How to Analyze
Your Firm's Cost Position
The purpose of this analysis is to analyze a few large value activities in
order to better understand their costs.
Cost drivers are the underlying basis for why an activity is more or less
costly. A clear understanding of the relevant cost drivers for each significant
activity the business performs improves the odds that the business can perform
those activities at a relatively lower cost than competitors not aware of the
cost dynamics at play.
This analysis is very different than analyzing the expenses on a profit
and loss (P&L) statement. On a P&L statement, "Salaries"
often represent the largest expense item. Controlling "Salaries" is a
different concept than controlling the cost of performing "Activity
X." The typical reaction of a financial analyst using the P&L statement
is to cut employees by X% across the company. An alternative approach is to use
the value chain to analyze each activity for possible cost savings and to reduce
costs in those activities that do not cost-effectively support customer needs
and competitive advantage.
The major point, however, is that companies, by their actions, are able to
control the relative costs of the activities they perform. Starting with the
most significant activities performed by the business, measure the relative
impact of each cost driver, and then manage the cost driver(s) with the most
impact in order to control costs to the greatest extent possible.
It is important not to lump strategically distinct activities together. For
example, sales and marketing are often lumped together organizationally, but
each is strategically distinct and cost drivers affect each differently. In
fact, depending on the objective and detail of the analysis, sales
administration should often be analyzed separately from selling; marketing
administration, market research, general advertising, and direct marketing
should be analyzed separately as well.
Besides just indicating the impact of a particular cost driver on given
activity, it is important to explore alternatives for how best to perform the
activity in light of the relevant cost drivers.
In practice, it is often sufficient to analyze the four or five largest
and most significant activities. If the will and desire is still there,
analyze other significant activities as well.
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