How to determine the effect of an operating lever

The effect of operating leverage (or production leverage) makes it possible to determine the most advantageous combination of the relationship between price, volume of production, fixed and variable costs. An analysis of the results allows economists to make adequate management decisions in the field of pricing and assortment policy.

The mechanism of action of the operating lever

The effect of operating leverage is based on the division of costs into fixed and variable, as well as on the comparison of revenue with these costs. The effect of production leverage manifests itself in the fact that any change in revenue leads to a change in profit, and profit always changes more than revenue.

The greater the share of fixed costs, the higher the production leverage and entrepreneurial risk. To reduce the level of operational leverage, it is necessary to strive to translate fixed costs into variables. For example, workers employed in production can be transferred to piecework wages. Also, to reduce depreciation costs, production equipment can be leased.