Lesson 6 of 10 · All lessons in this module
- Competitive strategy and positioning
- Strategy over the life cycle and addressable markets
- Generic strategies in practice: capacity, moats and two kinds of focus
- Revenue drivers: bottom-up and top-down
- Pricing power
- Operating costs and operating leverageVideo lesson
- Operating profitability and working capital
- Choosing a profit margin, cost components and price elasticity
- Capital investments and capital structure
- FCFE, net capex and financing across the life cycle
This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 6 of 10 · 14 min
Operating costs and operating leverage
How much of a company's cost base is fixed decides how violently operating profit reacts to a change in sales; operating profit = Q × (P − VC) − FC, and the degree of operating leverage measures the sensitivity.
In short
- Operating costs relate to current-period revenue; investing costs buy long-term assets; financing costs reward debt and equity investors. Accounting classification does not always follow this intuition.
- Operating costs can be categorised by behaviour (fixed vs variable), nature (what the cost is) or function (what it is for).
- Operating profit = . The contribution margin (P − VC) must be positive and Q must be high enough to cover FC.
- Degree of operating leverage (DOL) = %Δ operating profit / %Δ sales. More fixed and fewer variable costs mean a higher DOL: faster profit growth in good times, faster falls in bad.
- IFRS and US GAAP do not require fixed/variable or volume disclosure, so this analysis is often limited, except in industries such as oil and gas where it is customary.
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