Microeconomic and business strategy concepts are useful in understanding the behavior of rate of return on assets (ROA) over time and across firms and industries. ROA variability differs across industries, for example, according to their levels of operating leverage. ROA also differs across industries and through time as products pass through different stages in their life cycles.
A firm’s business environment and the strategies it uses to deal with that environment affect its ability to increase ROA. The extent to which a firm is subject to capacity or competitive constraints, for instance, may determine whether it can pursue a higher ROA by increasing profit margin via product differentiation strategies or by increasing asset turnover via cost leadership strategies.
Examination of the ROAs, profit margins and asset turnovers of some 22 industries over the 1977–86 period indicates that industries with significant operating leverage and high entry barriers tended to have the lowest asset turnovers and the highest profit margins, while industries with low capital intensity and commodity-like products tended to have the highest asset turnovers and the lowest profit margins. The concept of marginal rate of substitution—the ability to trade off profit margin and asset turnover—can be used to generate highly credible interpretations of trends in and differences across firms’ and industries’ ROAs.
