Question 3.9 - Technology

[gdmiccc]

In the solution to question 3.9 it lists "the balance between fixed and variable costs (i.e operational gearing)" as an impact of technological change. What is meant by this?

 

[Mark Willder]

Operational gearing is the effect of fixed costs on profits. If a company had only variable costs, then if sales doubled, expenses and profits would also double. If a company had mostly fixed costs, then if sales doubled, expenses would only go up slightly and profits would more than double.

Technology could lead to this gearing effect in many ways. For example, a company might use human underwriters. In this case most of the expenses are variable, ie if new business doubles, they will need twice as many underwriters.

Alternatively, the company could use new technology to underwrite, perhaps an artificial intelligence computer program. This would have high fixed costs but little variable costs. So if business doubles, expenses would increase slightly and profits would more than double.

I hope this example helps.

Best wishes

Mark

 

[gdmiccc]

Thanks Mark! That helps a lot.