[kevinpet]

A thin margin is a little like being highly leveraged.

Spacely Sprockets buys sprockets at about $9.50 and sells them at $10.

Cogswell Cogs makes cogs from scratch for $5 and sells them at $10.

If these companies are "the same size" meaning they generate roughly the same profit, then SS is selling 10x the volume of CC. If they can both cut costs by 10%, then SS's profit almost triples, while CC's only increases by 20%.

This cuts the other way too -- if you are operating at thin margins, a small change can push you into unprofitable. If you have fat margins, your profits just decline.

[jessriedel]

Thanks, this was the only reply I got that gave me a decent explanation. I guess it all boils down to defining business size by the amount of profits rather than by revenue or assets. The article's claim, then, is contingent on the cost of a single unit of innovation being set by this size metric and not the others. I'd say this is a very non-obvious assumption, but at least I now understand the claim.

Can anyone give an argument for why the cost to reduce costs by 1% should be a function of profits rather than of revenue or assets?

[jw_]

Hadn't thought of it this way - thanks.

[dllthomas]

A very useful perspective, thanks!