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Tag Archive | CVP

Operating leverage – seasonal woes at UPS & Fedex

Apparently, logistics firms UPS and Fedex ran into a bit of bother during the pre-Christmas parcel rush – see this article on Forbes by Steve Banker.

The problem may be one of bad planning. Simply put, Steve Banker suggests both firms did not have enough capacity in terms of aircraft or parcel sorting at their highly automated distribution centres. While Banker talks about strategic planning, when I read his article I immediately thought about operating leverage – which would of course be part of the strategic planning.

Operating leverage can be simply defined as the percentage of fixed costs compared to total costs. If UPS or Fedex wants to add capacity, by either leasing aircraft or adding more automation, this will increase fixed costs and operating leverage worsens as these fixed costs affect profits. Alternatively, firms like UPS or Fedex could instead hire more temporary staff, which represents a variable cost. No doubt they do this, but from my limited knowledge it would seem Amazon have this well organised. Increasing variable costs does not affect operating leverage, and is thus preferable in the longer term.

Of course it may be that firms like UPS and Fedex actually need to increase capacity and thus fixed costs. But as Banker points out in the Forbes article, investing to cover short term seasonal capacity issues implies over or idle capacity at other times.

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CVP in farming

Farmers Market

Farmers Market (Photo credit: Macomb Paynes)

As you may know CVP analysis looks at costs, revenues and volumes to determine things like at what output level a business will break even or make a certain profit. This post provides a simple example of the effects of volume on the viability of a business.

Recently, a local authority in Dublin, Ireland announced plans to build a large sewage treatment in the north of the city. As part of this, a vegetable farmer in the area will lose 35 of his 120 or so acres to the plant. I listened to a radio broadcast where the farmer simply said this is too much land to lose and his operation becomes uneconomic.

Let’s think about this briefly in CVP terms. If we assume a stable price for the farmer’s products and stable variable costs (seeds, labour, fuel, fertilisers for example), then it would seem that a loss of about 25% of capacity would reduce the farmer from a profit scenario to a loss one. I am not an agricultural expert, but I would assume that the fixed costs consist largely of the equipment and buildings needed to operate the farm. If the land area is reduced (i.e. capacity is reduced), then the farmer simply does not have enough land left to produce enough revenue to cover these fixed costs and make a profit.

You can read more here.

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