Question

Does plant expansion help or hurt operating leverage when determining a company's ability to bring in new customers or keep existing customers? Please explain your answer.

2. Why would companies have greater operating leverage if they were manufactures, rather than retailers, restaurants or movie theaters?

Answer 1

Solution:-

Typically, the first shot for a business to create shareholder wealth is plant expansion. I use this term very broadly because it can refer to factories, distribution facilities, and retail or service locations. The amount of planned plant expansion will depend on the operating leverage of the business. The prime driver of operating leverage is the ability of a business to get new customers or to grow existing customers with minimal new plant investment. Businesses with little operating leverage include retailers, restaurants, and movie theaters. For such businesses to meaningfully grow their customer bases requires sustained new store development. Businesses having greater operating leverage may include manufacturers, where individual plants can be run longer or be efficiently expanded to add new production lines. For such companies, plant expansion may accompany entry into new markets that can't be served by existing facilities. A secondary form of operating leverage is the ability of a company to expand with minimal incremental operating costs, which offers the potential for increased profitability. Expense operating leverage is a part of cost control, which is illustrated in the Fourth Shot.

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