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Cost Management-final                                                                                                       7

3. Identify the cost drivers for each process : The next step of internal cost analysis is to identify the factor or cost determinants for each value-creating process. By understanding b» factors drive costs, a firm can assign priorities among its cost improvement initiatives, artier to determine its relative cost advantage, a firm should also know the cost factors of its competitors.

While management accounting systems may contain the total cost of each value-creating process, they may not reveal the causes or factors for the significant individual costs. Using single output or volume measures (e.g., units, labour hours, sales in Rs.) to assign costs is often misleading. Multiple cost drivers usually provide more useful information. Exhibit 1 illustrates examples of structural and executional cost drivers.

EXHIBIT 1

PROCESS COST DRIVERS

STRUCTURAL COST DRIVERS

Scale- How big an investment to make in manufacturing, R&D,  marketing and other resources

Scope- -What is the degree of vertical integration —

horizontal integration is more related to scale?

Experience or learning- How often has the firm already done this ?

Technology- What process technologies are used within

each step of the firm's value chain ?

Complexity- How wide a line of products or services to

offer to customers ?

EXECUTIONAL COST DRIVERS

Work force involvement or- Is the workforce involved in decisions and participationimprovements in performance?

Total quality management- Are the workforce and managers committed to total quality in processes and products?

Capacity utilisation- What are the scale choices on maximum plant construction?

Plant layout efficiency- How efficient, against current norms, is the plant's layout?

Product configuration- Is the design or formulation of the product effective?

Linkages with suppliers and-Is the linkage with suppliers and customersexploited, according to the firm's value chain

Structural cost drivers consist of organisational factors that determine the economic structure driving the cost of a firm's products. These cost drivers reflect a firm's long-term decisions, which position the firm in its industry and marketplace. Structural c« drivers may change. For example, large pharmaceutical companies enjoy economies c scale that lowers their unit costs for expensive R&D.

Executional cost drivers capture a firm's operational decisions on how best to employ its resources to achieve its goals and objectives. These cost drivers are determined b management policy, style and culture. How well a firm executes its use of human an physical resources will

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