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Finance: What is operating leverage? 729 Views
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Operating leverage is... good leverage. Unlike debt, which is a liability. What gives you operating leverage? Scale. Not the bathroom kind.
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Transcript
- 00:00
Finance a la shmoop. What is operating leverage? It's good leverage not like
- 00:08
debt which is a liability and quote bad leverage unquote. Good leverage means a [Operating leverage vs debt diagram]
- 00:15
few things like when you scale in operations and grow very very large then
- 00:22
you have leverage over your suppliers. It's a very different discussion when [Tomatoes in water]
- 00:27
you're buying Tomatoes for your spaghetti sauce like when you're buying
Full Transcript
- 00:30
ten thousand tomatoes a month versus when you get very very big like Egyptian [Pyramid of tomato baskets]
- 00:35
pyramid big and are buying 10 million Tomatoes a month like that scale, you get
- 00:40
way more attention at that point from the non-union labor picking them in [Two guys pop out a bush]
- 00:44
Mexico and can command a whole lot more in discounting as far as deal terms go
- 00:49
and you know other favors when you negotiate well operating leverage works [A trolley being pushed around a supermarket]
- 00:54
with stocking grocery shelves as well, meaning that if you are coca-cola you
- 00:59
have a whole lot more operating leverage with Safeway than does Salmonelli's [Scales of the businesses and Safeway showing Coca-Cola with more leverage]
- 01:05
pesto in a can like nobody goes into a Safeway or Kroger's hunting for a brand
- 01:10
of pesto sauce but pretty much every soda drinker on earth which is pretty [Lots of people on a map of the world]
- 01:15
much every human on earth buys Coke or Pepsi and both have extreme operating
- 01:20
leverage. While operating leverage comes in a range of forms like for example
- 01:24
let's consider a semiconductor maker this isn't fizzy water and sugar and [Someone opens a soda can and it explodes everywhere]
- 01:30
union Teamster co-opting this is actually really hard Tech where it took
- 01:34
decades to be able to produce gigaflops of information put through a tiny piece [Binary code going by]
- 01:39
of fiber for a dollar, really hard to make highly unlikely that Somalia is
- 01:46
gonna one day be a big competitor in the semiconductor architecture business so [Guy plugs something in and it explodes]
- 01:50
the winner in that space a little company called
- 01:53
Intel. Yeah it had for a long time a virtual monopoly in being able to [Monopoly logo appears]
- 01:57
produce massive computing power for an incredibly cheap or high value price. [High value price tag appears]
- 02:03
Well Intel had massive operating leverage in its heyday until Apple and a
- 02:08
few Chinese companies spent a hundred billion dollars or so making themselves [Apple and Intel in a boxing ring]
- 02:13
into viable competitors and yeah and that's [Apple chucks a fire ring at Intel and knocks it out the ring]
- 02:15
what happens when you try to be a monopoly in a competitive world.
- 02:18
Well the key idea here is that operating leverage or power that a business has in [Definition of operating leverage]
- 02:23
running itself usually translates directly in the form of profit margins
- 02:28
like the more operating leverage accorded a company the higher its profit [Operational leverage is piled onto the scale and profit margins take off]
- 02:33
margins will usually run which is very different from this kind of operating [A surgeon wiggling a tool round in an operation]
- 02:38
leverage...
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