9h • General
Operating Leverage
Your accountant handles the books. But they probably don't tell you what the next customer is worth to you. That's operating leverage. It matters more than you think.
What is operating leverage?
Simply put, it's the relationship between your variable and fixed costs. The higher the proportion of fixed costs you have, the more operating leverage you have.
Let me start with an ideal scenario. I'm building a course that takes 40 hours of work to produce. Once it's built, there's no additional time investment. Hence, no variable costs.
- Total fixed cost: $1,000 ($25/hour)
- Total variable cost per member: $0
- Selling price: $100 (for this example)
How many members to break even?
Fixed costs / (Selling price - Variable Costs) = 1,000 / (100 - 0) = 10 members
After member #10, every additional member generates $100 of pure profit. That's operating leverage at its best. This can be seen in the graph below. The orange section shows my cumulative profit after the breakeven point. Notice that it is identical to the section for cumulative sales.
This example is for illustrative purposes only.
But your business is different.
You run a service business. You don’t build it once and sell it repeatedly. Every customer requires labor.
Let's say you're a plumbing service doing $400K in revenue:
- Average job: $200 revenue
- Labor cost per job: $120
- Materials: $15
- Contribution margin per job: $65
That's 32.5% of revenue. Not bad. There’s one problem: is your labor truly variable? Your plumber is paid a salary. If you add 5 jobs, labor doesn't scale smoothly. You likely hit overtime or need part-time help. The margin per job drops to $50 or $45. Your operating leverage tightens.
Your accountant can tell you that you made $60K profit last year. But they won't tell you whether job #200 next month adds $65 or $40 to your bottom line. That gap? That's your actual operating leverage.
Why should YOU care?
Once you understand your operating leverage, you can answer the real question: "How many customers do I need to break even, and what does each one actually earn me?"
Without that answer, you have no control over your growth. You might think you need to hit $500K revenue. But if your operating leverage is tighter than you think, you might need $600K to hit your profit target.
Stay Under Par,
Samuel
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Operating Leverage
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