What is an asset heavy business model? What are the advantages and disadvantages?

Asset heavy is a broad based term used to describe business model of companies which typically own a lot of their fixed assets outright which are utilized to generate income for the company, as opposed to asset light businesses which essentially control the IP and service and pay a rent to use the fixed assets they do not own but need to generate income: for example Uber does not own its fleet of cars, but it has to pay a majority of the revenue per ride to the driver (the rent in this case) of the car. 

Asset heavy companies are generally vertically integrated, which means they own end to end means of production from raw material to the finished product. Asset light business models might not work for some industries for example refineries, and asset heavy business models might kill some businesses for example Uber. It's a challenge for every company in any industry to choose the right business model or strike a balance between the two to create value for the shareholders. 

Generally speaking, asset light businesses have better return on assets in most industries than asset heavy companies.

Advantages of asset heavy business model:

• Greater control over the product - Zara is a great case study for that. Being vertically integrated suits them since it allows them to respond to trends really well

• Have better margins

• Great IP and know how (trade secrets) protection

Disadvantages:

• Generally inflexible, thus not suitable for industries with rapidly changing industries - tech is the first that comes to mind.

• Low return on assets: Even though there are higher gross margins, generating a return on the enormous upfront costs required to acquire the assets remains a challenge. Further, the management team has to be exceptional at efficient utilization of the assets to generate a good return.

• No rapid scalability: Asset heavy businesses are not rapidly scalable because of the high upfront costs. That's why technology companies prefer to be asset light, because the tech is rapidly scalable and an asset heavy business model will only be a hindrance. 

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An asset heavy business model is one where significant capital expenditure is required to start the business. The business model involves ownership / leasing of assets and therefore a lot of upfront capital investment. Good examples of asset heavy businesses are:

1. Aviation and Airline businesses

2. Hotels and resorts 

3. Power Distribution Companies 

4. Telecommunication Companies

5. Iron, Steel and Cement Manufacturing companies 

The Disadvantages of these businesses are : 

1. Significant capital expenditure is required upfront; It automatically means you need deep pockets to start and succeed

2. As a follow up, a failure in a project, plant or idea means you end up with significant losses. Much of the initial capital is borrowed or financed by external parties and hence you can get into deep debt 

3. The payback periods tend to be long. Long means very long. You may take years to even break-even due to the large negative initial cash-flow in your ROI Calculations. 

Now since many companies do operate on asset heavy models, there must be advantages too right! Here are some:

1. Extremely high entry barriers. Try starting an airline or a Telecom company (Yes only Mukesh Ambani can do Jio-like stuff!).

2. Monopolistic conditions which arise due to limited number of players courtesy the high entry barrier. You fight to keep your skin in the game during the initial years and you make a lot of money later on.

3. Certain asset heavy business have higher margins due to their exclusive nature. If you compare the margins of TAJ or Oberoi to the margins of consumer retail/FMCG companies you will know what I mean. But yes, the margins compensate the businesses for the additional risks taken.

Overall you need deep pockets, patience and conviction that you will make money in the long run before you start an asset heavy business.