Part 2 Read the excerpt below and answer the following questions: 1. In your own terms, explain the meaning of high/ low operating leverage and its effect on companies. [4 marks] 2. Why did Inktomi Corp. report a very large loss and eventually not able to survive in the market? [6 marks] Managerial Application: New Econ- omy Firms and High Operating Leverage High-technology firms incur large fixed costs and relatively low variable costs to pro- duce intellectual property such as software and Web sites. This combination creates high operating leverage that causes these firms to be very risky. In good times, they are flying high. In weak times, there is very little they can do to trim expenses. Inktomi Corp, was a high-flying software company. It spent $10 million develop- ing research engines and software to manage Web content. Once those fixed costs were incurred, each additional sale was almost pure profit. The president remarked, "You have no cost of goods. We don't even ship a physical diskette anymore. Next to the federal government, this is the only business that's allowed to print money." All this has changed. Software development costs rose and sales nosedived, causing Inktomi to report a very large loss. Enormous fixed costs were required to research, develop, design, test, and market software. Intense competition and rapid obsolescence required high levels of spending each year. The result was a dramatic reversal of fortune lead- ing to big swings in profits, stock prices, and hiring when sales sagged Inktomi did not survive the Internet bubble and was sold to Yahoo! in 2002. SOURCE B. McClure, "Operating Leverage Captures Relationships www.vestpedia.com Dec 28, 2006