What Is Capital Decay?

Capital decay is an economic term referring to the amount of revenue that is lost by a company due to obsolete technology or outdated business practices. A failure to adapt with the times and reinvest accordingly can lead once-loyal customers to jump ship, weighing on sales and the future viability of the company.

Key Takeaways

  • Capital decay is an economic term referring to the amount of revenue that is lost by a company due to obsolete technology or outdated business practices.
  • A failure to adapt with the times, rejig business models, and reinvest accordingly can lead once-loyal customers to jump ship and a company's income sources to dry up.
  • Capital decay is often a problem in industries where technology tends to move very quickly or where barriers to entry are low.
  • Companies that utilize older business models and that are locked into them due to management inflexibility or high fixed/sunk costs are most at risk.

Understanding Capital Decay

The business world is competitive. Things change, production techniques get better, and new, more efficient technologies arrive on the scene to displace those that came before it. Companies that fail to innovate or at least keep up with the latest developments risk losing market share, being stripped of their revenue, and being effectively pushed aside by their hungrier rivals.

Capital decay has become a growing problem for companies in recent years as the rate of technological development continues to increase.

Nobody is immune from capital decay, although some companies are more susceptible than others. Obvious examples include those operating in industries where technology tends to move very quickly or where barriers to entry—high startup costs or other obstacles that prevent new competitors from easily entering an industry or area of business—are low.

Whenever a business does well, it's likely that others will be watching from afar and plotting how to replicate its success. If barriers to entry are low and the launch of an immediately effective rival offering can be executed at a reasonable cost, expect fierce competition to be forthcoming.

Companies that utilize older business models and that are locked into them due to management inflexibility or high fixed/sunk costs are most at risk of suffering from capital decay. It's much easier to change and evolve when the costs incurred for doing so are affordable — less so when so much capital is tied up in an old technology and way of doing business.

Examples of Capital Decay

Capital decay was the boon of many companies in the early twentieth century, when modern production methods first came into use. When Henry Ford began to employ the assembly line for auto production, companies that relied on their employees to build an entire car suffered from capital decay and either went out of business or sold out to Ford Motor Co. (F) or another competitor.

A more recent example of a company that struggled to keep up with change is Blockbuster. The rise of the Internet and video streaming services drew customers away from stores and kiosks to online platforms. As is often the case, many pundits, investors, and executives failed to see this shift coming until it was too late.

Blockbuster, like many other companies that have become extinct over the years, wasn't entirely blameless for its demise. In 2000, Reed Hastings, founder of the then-unknown Netflix Inc. (NFLX), flew to Dallas to meet with Blockbuster CEO John Antioco about striking a partnership.

The proposal was for Netflix to run Blockbuster's brand online and for Blockbuster to promote Netflix in its stores. This suggestion was swiftly rejected by Antioco and his team. At the time, Blockbuster was the king of the video rental industry, with a loyal client base and thousands of retail outlets. Management saw no reason why that would change and continued to stubbornly bury its head in the sand until disruptor Netflix stole its crown and eventually forced Blockbuster into bankruptcy.

Blockbuster went from churning out sales of $272 million in 2003 to posting $1.1 billion in revenue losses in 2010.

Special Considerations 

Even when an industry appears to be in total decline and beyond saving, there can still be ways to maintain and squeeze out revenues. Survival often hinges on flexibility and management's responsiveness. Take Arm & Hammer, for example. At the end of the 1960s, it looked destined to fail as home baking declined and packaged foods were introduced with baking soda.

Against this tricky backdrop, management found a way for the company to bounce back. First, it found a way to use its baking soda product as a deodorizer for refrigerators. Then in later years, baking soda began being deployed as a laundry additive, toothpaste additive, and carpet freshener.

Executives that keep their ear to the ground and are humble enough to recognize the need for companies to reinvent themselves every now and then have a much better chance of staying afloat than those who get carried away with their success and believe that life cycles are indefinite. A handful of companies have been around for centuries. The lion's share, however, rarely survive more than a couple of decades.