Operating Leverage

Term

A measurement of how a company incurs costs as its sales grow. If a company’s costs are fixed, its profitability will increase with each additional sale.

3rd Party Definition

“Operating leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A business that makes sales providing a very high gross margin and fewer fixed costs and variable costs has much leverage. The higher the degree of operating leverage, the greater the potential danger from forecasting risk, where a relatively small error in forecasting sales can be magnified into large errors in cash flow projections.” (Investopedia)

Explanation

“Specifically, I’m talking about what’s known as “operating leverage”: the greater your percentage of costs that are fixed, the more operating leverage you have, which means the greater return you earn on every additional sale. To take an extreme example, consider Stratechery: I have extreme operating leverage, because the vast majority of my costs (time spent writing, reading, and researching primarily) are fixed; were I to accurately measure the profitability of an individual subscriber I would need to account for the value of that time and spread it evenly across my subscriber base and subtract each subscriber’s share of that cost — along with (marginal) credit card fees — from the $10/month (or $8.33/month for annual subscribers) fee. My leverage comes from the fact that adding an additional subscriber doesn’t increase that fixed cost at all: instead, one more subscriber makes every other subscriber more profitable, because the fixed cost is spread more broadly.” (Stratechery)

Source

Stratechery by Ben Thompson

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