The Asset-Light model refers to a business strategy that pursues capital efficiency by focusing the equity investment on those assets where a company’s expertise attains the best return for investors. The core of the asset-light approach is to enhance the company’s long-term value through enlarging valuable and unique resources.
Every company seeks to pursue its strategy with the lowest possible level of asset ownership, but determining the optimal level is challenging. Executives face a tough dilemma when considering asset weight. Asset-heavy, vertically integrated models offer superior control but they tie up significant capital and frequently prove less flexible in a fast-changing environment. By contrast, asset light business model confer greater flexibility, but it can be tough to manage them and the risk of leaking intellectual property (IP) or becoming less valuable is greater.
The Benefits of Going Light
Being asset light means lower operating costs and risks. The focus here remains on creating value through the business. The management is therefore able to focus on core risks and opportunities and manage them well, thereby extracting maximum value in the process. Let’s look at the benefits more closely.
Better Return on Assets: Although asset-light companies on average have lower margins (one way or another, they must “pay rent” on the assets they use but don’t own), these are usually more than offset by the benefits of lower asset weight (defined as the ratio of the company’s undepreciated operating assets to its annual sales). The more asset-light companies on average earn greater return on their assets than did their peers. Although this benefit reduces the price-to-earnings ratio in some industries, the fact remains that the ratio of price (market value of equity) to operating assets is better for asset light companies than for their peers.
Lower Profit Volatility: Companies with high fixed costs rely on revenues to cover those costs, so net income depends on utilization- and profits can swing widely from one year to the next. By contrast, asset-light companies’ costs are more variable relative to their revenues, so profits are less volatile. This dynamic is seen in a wide range of industries, including oil and gas extraction, utilities, electricity and gas distribution, media, technology, industrial machinery, chemicals and mining, retail, food and consumer goods.
Greater Flexibility: Companies with lower levels of asset ownership are able to respond faster to changing demand, technology advancements, new market opportunities, and supply chain disruptions.
Higher Scale-Driven Cost Savings: Asset light models can help companies achieve scale without having to invest capital. Being asset light can also help large companies avoid the diseconomies of scale that arise from owning many small shops in many locations. For instance, it is far more efficient for a mobile phone company to franchise its smaller retail outlets than to operate thousands of small stores. An added benefit: franchisees run the stores as owners, not employees, so they have a stake in the business and are highly motivated to succeed.
Asset Light Business Models
Outsourcing: Contracting with other companies to perform certain activities: works best if IP is either protected or is not a source of differentiation
Pay Per Use: Leasing an asset or paying variable rent on the basis of usage: requires an investor willing to buy the asset (typically, the asset maker) and is enhanced if many users keep utilization high
Marketplace: Providing a platform for asset owners to trade and taking a fee on transactions: works best if there is scale or network benefits and products or services are easily specified.
Licensing in: Making use of others’ IP to lower development risk or reduce R&D or brand investment; commonly used in the pharmaceutical industry: works best with smart-control techniques
Rebranding: Private labeling a product or service designed and executed by a third part: works best if the brand is relevant.
Asset Sharing: Pooling assets to minimize capital commitment and maximize utilization: works best for high-risk, utilization sensitive or noncompetitive assets.
Franchising: Harnessing the energy and capital of entrepreneurs: works best with smart control techniques, especially to enforce activities that benefit the franchisor
Licensing out: Allowing others to use a brand or IP: works best for expanding into adjacencies with strong IP protection or for exiting an undifferentiated brand
Product-to-service transitions: Moving from selling products to services: useful if products become commoditized, especially if wraparound services reduce systems cost for customers.
Doing right on Asset-Light
IndiGo, a low cost airline, has superior financials and dominant market share of 35.3 per cent of India's aviation industry. The airline operates on an asset light model. It buys aircraft from Airbus at a discount and then sells it to a lessor only to lease it back. Thus, the aircraft is not a part of IndiGo's assets. It earns the difference in the price of the aircraft at the time of delivery and price at the time of placing the order. One third of IndiGo's cumulative profit before tax and cash flow from operations (CFO) from FY11 to Q1 FY16 have been on account of cash and noncash incentives received from aircraft and engine manufacturers.
Apple is one such renowned company that takes the asset-light route by outsourcing and buying many of its chips from the Taiwan Semiconductor Manufacturing Company. Then, there is the asset-sharing model, where two companies share the cost of expensive assets if utilisation is the key to returns.
Yet another way to remain asset light is through licensing, whereby a company licenses the use of its product to a partner, sometimes in another industry. For instance, Armani Hotels & Resorts licensed its brand to Dubai-based Emaar Properties in 2004 as a way to participate in the luxury hotel market without actually buying properties.
Toyota is known for its long term, trusting relationship with suppliers. Using an open-book approach, the automaker and its suppliers share costs and operating information and work together to reduce costs and improve processes. Instead of squeezing its partners, Toyota ensures that suppliers earn a fair profit.
Asset Light Business Models Enable Scalability for Startups
Every business needs to grow in order to be successful and therefore, even before an entrepreneur begins to give shape to their idea, it is important that they come up with a scalable business model in order to ensure long term sustainability in the market.
If you look at all new age businesses, particularly the tech-enabled ones, they are in a position to scale up much faster (sometimes, even overnight!) as compared to traditional asset-heavy businesses and this quick scalability gives them a definite edge over others in the market.
Investing more on infrastructure, network, manpower and R&D in today’s still recovering economic scenario is a tough proposition and very risky since scaling up would involve huge costs and time in setting up the necessary infrastructure and resources. The growth in such businesses is usually linear.
Highly scalable businesses on the other hand, grow exponentially. They are not weighed down by the same sales-cost growth relationship as linear models. Instead, as sales increase, costs stay flat, allowing for higher levels of profit over time. Businesses with high scalability grow with lower capital requirements, making them more efficient, and therefore, more attractive to investors too.
When Asset Light Isn’t Right
Despite the benefits that an asset-light model can deliver, sometimes a vertically integrated model is a better choice. When coordination, speed, know-how, or knowledge sharing is essential-or when core strategic assets are scarce- greater integration can be helpful. Integration can also help ensure that the economic interests of all parties are aligned.
IS THE ASSET-LIGHT MODEL RIGHT FOR YOUR COMPANY?
To determine whether your company should hold on to its assets or adopt an asset-light model, you’ll need to answer two questions.
Is the asset strategic? Conventional wisdom says that if particular assets are integral to your company’s competitive position-for example, research or design labs that generate know-how—ownership is usually the best option. Still, the risks associated with offloading such assets can be offset by using smart-control techniques, particularly in conjunction with a franchising, asset-sharing, marketplace, or licensing model.
Is the asset in short supply? In certain cases it is wise to own scarce physical assets, such as premium hotels, installed power stations. But when demand, supply, and investor appetite for such assets are variable, a pay-per-use model may create more value.
In fast changing global economy, becoming asset light is, in many cases, the right choice. Companies can improve their returns, become more agile, capitalize on the scale and redeploy their operations more quickly. Having an asset light business, together with technology and smart-control techniques, can enable faster and better growth.