An owner with several locations has a limited amount to invest each year. The instinct is to back the largest location, because it brings in the most. That instinct can be wrong in two ways, and return on invested capital (ROIC) shows both. The largest location may already be close to the most it can sell. And it may be in a market where every improvement costs more.
Revenue measures size, ROIC measures return
Revenue tells you how big a location is. Return on invested capital tells you how much profit each dollar tied up in it produces.
Two locations with the same revenue can have very different returns. One may have needed a costly fit-out and carries a large lease. The other may run on older equipment that is fully paid for. Investing in the first earns less per dollar, even though the top line looks the same.
How to measure it per location
Operating profit by location. Start with the location's own results, then deduct its share of head-office and shared costs. Without that step, every location looks more profitable than it is. We cover how in allocating head-office costs.
Capital invested in the location. Fit-out and equipment at cost less depreciation, plus the working capital the location ties up in receivables and inventory, less what it owes suppliers.
Divide the first by the second. Track it over time. A single year can be distorted by a refurbishment or a one-off gain.
Returns fall as a location fills up
Every location has a ceiling: the most it can sell given its space, its market and its hours. Far from the ceiling, investment in marketing, staff or capacity produces strong returns. Close to it, each extra dollar buys less, because there is little more to sell.
So the right question for each investment is not "which location is best" but "which location earns the most on the next dollar". The answer often favours a smaller location with room to grow over a large one near its limit.
When a location approaches its ceiling, taper investment there. Keep it well run and maintained, and move growth capital to where it earns more.
Higher-cost markets
A location in a more expensive market may bring higher prices. It usually also brings higher rent, wages and costs to make any change. Revenue can rise while return falls. Compare return, not price, before deciding a premium market is the better bet.
Put it in front of the decision
Show return by location, with its trend, next to each investment request. A request to expand a location near its ceiling should have to explain why it beats the alternatives. Most of the value of the measure comes from asking that question every time.
What return on invested capital will not tell you
It will not tell you about strategic value. A location may earn a lower return and still matter because it anchors a market, trains managers or keeps a competitor out.
It will not tell you about people either. The right manager can lift a location's ceiling. The same investment under a weaker manager can produce much less.
Frequently asked questions
What is return on invested capital for a location?
The location's operating profit, after its share of shared costs, divided by the capital invested in it, including fit-out and equipment net of depreciation and the working capital it uses.
Why compare locations on return rather than revenue?
Revenue shows size, not efficiency. Two locations with similar revenue can earn very different returns on the capital they use, and investment should go where each dollar earns the most.
When should a business slow investment in a location?
When the location approaches the most it can sell. Close to that ceiling, each extra dollar invested earns less, and capital usually does better in locations with room to grow.
Are higher-cost markets better places to invest?
Not automatically. Higher prices often come with higher rent, wages and investment costs. Compare return on invested capital before assuming a premium market earns more.
Where CFOLogic fits
We build location-level results after allocating shared costs, measure the capital each location uses, and put return by location next to every investment decision. Navigator, our software, consolidates multi-entity groups each morning, so location results are current when the decision comes up.