The downside of "leverage"

The downside of leverage or "There is no such thing as a free lunch"

If you ever took classes in a Masters of Business Administration program or listened to seminars recorded in a certain era, it was impossible to avoid the word "leverage".

The concept lives with us today as "influencers". The thought process is that if you convince an "influencer" to shill your product then thousands of paying customers will follow them.

Not all skittles and cream

In the physical world (back when I worked), I ran into a downside of "leverage" that I want to share.

I was presented with a problem where the parking brake was marginal for performance.

Federal Regulations require that the parking brake be capable of restraining the vehicle on any road that the vehicle is capable of climbing. Since the steepest road in the United States is/was 30 percent grade, that was the de facto standard. The vehicle might be able to climb more vertical surfaces than that, but the steepest road was 30 percent grade.

Previous efforts to enhance the brake had not been successful. It continued to wobble on the edge of not passing the tests.

The brake was actuated with a lever between the driver's and passenger's front seats. The "build" of the vehicle was to install the electrical harnesses, install the carpet, install the parking brake and then install the center-console over the everything else.

The knee-jerk response of every previous effort to fix the problem had been to increase the mechanical advantage of the cable-drum-lever. That is, they made the diameter of the drum that the cable was spooled onto smaller so each throw of the lever pulled in less cable but was capable of generating more force.

It didn't work.

Hysteresis or slop

The problem was that there was slop in the system.

Too much of the travel of the drum was required to pull the slack out of the system and there was not much left when all of the belly in the cable and the squish of the carpet had been squeezed out.

INCREASING THE LEVERAGE CAME AT THE EXPENSE OF AN INCREASED VULNERABILITY TO SLACK OR GAPS OR HYSTERESIS.

Hydraulic jacks

The common hydraulic jack has a similar problem. It must be much short so it can slid beneath the load and it must be capable of very high mechanical advantage to lift very heavy loads. The problem is that the very high mechanical advantage means that many strokes of the jack handle will be required to raise the top of the jack before the moose-antlers are in contact with the vehicle.

The solution is to have two cylinders (typically telescoping) within the body of the jack. The smaller diameter cylinder is activated first and it moves relatively large distances with each stroke of the jack handle. When it encounters significant load, internal valves "lock" the fluid in the smaller cylinder and diverts additional incoming hydraulic fluid to the larger cylinder. The larger cylinder generates much greater lifting force with each stroke of the jack handle at the expense of much smaller vertical distance-per-stroke.

Another downside of leverage

Investors and businesses use leverage, or borrowing, to multiply the profits they can get from an investment.

If they can invest $100,000 and borrow $900,000 at a low interest rate and then sell their enterprise in two years at $1,400,000 they then pocket $400,000 (less interest paid) on an out-of-pocket investment of $100,000 for an almost return of 200% per year. Not bad business if you can get it.

The downside is when the "market" for flipped houses or widget factories or gaming-software soften and it drops 10%. On paper, the investors didn't lose 10%. Nope, they lost 100%.

If forced to liquidate, they lost every penny.