I think
this has happened to all of us, a friend who keeps asking “Hey dude, what’s the
degree of operating leverage (DOL) of the “x” sector? How is it different from
other countries? Why is it different? Trying to help all of you, I will try to
explain this concept using the airport, retail and bottler sector.
Before we
get started, it is important to understand the concept of operating leverage.
The degree of operating leverage is the sensitivity of the operating income to
changes in sales. We could say that the degree of operating leverage is how
much the operating income changes when the sales change.
FC = Fixed costs
X = Units
produced and sold
P = Price
per unit
V =
Variable cost per unit
The
operating leverage is the result of the existence of fixed costs. If accompany
didn’t had fixed costs, a 10% increase in sales would lead to an increase of
the same magnitude of the operating income (in the case of a nonexistence of
fixed costs the degree of operating income will be 1). Using the formula of
above, if FC = 0 then DOL = 1. Following the logic, the higher the fixed costs
of a company compared to the variable costs, the higher the DOL; also, the
higher the DOL, the higher the fixed costs of a company compared to the
variable costs (it works in both ways XD, if you want to learn more details you
can go HERE).
In most of
the cases we don’t know the cost structure of a company, but that’s not a
problem. We can estimate the DOL with a simple regression (Operating Income = c
+ DOL (Sales) + e).
With a
linear regression and data from Bloomberg since 2008 I came up with the next
table (Btw, all the B´s are significant):
To the left
side we can see Mexican companies and to the right side we can see similar
companies from other countries (USA, Europe). Comparing the averages we can see
that the DOL of the Mexican companies are smaller.
At first I
was expecting different results. The little voice inside my head was telling me
“we can expect higher DOL´s in companies outside Mexico because they must have
more efficient assets (because of technology, prepared workers, etc.). This
efficiency is going to translate in smaller fixed costs and the more skillful
workers are going to translate in higher variable costs.” The voice was wrong :(
One
explanation for these results is the cost of hiring people in Mexico; it seems
that it is still cheap. It´s possible that companies in Mexico decide to
increase their production hiring more people than investing in fixed assets (we
can see the effects of this on HERE). In countries like Germany the
companies prefer to buy machines and equipment to increase their production
because hiring workers is really expensive. Another explanation is that the
voice isn’t as wrong as it seems, the assets in foreign countries could be more
efficiently used but the cheapness of the Mexican labor compensates this
effect.
Consequences:
- Mexico continues to be a good place to invest. With a small investment in fixed costs you can do a lot of things.
- The wages in Mexico are still very low :( . This affects the domestic demand, quality of life, etc.
- Mexican companies are more defensive, the equilibrium point is lower than in foreign companies.
- None if the samples do not represent the population XD.
