Leverage in business is the secret ingredient to multiplying success. It’s like using a lever to lift a much heavier object than you could manage with brute strength alone. At the risk of sounding cliché, it’s not about working harder, but smarter.

By harnessing the power of leverage to make business easier and more profitable, any business owner can propel their business to greater heights.

Let’s explore how to leverage your resources to improve the way you do businbess and enhance your impact.

What is Leverage in Business?

Leverage is the key to scalability. It means using various resources to achieve business goals more effectively and efficiently. Like how a lever allows you to move a heavy object with less effort than you could do on your own.

In business, it means getting more done with the same amount of resources, or achieving more with less. It’s about amplifying output while keeping input at a manageable level. It’s not tied to any specific resource—rather, it’s a mindset, a strategy, an approach to doing business that prizes efficiency and impact over mere effort.

If doubling your business requires doubling your effort and overhead, your business will quickly hit a ceiling on growth. However, once you learn how to use leverage, you can transform the way you operate, making it possible to grow more without working more.

How Does Leverage Work?

To understand the power of leverage, you need to know that it works by maximizing the effectiveness of your resources in a way that proportionally exceeds the amount you invested. It’s about optimizing your inputs to achieve outsized outputs.

In other words, it’s not a one-to-one equation, where you put in one unit of effort and get one unit of results. Instead, it’s about putting in one unit of effort and getting multiple units of results.

The essence of leverage is understanding that small things can compound into big results. Whether applied in finance, time management, or knowledge acquisition, leverage is about achieving greater results without necessarily increasing the amount of resources used. You’re essentially using what you have more effectively to get more out of it.

Types of Leverage in Business

The 3 Types of Leverage in Business

Financial Leverage

Financial leverage is a powerful tool that can help you grow your business if used judiciously. This form of leverage taps into outside funding sources (that is, other people’s money) to give you financial fuel for growth that otherwise might take years to accumulate. In a typical scenario, a business might borrow capital to finance projects, acquisitions, or expansions with the expectation that the future profits will supersede the cost of the debt.

A key component of creating leverage through finance is the inherent risk-reward trade-off. When used effectively, it can take your business to unprecedented heights, multiplying revenues and profits. For instance, consider a business that borrows $1 million at an interest rate of 6% to finance a project that generates a profit margin of 10%. Here, the business benefits from a net gain of 4%, which would have been unattainable without leveraging.

However, using debt as leverage also carries a level of risk. If the investments funded by the borrowed capital do not yield expected returns, the business may struggle with debt repayment, which can lead to financial distress or even bankruptcy.

Therefore, it’s crucial to be diligent when borrowing – balancing the potential gains against the associated risks. This involves conducting thorough research, detailed financial forecasting, and risk assessment before diving into debt financing. The measure of success with leveraging debt lies not just in accessing funds, but in investing them strategically, and efficiently putting that money to work for maximum return on investment.

Operating Leverage

Operating leverage is a different type of leverage that relates to how a company’s cost structure can affect its profitability. It primarily looks for efficiencies in fixed costs as opposed to variable costs, or COGS. The higher the proportion of fixed costs, the higher the company’s operating leverage.

When a business has high operating costs, it means a large portion of its expenses are fixed, and a small change in sales can significantly impact its profitability. The reason is that once fixed costs are covered, every additional unit sold contributes directly to the bottom line, since variable costs per unit remain constant.

For example, a software company might have high fixed costs, such as salaries for developers and rent for office space, but low variable costs because once the software is developed, it can be sold to many customers at little additional cost. In such a scenario, after the company covers its fixed costs, or overhead, every additional software sale significantly boosts profits.

On the flip side, while high operating leverage can compound profits during good times, it can also increase losses when sales are down. Consequently, businesses with high operating overhead face greater risk during economic downturns, since they still have overhead to cover regardless of whether revenue is high or low.

Operating leverage, therefore, can be a double-edged sword, and it’s essential for business leaders to understand this dynamic to make informed operational and financial decisions. A thorough understanding of this type of leverage can help businesses to plan their cost structures strategically, enhancing profitability while mitigating risk.

Combined Leverage

Combined leverage encompasses both financial and operating leverage, offering a more holistic view of how decisions can impact a company’s profitability, volatility, and risk. This form of leverage takes into account not only the fixed operating costs and the proportion of borrowed funds but also how these two interact within the business.

The degree of combined leverage (DCL) is a ratio that illustrates this interplay. It is calculated by multiplying the degree of operating leverage (DOL) by the degree of financial leverage (DFL). A high DCL indicates a higher level of risk but also a higher potential return, given a change in sales.

Consider, for example, a manufacturing company with high fixed costs (operating leverage) that has also borrowed significantly to expand its operations (financial leverage). This company’s combined leverage would be high, which means even a small increase in sales could result in significant profit growth. However, in contrast, a decrease in sales could lead to substantial losses due to the burden of fixed costs and debt repayments.

Thus, understanding combined leverage is vital in making strategic business decisions. It provides insights into the overall risk and return of the company and helps in making informed financial and operational planning. Decision-makers should be mindful of their company’s combined leverage to successfully navigate periods of growth and downturns in the market. It’s about striking the right balance between risk and reward to ensure sustainable and scalable business growth.

The Pros & Cons of Leverage

The Pros & Cons of Leverage

Pros

  • Maximized Returns: By utilizing borrowed capital, businesses can potentially achieve higher returns than would be possible using only their own resources. This maximized return on investment can significantly enhance profitability and contribute to business success.
  • Expansion Opportunities: Using the power of leverage means businesses are able to undertake larger projects or expansions than they could afford with their own capital. This can lead to increased market share and help entrepreneurs grow their business faster.
  • Tax Benefits: In many jurisdictions, the interest paid on borrowed funds can be deducted from taxable income, giving you access to cash while reducing the overall tax burden.
  • Ownership Dilution Prevention: Unlike equity financing, where ownership shares are sold to raise capital, debt financing enables you to retain full ownership and control and achieve your goals.

Cons

  • Increased Risk: Leverage, be it financial, operating, or combined, inherently increases a business’s risk. The more borrowing or fixed costs, the higher the burden to meet those obligations, which can intensify potential losses, particularly during downturns.
  • Interest Expenses: Borrowed capital comes with interest costs, which can eat into profitability. If the investment fails to yield a return higher than the interest rate, the business may face financial difficulties.
  • Cash Flow Pressure: Regular interest payments can put a strain on the cash flow, especially if the business experiences an unexpected slump in sales or increased operational costs. If one does not properly understand financial statements, this risk can be even greater, as debt payments do not appear on the Profit & Loss (P&L). So the P&L statement can give the illusion of a healthy bottom line; meanwhile, cash is being drained.
  • Loss of Control: Although debt financing doesn’t dilute ownership like equity financing, creditors may impose certain restrictions as part of loan agreements, potentially limiting management’s autonomy in decision-making.
  • Bankruptcy Risk: In worst-case scenarios, an inability to meet debt obligations can lead to financial distress and bankruptcy. This risk is magnified for highly leveraged companies, making prudent financial management essential.

Power of Leverage in Business

In addition to the areas of financial leverage explained above, there are several other ways to gain leverage in your business. That is, your ability to do more with less, and to make your business scalable without continuing to increase costs in lockstep with growth.

Business Model

A business model acts as a powerful lever in the hands of a savvy entrepreneur. An efficient business model can multiply profits by streamlining operations, lowering costs, and maximizing revenue generation.

For example, the software-as-a-service (SaaS) model leverages technology to deliver software solutions to a large customer base at minimal marginal costs. Once the initial software development costs are covered, each additional subscription adds directly to the bottom line, amplifying profitability.

Membership or subscription models also provide massive leverage, as the lifetime value of a customer is disproportionately high compared to the cost to acquire a customer. Generally speaking, it costs 6-10 times more to get a new customer than it does to keep or grow one you already have. This makes membership or subscription models incredibly profitable over time, assuming you offer great value and service to retain existing clients,

Similarly, a franchise model can leverage a strong brand and operational systems to scale quickly through partnerships with franchisees, each contributing a share of their revenue. In these ways, effective business models harness the power of leverage to drive business growth and success.

Business Plan

A robust business plan is another form of leverage that can significantly impact a company’s trajectory. Serving as a roadmap, it outlines a clear path from where the business is currently to where you want it to be, detailing the strategies and actions needed to get there.

A well-articulated business plan can help secure funding from investors who are persuaded by the clarity of vision and the thoroughness of the plan. It also provides a framework to measure progress, set milestones, and realign actions when necessary.

Moreover, with a clear plan businesses can leverage their resources more effectively, provides direction for team members, and sets a benchmark for assessing performance and making necessary adjustments. In essence, a solid business plan leverages foresight, strategic thinking, and tactical planning to guide a business towards its objectives in the most efficient way possible.

Human (Capital)

Human capital is one of the most power resources you can leverage for maximum achievement. It refers to the collective skills, knowledge, and abilities of a company’s employees – the ‘human’ resources that contribute to its success. Often underestimated in its importance, the right team can significantly amplify a company’s performance when properly trained, empowered and directed.

Investing in human capital – via continuous learning opportunities, skill development programs, and fostering a positive corporate culture – can yield substantial returns. According to the Society for Human Resource Management, companies that invest $1,500 per employee per year on training can see an average of 24% more profit compared to those who invest less. The knowledge and skills employees gain can lead to improved operational efficiency, better decision-making, and more innovative ideas – all of which can enhance a company’s competitiveness, service levels and profitability.

Gallup research also shows that companies with highly engaged teams are 21% more profitable. When employees believe in the mission and values of the company, are respected and recognized for their contributions, they are more likely to go the extra mile. This commitment and passion, difficult to quantify but apparent in results, is the unique advantage that human capital brings.

But leveraging human capital does require careful management. Leaders need to balance the need for productivity with the well-being of team members, creating an intentional environment where employees feel valued, heard, and motivated. The return on investment in your team may not be instantly visible, but it is far-reaching and long-lasting.

Marketing

Marketing is essential for any business looking to scale up and achieve better results – like a tap that you can turn up or down to generate more leads on demand.  Great marketing creates visibility, fosters customer engagement, and drives sales.

In today’s digital age, marketing has taken on a whole new dimension with the rise of online platforms, social media, and content marketing strategies. A well-executed marketing campaign can exponentially increase a business’s reach, and keep your business from being the “best kept secret” in your industry.

Demand Metric reports that a well executed content marketing strategy costs 62% less than traditional marketing but generates about three times as many leads – wow! Such strategies leverage high-quality, relevant information via text, video, infographics, etc. to attract and engage a steady stream of potential customers.

Social media marketing, another powerful leverage tool, has the potential to reach millions of users worldwide with targeted, personal content. The global data analytics company, Statista, reports that as of 2020, over 3.6 billion people are using social media worldwide, a number projected to increase to almost 4.41 billion in 2025. This vast pool of potential customers can be tapped into with a well-orchestrated social media marketing campaign.

However, like any form of leverage, marketing must be used judiciously. Missteps can damage a company’s reputation, and poor execution can simply waste a ton of money. It’s essential to have a well-thought-out marketing strategy in place, one that aligns with your brand’s values, resonates with your ideal target audience, and is adaptable to the rapidly changing digital landscape.

Your Products and Services

Your company’s offerings, whether physical products, digital solutions, or service-based activities, are what your customers interact with directly. The more valuable your offerings are, the higher the potential for business growth.

When your products or services meet a clear market need or solve a problem better than anything else available, you’ll have a competitive advantage that’s hard to beat. In fact, according to a survey by CB Insights, the lack of a market need for products or services is the top reason startups fail, demonstrating the importance of doing market research to align your offerings with the demand, versus making assumptions.

Even if you already have great products or services, don’t assume you should stop there. Innovating and expanding your offerings can also create leverage. A report from Nielsen shows that 76% of new products don’t last more than a year on the shelf, highlighting the importance of continual product innovation and adaptation to market trends. If you provide a service, what else can you offer to your target audience to give them more reasons to buy?

Just as important as the product or service itself is the customer service that accompanies it. Businesses that provide exceptional customer service gain a competitive edge and see higher customer loyalty and retention rates. According to a report by American Express, 7 out of 10 U.S consumers say they’ve spent more money to do business with a company that delivers great service.

In essence, your products and services – along with the overall customer experience – are powerful ways to leverage existing resources. They can significantly impact your company’s reputation, customer satisfaction, and ultimately, your bottom line. By focusing on the quality, relevance, innovation, and service associated with your offerings, you can leverage them for substantial business growth and success.

The Risks Of Leverage

The Risks Of Leverage

While leverage provides means that can accelerate growth and profit, it’s not without its risks. These potential pitfalls must be carefully considered and managed to prevent any damaging consequences.

Overextension is one of the risks associated with leveraging resources. While resources like human capital, marketing, and product innovation can drive growth, they also require investment. Over investing without seeing a proportional increase in returns can lead to financial difficulties. According to a report by CB Insights, 29% of startups fail because they run out of cash, often a result of over-leveraging resources.

Then, leverage comes with a danger of customer alienation. For example, aggressive marketing strategies or product changes can backfire if they don’t resonate with your target audience. A study by Marketing Week revealed that 61% of people have switched brands due to poor customer experiences. Therefore, maintaining a customer-centric approach is crucial while leveraging marketing or product strategies.

Finally, the mismanagement of human capital can lead to employee dissatisfaction, decreased productivity, and even high turnover rates. A survey by Gallup showed that 75% of workers who voluntarily left their jobs did so because of their bosses and not the job itself. Leaders must ensure they’re creating an environment that nurtures and values their team members, treating them as unique humans, not a corporate resource.

FAQs

What is an example of the power of leverage?

A prime example of the power of leverage can be seen in the use of technology in business operations. For instance, think about a retailer who employs an e-commerce platform to sell products. By trying to leverage technology, they are able to reach a global audience, operate 24/7, and automate various processes like inventory management, payment collection, and customer service. This significantly amplifies their potential for increasing customer base and sales volume beyond what a traditional brick-and-mortar store could achieve. In essence, the retailer invests in technology to magnify the reach and efficiency of their operation, which is a powerful form of leverage.

How does leverage relate to ROI (Return on Investment)?

If done right, leverage should always produce a positive Return on Investment (ROI). In fact, ROI is a key performance metric used to evaluate the efficiency or profitability of such an investment. When you utilize leverage—be it financial leverage like loans or operational leverage like technology—you’re essentially amplifying your resources.

Let’s consider an example. Say, you invest in an automated customer service system. This system allows you to handle more customer queries 24/7 without hiring additional staff. Thus, while you’re incurring an upfront cost for the system, the potential for increased customer satisfaction, repeat business, and improved reputation greatly enhances your returns over time.

However, it’s important to remember that leverage can also amplify potential losses. If the investment doesn’t generate expected returns, the loss is also leveraged. As with any investment decision, the use of leverage should be carefully considered and managed to ensure it contributes positively to the ROI.

According to a report by Deloitte, companies that effectively leverage their resources often see a higher ROI—illustrating the link between strategic use of leverage and improved return on investments.

How can businesses measure the impact of their leverage strategies?

Measuring the impact of leverage strategies can be done through a variety of metrics based on the specific form of leverage. For instance, if you’re leveraging technology, you could look at metrics such as operational efficiency, cost savings, increased sales, or improved customer service ratings.

If you’re leveraging financial resources, you might look at your return on investment (ROI) or profit growth, compared to your cost to repay the debt. You could also consider the increased speed at which you’re able to grow or expand your business as a result of the leveraged resources.

For human capital leverage, you might measure employee productivity, turnover rates, or even employee satisfaction surveys.

In essence, the key is to identify the appropriate metrics that directly reflect the effectiveness of your leverage strategies, and track those over time. This will give you a clear picture of whether your efforts are proving fruitful or if adjustments are needed.

According to a research published in Harvard Business Review, companies that regularly measure and manage their leverage strategies are 60% more likely to be in the top quartile of their industry. This underscores the importance of not just implementing, but also measuring the impact of your leverage strategies.

How often should a business re-evaluate its leverage strategies?

Businesses should regularly re-evaluate their leverage strategies to ensure they are still effective and aligned with the company’s goals. A general rule of thumb would be to review these strategies at least once a quarter. This allows for a more agile approach, adjusting quickly to market changes or shifts in business objectives. However, it’s also important to note that the frequency may vary depending on the specific circumstances of the business, such as the nature of the industry, the rate of change in the business environment, or the outcome of the previous leveraging efforts.

For example, in rapidly evolving industries like technology, businesses may need to re-evaluate their strategies more frequently, perhaps even monthly. On the other hand, in more stable sectors, a semi-annual or annual review may suffice. Ultimately, the goal is to ensure the leverage strategies continue to drive growth and success for the business, while mitigating potential risks.

According to a survey by McKinsey & Company, companies that review and adjust their leverage strategies more frequently are 45% more likely to report a significant performance improvement than those that don’t. This highlights the importance of regularly re-evaluating your strategies to ensure they’re delivering optimal results.