Question

Cost driver analysis is an important component of strategic analysis. There are two types of organisational cost drivers that determine its long-term cost structure.

Required: What are the two types of organisational cost drivers? Give examples and explanations of the various factors in both cost driver categories. How does an understanding of them contribute to the identification of profit improvement opportunities?

Answer 1

Part A

There are two types of organizational activities for studying overhead cost: structural and executional. Structural cost drivers relate to business strategic choices about an organization’s underlying economic structure, such as scale and scope of operations, use of technology and complexity of products. Executional cost drivers relate to the execution of the business activities, such as utilization of employees, provision of quality service, and product design and manufacturing.

The structural and executional activities determine the nature and number of the daily activities performed in the company. If a company decides to manufacture more than 2 one product at a plant, this structural choice will produce a need for scheduling, a product-level activity. Similarly, providing a plant layout defines the nature and extent of the materials handling activity. Although organizational activities determine operational activities, analysis of operational activities and cost drivers can be used to suggest strategic choices of organizational activities and cost drivers.

For instance, the number of material moves as a measure of the materials moving activity by individual products suggests that resource spending can be reduced if the plant layout is redesigned to reduce the number of moves required. Examples of some structural and executional activities with cost drivers are listed by category in Table 1 below.

Part B & C

Table 1 Organizational activities and cost drivers

Structural activities	Structural cost drivers
Plant construction	Number of plants, scale, degree of work centralization
Employee grouping	Number and type of work units
Complexity	Number of product lines, number of unique processes, number of unique parts, degree of complexity
Process selection and use	Types of process, experience of usage
Executional activities	Executional cost drivers
Employee utilization	Degree of involvement
Quality service provision	Quality management approach
Operation of plant layout	Plant layout efficiency
Product design and manufacturing	Product configuration

As illustrated in Table 1, a company activity can commonly be driven by more than one cost driver. For instance, the number of plants, scale and degree of centralization all affect the cost of plant construction. Companies that have a commitment to a high degree of centralization may build larger plants, so that there are more physical concentration and more control. Similarly, complexity may be driven by the number of different products, number of specific processes and number of specific parts.

There are four key areas that can help drive profitability. These are reducing costs, increasing turnover, increasing productivity, and increasing efficiency. We can also expand into new market sectors, or develop new products or services.

Thus, by understanding the structural & executional drivers we can emphasised the optimum utilasation resoucre stragtegy which is indeed compund of operational efficency, technical competience & excellent mangement overview/supervision.