EBIT and $250 million in capital employed has a ROCE of 20%. Automated productions is when the production process is mainly carried out by machinery/robots and is mostly controlled by computers.
In some of the organizations, being initial capital intensive is mandatory like power, utilities, automobiles, while there are other businesses where being high capital intensive is a choice such as software, streaming, etc. In such businesses or industries, the operating and maintenance cost will also be more as the assets need constant servicing and maintenance. However, such businesses save the tax as the devaluation or depreciation and other expenses are higher which brings about lower ROIs. Capital intensive prompts an increment in operating and other upkeep costs while labor-intensive prompts ideal use of labor resources which lessens the production cost. Capital intensive businesses need a huge amount of money while to be labor-intensive businesses demand an effective and enthusiastic labor force. For all such requirements, there will billions of USD dollars needed as upfront costs that will be included as assets in the balance sheet of the company.
All in all, analyzing the power that a company has and the capacity it has to keep the market share will help in understanding how capital intensive a business or project ought to be. The Asset Turnover Ratio (ATR) evaluates how efficiently a company uses its assets to generate sales. For example, a company with $400 million in sales and $200 million in average total assets has an ATR of 2.0. The telecommunications industry also requires significant capital outlays, particularly for infrastructure development. The deployment of 5G networks has driven companies to invest heavily in fiber optic installations and advanced network equipment.
Debt vs. Equity Financing Decisions
Market dynamics, such as competition and consumer demand, further impact capital intensity. In competitive markets, firms invest in advanced production facilities to achieve economies of scale and lower per-unit costs. The automotive industry illustrates this, with manufacturers adopting automated assembly lines to improve efficiency and respond to changing consumer preferences. Sectors like energy and utilities face stringent environmental and safety regulations, necessitating costly compliance investments.
Table of Contents
The choice of depreciation method—straight-line or accelerated—can influence financial statements and perceived profitability. Another way to measure a firm’s capital intensity is to compare capital expenses to labor expenses. For example, if a company spends $100,000 on capital expenditures and $30,000 on labor, it means the company is most likely capital-intensive. Likewise, if a company spends $300,000 on labor and only $10,000 on capital expenditures, it means the company is more service- or labor-oriented. Multiple reasons and decisions go into whether the company should be capital intensive. There are businesses where initial high capital is not a choice (utilities, power, automobiles), and there are businesses where high capital intensive nature is a choice (streaming, software, etc.).
Why is being Capital Intensive considered a barrier to entry in some industries?
You will just need to hire engineers and hence, the main upfront expenses will be their compensations or salaries. Some of the common examples of such industries can be transportation sectors such as airways, railways, waterways that need loads of investments in purchasing the transportation medium or creating the transportation medium. Industries with high capital requirements are often foundational to the global economy. The aerospace sector, for example, demands large investments in research, development, and the production of sophisticated aircraft and spacecraft. Companies like Boeing and Airbus spend billions annually to innovate and manufacture advanced fleets. Capital intensity refers to the weight of a firm’s assets—including plants, property, and equipment—in relation to other factors of production.
Economics
- Prof. Harvey Leibenstein, Paul Baran, Rostow, Hirschamn Maurice Dobb and Mahalanobis are the chief advocators of capital intensive technique.
- Besides operating leverage, the capital intensity of a company can be gauged by calculating how many assets are needed to produce a dollar of sales, which is total assets divided by sales.
- Examples of capital-intensive industries include automobile manufacturing, oil production and refining, steel production, telecommunications, and transportation sectors (e.g., railways and airlines).
- As technology evolves, businesses often invest in state-of-the-art machinery and equipment to remain competitive.
In case you are a utility service provider who wants to set up a plant for offering electricity, then for this, you will be required to build either wind, coal, or nuclear power stations. Additionally, such industries can prompt lower costs and higher wages that cause an optimized interest for a more assortment of services. Nonetheless, the growth of more capital-intensive industries creates new types of job opportunities like jobs in AI, software design, marketing, etc. Boosted capital intensity can be a reason behind the job of a few workers since they are will not be generally required after the advancements. Frequently the specialization takes place because nations were quick to produce and profited from their capital intensity.
Capital intensive technique refers to that technique in which larger amount of capital is comparatively used. In such a technique the amount of capital used per unit of output is larger than what it is in case of labour intensive technique. This technique fulfills two objectives of capital formation and skill. It raises agriculture production through the use of minor irrigation, better seeds, manure, implements and the introduction of short duration crops.
- These industries need heavy equipment and machinery, making them Capital Intensive.
- This is the inverse of the asset turnover ratio, an indicator of the efficiency with which a company is deploying its assets to generate revenue.
- As a result, capital intensive industries need a high volume of production to provide an adequate return on investment.
- For example, if a company spends $100,000 on capital expenditures and $30,000 on labor, it is most likely capital-intensive.
- Capital-intensive businesses need significant profit margins in order to remain operational.
- Companies in capital-intensive industries are often marked by high levels of depreciation.
Economic problem arises due to
For example, manufacturing, utilities, and transportation are often considered capital-intensive industries since they require large facilities, expensive machinery, and equipment. Investment in technologically complex devices or materials, as well as assets like real estate, also creates a capital-intensive environment. Mechanised production is when the production process requires both machinery and humans. Machines are required to carry out capital intensive technique refers to most of the work although they are operated and controlled by humans. While deciding whether a business or company should go for capital intensive setup or not, a few reasons or decisions go in the process.
Capital-intensive businesses will quite often have higher degrees of operating leverage that can be understood as the ratio of fixed costs to variable costs. Therefore, such industries need an optimized volume of production to give a sufficient ROI. It additionally implies that little changes in sales can prompt huge changes in profits and return on invested capital. While winding up this post, it is clear that capital intensive refers to those businesses or companies that invest more in capital resources or assets.
Prof. Paul Baran has the strong opinion about the necessity of using the capital intensive in less developed countries. Capital-intensive firms generally use lots of financial leverage, as they can use plant and equipment as collateral. However, having both high operating leverage and financial leverage is very risky, should sales fall unexpectedly. Capital Intensive refers to the business processes or industries that require large amounts of investment to produce a good or service and are typically characterized by high levels of depreciation of plant and machinery. The primary purpose and use of assessing whether a company or sector is capital intensive is to understand the scale of financial resources required for its operations and the nature of expenses.
The term “capital intensive” refers to business processes or industries that require large amounts of investment to produce a good or service. As a result, these businesses have a high percentage of fixed assets, such as property, plant, and equipment (PP&E). Companies in capital-intensive industries are often marked by high levels of depreciation. In finance, the term “capital intensive” refers to industries that require significant investment in physical assets to produce goods and services.
Labour intensive technique has been illustrated with the help of diagram I. In this diagramme, isoquant Q shows the initial level of output which is being produced by using OL labour and OC amount of capital. With the adoption of new technology a higher level of output is represented by the isoquant Q1; can be produced by the same amount of capital i.e.
The more a Capital Intensive business can produce, the lower the cost per unit of the product becomes. This is an example of economies of scale and is particularly prevalent in Capital Intensive industries. Hitesh Bhasin is the Founder of Marketing91 and has over a decade of experience in the marketing field.