Question

What types of companies or industries might be high operating leverage companies? What are some examples? What is the benefit of high operating leverage? What is the danger of high operating leverage?

Answer 1

The operating leverage is a measure of how much operating income will increase with the increase in revenue. A high operating leverage means that the variable cost of company is low and thus it has higher gross margin

Operating leverage = Contribution margin / Profit

Industries like Retail or manufacturing has high operating leverage.

For example, the major cost for Walmart is in setting up its shop by leasing or purchasing land. Therefore, by high inventory turnover, they can increase their sales a lot as the amount their variable cost is not so much. Similarly for Car manufacturers, the major cost is in setting up the assembly line which is fixed cost and thus their operating leverage is high

The benefits of high operating leverage are that by increasing the sales volume the companies can increase their profit significantly

The danger of high operating leverage is that you need to sell a significant amount of units to break even with the fixed cost because you have to bear it even if you sell nothing. The present situation has worsen the situation for these industries which has high operating leverage.