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Finance: What is operating leverage? 729 Views


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Description:

Operating leverage is... good leverage. Unlike debt, which is a liability. What gives you operating leverage? Scale. Not the bathroom kind.

Language:
English Language

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

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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