Asset-intensive industries are industries that require big investments in fixed assets such as property, plant, and equipment (PP&E) to produce the goods or services they sell. Companies will have a high assets-to-sales ratio. Depreciation has a big impact on the income statements of companies in asset-intensive industries.
That’s the gist of it.
For a more comprehensive answer, keep reading:
What Are Asset-Intensive Industries
An asset-intensive industry (also called capital-intensive industry) is one where companies depend heavily on physical assets to generate revenue and operate effectively.
As a result, operating in these industries requires large capital expenditures in land, buildings, factories, facilities, machinery, infrastructure, vehicles, and equipment. All these are fixed assets.
This creates barriers to entry for new companies. Here’s why:
Asset-intensive companies often create economies of scale. This is when massive production facilities enable them to boost efficiency and reduce the cost of production per unit. A new company will have trouble competing with this cost advantage.
Not only are the required capital expenditures significant, but they take a while to generate returns. New entrants must be prepared to face long payback periods.
Not to mention the competitive advantage existing players have in terms of the established relationship with suppliers and customers. Asset-intensive organizations usually deal with million-dollar contracts. As a result, relationships build up over time. New entrants may struggle to establish similar connections.
Asset-intensive industries contrast with labor-intensive industries, where businesses rely heavily on manual labor, skills, and human effort to deliver goods or services. The most significant component of their expenses is the cost of labor.
They also contrast with software-based businesses such as SaaS and tech startups, where new technologies (intangible assets) drive the generation of revenue, rather than physical assets.
Now, what are examples of these asset-intensive industries?
Asset-Intensive Industries Examples
Some examples of asset-intensive industries include:
- Energy and utility sector: This is oil and gas production and refining. It requires big investments in refineries, pipelines, storage facilities, and distribution networks. Heavy machinery, drilling rigs, offshore platforms, and processing equipment. You get the picture.
- Automobile manufacturing: Companies in this sector rely on fixed assets such as assembly lines, robotics, specialized machinery, and tools.
- Metals and mining: Extracting and processing minerals, metals, oil, gas, and other natural resources requires large-scale asset investment in blast furnaces, rolling mills, excavation equipment, and processing facilities.
- Telecommunications: What does it take to establish a communication network? Fiber-optic cables, cell towers, and data centers. All of which are physical assets that require high capital expenditures.
- Infrastructure: Building motorways, bridges, railways, tunnels, and airports require heavy machinery, equipment, and materials for earthworks, paving, structural components, and utility systems. The public sector is often responsible for planning, financing, and developing these critical infrastructure projects.
- Transportation: For instance, airlines. It’s asset-intensive because of the need for large-scale transportation infrastructure, fleets, and maintenance facilities.
- Semiconductors: Asset-intensive due to the sophisticated manufacturing equipment needed.
- Real estate: Owning and developing physical properties, including land, buildings, and housing units requires substantial capital.
All these industries require massive amounts of capital expenditures.
Ok, you have a list of asset-intensive industries. But how do you determine asset intensity?
How to Measure Capital Intensity of a Business
The most common way to measure the capital intensity of a business is by comparing the value of its assets to its revenue—total assets divided by sales.
The total assets to revenue ratio tells you how much in assets the company needs for every dollar of revenue it generates. (This is the inverse of the asset turnover ratio.) A higher ratio indicates a significant portion of the revenue is tied to the value of physical assets.
Another useful ratio is fixed assets to total assets. It measures the proportion of fixed assets (buildings, machinery, equipment) to the total assets of the company. Industries with a higher ratio have a higher reliance on fixed physical assets.
Also, compare how much the company spends in capital expenditures to expand its capital assets, versus service or labor-oriented expenses. Companies in asset-intensive industries will likely have a significant difference between both.
Along the same line, you can measure asset intensity by looking at the physical capital per worker. For example, the process of manufacturing cars requires a substantial amount of expensive equipment for each worker.
It’s also worth knowing the downsides of operating in asset-intensive industries:
Challenges Faced in Asset-Intensive Industries
Businesses in asset-intensive industries have high fixed costs such as overhead, namely administrative costs, insurance, property taxes, and utility bills. There are also the maintenance costs of the assets, which are essential to ensure their longevity, productivity, and operational efficiency.
High fixed costs make these companies much more vulnerable to economic downturns when compared with labor-intensive businesses. Why?
Firstly, it means asset-intensive industries have lower profit margins.
And secondly, companies pay fixed costs even when the industry is in recession. In contrast, businesses with a higher percentage of variable costs will see a decrease not only in revenue but also in costs during a recession.
Depreciation is another item with a significant impact on the income statement of capital-intensive businesses.
The cost of the physical assets used in these industries is spread over their useful life through depreciation.
It’s important to keep this in mind when valuing a company through relative valuation. The difference between the EBITDA multiple and the EBIT multiple will be significant. More so than companies in other industries.
Asset-intensive firms require lots of capital investments to acquire new physical assets and maintain their existing assets. As a result, they tend to prefer using debt financing over equity.
It’s common for projects to take a long period until they start generating positive cash flows. Debt allows these businesses to spread payments over time as revenues start coming in.
Also, physical assets have stable value. Thus, they’re perfect collateral for loans, making it easier for companies to secure funding from banks at favorable terms.
However, this highlights another disadvantage of capital-intensive industries. Although debt is cheaper than equity, having both high fixed costs and high leverage is a big risk. Any sudden drop in revenue can put the company out of business.
Frequently Asked Questions (FAQs)
What are the most asset-intensive industries?
Asset-intensive industries are those where companies heavily rely on significant investments in physical assets to conduct their operations and generate revenue. These industries include sectors such as manufacturing (especially automobile and steel production), energy and utilities (including oil and gas exploration, production, and refining), mining and metals extraction, infrastructure development (motorways, airports), transportation (railways and airlines), telecommunications, and real estate.
What are the characteristics of capital-intensive industries?
Businesses in asset-intensive industries face high fixed costs. During a recession, they continue paying these while companies with higher variable costs have more flexibility. Depreciation is a significant item affecting the income statement for capital-intensive businesses, as the cost of physical assets is spread over their useful life. They also tend to use lots of leverage, as physical assets are suitable collateral for loans.
What industries are not capital-intensive?
Asset-light industries do not heavily rely on significant investments in physical assets to conduct their operations. Instead, human resources, intellectual capital, and knowledge-based services drive revenue. Examples include software development, consulting, digital marketing, media, design, and most online businesses. These companies generally require lower initial capital investments and their value proposition is based on expertise, skills, and innovation rather than large-scale physical assets.
