Understanding Leverage and Elasticity

Archimedes famously said “give me a lever long enough and place to stand and I will move the world”.  This astrophysical image demonstrated what has become known as Archimedes Lever – the notion that if you apply the right pressure to the right place, you can gain outsized results, In Archimide’s time, this meant that sailors could move heavy objects using a block and pulley system. In today’s business world, it can mean the difference between making money only when you are working hard versus making money while you sleep.

As is the case with other great changes, I think the path to finding leverage begins with inaction. I’ve always enjoyed the reversed order of a famous aphorism “don’t just stand there – do something!”. Don’t just do something – stand there….and think.

Finding leverage is something I often think about. How can I help my company make money while we sleep?  How can I enable someone on my team to drive 3x or 10x the results they currently are driving simply by altering their focus a bit? If we slide the fulcrum (focus), we can gain much greater leverage (outsized results).

Much of today’s economy is driven by companies seeking leverage – and I’m not talking about leverage in terms of debt. Mark Andreessen’s now-famous WSJ column, Why Software is Eating the World, is a great way to see how the seeking of leverage is transforming entire industries.

Thinking of leverage can be a key part of thinking about elasticity.

Elasticity in business is often associated with pricing. The idea is simple: if small changes in price lead to large changes in demand, than your pricing is considered “elastic”. If, on the other hand, changes in price don’t significantly impact demand, your price is considered to be “inelastic”.

Although price elasticity is important to understand, I tend to think about elasticity more broadly than just price. Demand might be impacted with different packaging or enhanced service offers.

Both elasticity and leverage concern themselves with inputs and outputs. If price is inelastic, then you gain leverage by increasing price. Here’s some math, courtesy of Seth Godin:

If you make a product that costs $5 to produce and package, how much should you charge for it?

I don’t know.

But there’s a simple bit of arithmetic you can do to understand sensitivity in pricing.

Should you charge $7 or $9?

Well, if you charge $7, you make $2 a unit.

If you charge $9, you make $4 a unit, or twice as much.

Which means, all other things being equal, you’ll need to sell twice as many at $7 as you’ll need to sell at $9.

It doesn’t feel that way, but it’s true. 100 sold at $9 is more profitable than 180 sold at $7. And to take it a step further, you’ll need to sell 800 at $5.50 to make as much as you would have made at $9. Eight times as many.

The above example doesn’t factor in the concept of price elasticity. After all, why stop at $9? Why not charge $100 – or a cool million?  But it does show how a small difference can create an element of leverage. Depending upon demand, charging an extra $.50 might enable you to hire 2 new developers to build a better version, or open an office in a different country – the sort of investments that can drive outsized results for the business.

Questions to Ponder

• How do you build time into your schedule to just stand there and look at your part of the business? Opportunities for leverage are missed because people are busy pounding the next nail in front of them, answering the next email, and solving the crisis du jour.
• What resources would you need to double your results? Force yourself to answer this question. The answer may be implausible (I once had a young sales rep seriously answer this question to me by suggesting our small company consider a Super Bowl ad). But perhaps some element of the answer is not implausible and can lead to better results.
• What possible moves by your biggest competitor might give them leverage that you can’t overcome? Figure out what those moves might be, and consider them yourself.
• What small moves could positively swing demand in your favor? I’m not just talking about pricing. Think service offers, enhanced packaging options, distribution changes and so forth. If you hit upon something, you have found an area of elasticity. Apply pressure to that area and drive outsized results (leverage).

The terminal valuation of any business is driven largely by perceived leverage in the business model. Can the acquirer, or shareholders, make money while they sleep? If so, the multiples are generous. If you have a business where money is made only when you and your smart staff are working, then the multiples are pedestrian.

Finding opportunities for leverage often requires us to find where the demand elasticity resides. If you find a place to stand on, and position your fulcrum in the right place, you can move the world.

Good luck!