Capital intensity is a measure of efficiency, in regard to how much money a company needs to spend to make money. Companies with high capital intensity are not operating very efficiently and may not hold a strong market position. Lower intensities suggest a higher return on investment. Some industries are naturally more intensive that others because of the infrastructure support they require in order to function.
A simple measurement of capital intensity can be made by dividing assets by sales revenue. For the purpose of this calculation, the assets include equipment, structures, labor, and other costs the company has incurred in order to produce products and services. If the capital intensity is greater than one, it means the company is spending more than it brings in. Ratios less than one indicate that the company is generating a return on its investments. The size of the return may vary.
Some reasons companies might have high capital intensity include the use of complex, expensive equipment and large numbers of laborers. Companies that need large, complicated machinery to produce products will need to spend more in order to produce, although this may equalize over the long term as the company’s initial investment in assets is spread out over many years. Labor intensive industries also require a lot of capital, because the company needs to pay workers in addition to paying taxes, purchasing insurance, and handling other costs associated with employees. These expenses can drive up the investment needed to generate returns.
A variety of measures can be used to lower capital intensity and make a company more efficient. Companies may try to cut costs by streamlining manufacturing, for example, or by reorganizing management structures. Employees themselves may have recommendations. Companies may also take a long strategic position, investing large sums one year in assets that will begin to pay for themselves over time. A temporary dip in profits might be an acceptable tradeoff for the eventual benefits.
Companies can use calculations of capital intensity for internal reference and research purposes. They may track not just performance as a whole, but also individual departments. Divisions within a company may be more or less efficient. Finding out which ones are not contributing to the bottom line may allow a company to restructure, withdraw some products, or change practices within a department to make it efficient again. These calculations can also be discussed in annual reports, where executives may wish to explain decisions to stockholders and other investors.
