Significant Activities
& Their Cost Drivers
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Template for: Significant Activities & Their Cost Drivers
The purpose of this section is to truly understand the cost
dynamics of each strategically significant activity. In practice, it is
usually sufficient to analyze in detail the four most important activities. This
will help ensure that the task is not skipped or rushed through in order to just
finish it. In theory, every activity can (and eventually should) be analyzed for
improvement.
At first glance, the following may look intimidating. (Some say it's
intimidating on the second glance too.) But it is less frightening if viewed as
a simple checklist to help analyze why an activity is relatively more or less
costly by considering the impact of each cost driver.
From Michael Porter's Competitive
Advantage, cost drivers are defined as the structural factors that influence
cost and can be more or less under a firm's control. The cost drivers are:
- Economies of scale: refer to declines in unit cost of a product or
service as the absolute volume per period increases, or to the ability to
spread fixed costs like advertising or R&D over a larger customer base.
- Capacity utilization: high fixed costs of an activity imply that
unit costs are affected by volume.
- Learning and spillover: cost declines over time due to learning
that increases efficiency.
- Value chain linkages: are relationships between the way one value
activity is performed and the cost of performing another activity. (For
example, the better a product is designed, the fewer the service calls.)
- Supplier linkages: the cost of activity can be affected by how
suppliers perform their activities.
- Channel linkages: the cost of activity can be affected by how
channels perform their activities.
- Interrelationships: sharing an activity with another corporate
business can affect costs.
- Integration: performing an activity in-house versus purchasing
services externally can affect costs.
- Timing: the cost of an activity can be affected by timing,
including first-mover or late-mover advantages.
- Discretionary policy: costs are affected by strategies pursued and
features provided or not provided.
- Location: activity location can affect the cost of the activity (as
can location relative to other activities).
- Institutional factors: such as government regulations and taxes can
affect costs.
Each activity performed by the business should be analyzed in terms of how
the activity costs are affected by the cost drivers listed above. Alternatives
for controlling the costs of each activity should also be addressed. If a cost
driver has no impact on a particular activity, leave it out.
Example for Shoe Manufacturing Company XYZ:
ACTIVITY NAME: Product Development
.Activity Cost: $4 million
.Percent of Total Cost: 15%
.Activity Description: Worldwide product development of a full line of
ladies shoes.
.Activity Analysis in Terms of Cost Drivers: In 1991, in order to
appreciate global economies of scale in production by using extremely expensive
equipment, we streamlined our product line and switched to one manufacturing
plant.
.Approach/Alternatives for Controlling Activity Costs: New, flexible
technology has diminished many of these economies of scale in production and
will allow us to have additional production sites that can manufacture custom
designed shoes based on local consumer demand; as well as minimize shipping
time, shipping costs and tariffs.
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