Traction Efficiency Ratio: A Key Metric for Assessing ROI in Consumer Packaged Goods
In the fast-paced world of Consumer Packaged Goods (CPG), where competition is fierce and margins can be razor-thin, understanding how efficiently a company converts its capital into revenue is critical. One powerful metric for evaluating this is the Traction Efficiency Ratio (TER), which offers unique insights into a company’s Return on Invested Capital (ROIC) and can serve as a leading indicator of future equity dilution.
What is the Traction Efficiency Ratio?
The Traction Efficiency Ratio is a financial metric that measures how effectively a company generates revenue relative to the capital invested in its operations. While not as commonly cited as traditional efficiency ratios like inventory turnover or asset turnover, TER is particularly useful in high-growth industries like CPG, where companies often rely on significant capital investments to scale production, distribution, and marketing.
TER is typically calculated as:
TER = Revenue / Invested Capital
Where:
Revenue is the total net sales over a specific period.
Invested Capital includes equity and debt used to finance the company’s operations, often calculated as total assets minus current liabilities or as non-current liabilities plus total equity.
A higher TER indicates that a company is generating more revenue per dollar of invested capital, reflecting efficient capital allocation. This efficiency is a strong driver of ROIC, which measures the return generated on all capital invested in the business (ROIC = Net Operating Profit After Tax / Invested Capital). A high TER often correlates with a high ROIC, signaling that the company is not only profitable but also adept at utilizing its resources to drive growth.
Why TER Matters for ROIC
The Traction Efficiency Ratio is a forward-looking metric that complements ROIC by focusing on revenue generation rather than just profitability. Here’s why it’s a critical tool for investors and CPG leaders:
Capital Efficiency Insight: TER highlights how well a company turns capital into sales, which is especially important in CPG, where heavy investments in inventory, branding, and distribution are common. A high TER suggests a lean operation that maximizes revenue without excessive capital expenditure.
Predictive Power for Growth: Unlike ROIC, which focuses on after-tax profits, TER emphasizes top-line revenue generation. This makes it a leading indicator of a company’s ability to scale efficiently, which is critical for forecasting future profitability and cash flow.
Indicator of Future Dilution: In CPG, companies often raise additional capital to fund growth, which can dilute existing shareholders’ equity. A low TER may signal that a company requires more capital to achieve revenue growth, increasing the likelihood of future funding rounds and dilution. Conversely, a high TER suggests the company can grow revenue with less capital, reducing the need for dilutive financing.
Industry Benchmarking: TER allows for easy comparison across CPG peers. Since CPG companies vary widely in their business models (e.g., food vs. personal care), TER provides a standardized way to assess capital efficiency relative to industry norms.
Real-World CPG Example: Beyond Meat vs. Oatly
To illustrate the power of TER, let’s compare two prominent CPG companies in the plant-based space: Beyond Meat(plant-based meat alternatives) and Oatly (plant-based dairy). Both companies have raised significant capital to fuel growth, but their traction efficiency tells different stories about their capital utilization and potential for future dilution.
Beyond Meat
Revenue (2022): $418.9 million (based on public financials).
Invested Capital (2022): Approximately $1.2 billion (estimated as total assets minus current liabilities, derived from balance sheet data).
TER: $418.9M / $1.2B ≈ 0.35x. This means Beyond Meat generated $0.35 in revenue for every dollar of invested capital.
Beyond Meat’s relatively low TER reflects its capital-intensive model, with significant investments in R&D, manufacturing facilities, and global marketing to establish its brand in the competitive plant-based meat market. While the company has achieved strong brand recognition, its low TER suggests it requires substantial capital to drive revenue, which could lead to higher ROIC only if profitability improves significantly. Additionally, a low TER raises concerns about future dilution, as Beyond Meat may need to raise more capital to sustain growth, especially if margins remain under pressure due to high production costs and competition.
Oatly
Revenue (2022): $722.2 million (based on public financials).
Invested Capital (2022): Approximately $1.5 billion (estimated similarly).
TER: $722.2M / $1.5B ≈ 0.48x. Oatly generated $0.48 in revenue per dollar of invested capital.
Oatly’s higher TER indicates better capital efficiency compared to Beyond Meat. Its focus on scalable products like oat milk, which require less complex production processes than plant-based meat, allows Oatly to generate more revenue per dollar invested. This suggests a stronger potential for ROIC improvement as the company optimizes its operations. Moreover, Oatly’s higher TER implies a lower reliance on additional capital raises, reducing the risk of future equity dilution compared to Beyond Meat.
Key Takeaways from the Comparison
Capital Efficiency: Oatly’s higher TER (0.48x vs. 0.35x) shows it generates more revenue per dollar of capital, making it a more efficient operator in the CPG space.
ROIC Implications: A higher TER often foreshadows stronger ROIC potential, as efficient revenue generation can translate into higher profits if costs are managed well. Oatly’s model appears better positioned for long-term profitability.
Dilution Risk: Beyond Meat’s lower TER suggests it may need more capital to sustain growth, increasing the likelihood of issuing new shares and diluting existing shareholders. Oatly, with a higher TER, may face less pressure to raise funds, preserving shareholder value.
TER as an Indicator of Future Dilution
In the CPG industry, where growth often requires heavy upfront investments, TER can serve as a red flag for future dilution. Companies with low TERs, like Beyond Meat, may struggle to scale without additional capital, especially if their revenue growth doesn’t keep pace with their capital expenditures. Issuing new shares or convertible securities (like SAFEs or convertible notes) to fund growth dilutes existing shareholders’ ownership. For example, if Beyond Meat issues 500,000 new shares to raise capital, an investor holding 10% of the company (100,000 shares out of 1,000,000) would see their stake drop to 6.67% (100,000 out of 1,500,000).
Conversely, a company like Oatly, with a higher TER, can generate more revenue with less capital, reducing the need for frequent funding rounds. This efficiency not only supports a stronger ROIC but also mitigates dilution risks, making it more attractive to investors concerned about long-term value.
Why CPG Leaders Should Track TER
Strategic Decision-Making: A low TER may prompt leaders to optimize operations, such as streamlining supply chains or reducing marketing spend, to boost revenue efficiency.
Investor Confidence: High TER signals to investors that the company can scale without excessive capital, boosting confidence in its financial health and reducing perceived risk.
Sustainability: In an industry increasingly focused on sustainability, efficient capital use (reflected in a high TER) aligns with lean operations that minimize waste and environmental impact.
Conclusion
The Traction Efficiency Ratio is a powerful lens for evaluating how effectively CPG companies deploy capital to drive revenue, offering a clear link to ROIC and a window into future dilution risks. By comparing Beyond Meat and Oatly, we see how TER highlights differences in capital efficiency and growth sustainability. For CPG leaders and investors, tracking TER alongside traditional metrics like ROIC can provide a competitive edge in navigating the complex landscape of consumer goods.
As the CPG sector evolves with innovations like plant-based and synthetic meat, mastering metrics like TER will be key to staying ahead. What’s your take on capital efficiency in CPG? Are you tracking TER in your business or investments? Let’s connect and discuss!
Sources:
Public financial data for Beyond Meat and Oatly (2022).