This document discusses cost drivers and their use in strategic cost management. It defines a cost driver as any factor that causes a change in total cost. Costs are grouped into cost pools and then assigned to cost objects using cost drivers. There are four types of cost drivers: volume-based, activity-based, structural, and executional. Volume-based drivers look at aggregate costs, while activity-based drivers examine costs at a more detailed operational level. Structural drivers influence long-term strategic decisions, while executional drivers affect short-term operational decisions. Understanding a company's value chain, strategic positioning, and relevant cost drivers provides insights into cost behavior.

1. Cost Drivers
The Third Key to Strategic Cost
Management

2. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
 A cost is incurred when a firm uses a resource for some purpose
 Costs are assembled into meaningful groups called cost pools
(e.g., by type of cost or source)
 Any factor that has the effect of changing the level of total cost
is called a cost driver
 A cost object is any product, service, customer, activity, or
organizational unit to which costs are assigned for some
management purpose
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Basic Definitions on Cost

3. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Cost Assignment: General Principles
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Costs
Electric Motor
Materials
Handling
Supervision
Packing
Materials
Cost Pools
AssemblyAssembly
PackingPacking
Cost Objects
DishwasherDishwasher
WashingWashing
MachineMachine
Final
Inspection
Cost Drivers and Cost Assignment

4. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
 For product and service costing
 For strategic decision-making (cost-driver analysis)
 For planning and decision-making
 For control/feedback
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Basic Purposes of Cost

5. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
The process of assigning costs to cost pools or from cost
pools to cost objects
 Direct costs can be conveniently and economically traced to
a cost pool or a cost object
 Indirect costs cannot be traced conveniently or economically
to a cost pool or a cost object
 Because indirect costs cannot be traced, assignment is made
through the use of cost drivers (cost allocation)
 These cost drivers are often called allocation bases
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Product/Service Costing

6. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Product and Service Costing Concepts
 Product costs include only the costs necessary to
complete the product at the manufacturing step in the
value chain (manufacturing) or to purchase and
transport the product to the location of sale
(merchandising)
 Period costs include all other costs incurred by the firm
in managing or selling the product (indirect costs
outside the manufacturing step of the value chain)
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7. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Costs for Strategic Decision-Making – Cost driver
Analysis
 Cost drivers provide two roles for the management
accountant
 Assigning costs to cost objects
 Explaining cost behavior, i.e., how total cost changes as the cost
driver changes
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8. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Types of Cost Drivers
 The four types of cost drivers:
 Volume-based cost drivers,
 Activity-based cost drivers,
 Structural cost drivers, and
 Executional cost drivers.
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9. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
 Activity-based drivers are developed at a detailed level of operations
and are associated with a given manufacturing activity. Activity-based
cost drivers are identified by using activity analysis, a detailed
description of the specific activities performed in the firm’s operations.
 Volume-based cost drivers are developed at an aggregate level. The
relationship between the cost driver and total cost is approximately
linear within the relevant range.
 Cost concept relating to the volume based:
Fixed Vs. Variable, Average cost Vs. Marginal cost, CVP analysis, Break even
Analysis etc.
 Volume based cost drivers capture very little of richness of cost
behavior.
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10. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Drawbacks of volume based cost drivers
 Ignores the fact that different products make different demands on
factory support services. It not relate to unique manufacturing
characteristics in different operations
 As absorption costing emphasized on total cost namely both variable
and fixed, it is not so useful for management to use to make decision,
planning and control.
 It only uses a common plant wide or departmental cost driver and
ignores differences in activities for different products or productions
runs with in the plant.
 Employs a common activity volume of all products
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11. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
 Structural and executional drivers involve strategic and
operational decisions that affect the relationship between these
cost drivers and total cost.
 Structural cost drivers facilitate strategic decision making
because they involve plans and decisions that have long-term
effects.
 It involves choices by the firm that drive product cost
 Scale, experience, technology, and complexity are considered in
hopes of improving competitive position
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Structural and executional drivers

12. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
 Executional cost drivers facilitate operational decision making
by focusing on short-term effects.
 Those determinants of a firm’s cost position that hinge on its
ability to execute successfully. (Related to organizational skills)
 Workforce involvement, design of the production process, and supplier
relationships are considered in an attempt to reduce costs
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13. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Structural Cost Drivers
Scale: Investment size in manufacturing, R&D, and
marketing
Scope: Degree of vertical integration
Experience: Previous repetitions of current work
Technology: Process technologies used at each step in
value chain
Complexity: Broadness of product line
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14. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Executional Cost Drivers
Work Force Involvement: participation; empowerment;
commitment to continuous improvement
Capacity Utilization: given scale choices on plant
construction
Plant Layout Efficiency: compared to current norms
Product Configuration: design or formulation
effectiveness
Exploiting Linkages with Suppliers/Customers: in
relation to the value chain
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15. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Cost Driver Analysis – Some Key Ideas
 Volume is usually not the best way to explain cost behavior
 More useful to explain cost position in terms of structural choices and
executional skills
 Not all strategic cost drivers applicable or equally important all the time but
some are probably very important in every instance.
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16. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Cost Driver Analysis
Management Accounting Strategic Cost management
What is the most
useful way to analyze
costs?
In terms of products, customers,
functions
In terms of various stages of the overall
value chain of which the firm is a part
Strongly internal focus Strongly external focus
What is the objective
of cost analysis?
Not regard to the strategic
context
Design of cost management system
changes dramatically depending on the
basic strategic positioning of the firmScore keeping, Problem solving,
attention direction
How should we try to
understand cost
behavior?
Cost is primarily a function of
output volume
Cost is a function of strategic choices
about the structure of how to compete
and managerial skill in executing the
strategic choices.
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17. Blocher,Stout,Cokins,Chen, Cost Management 4e ©The McGraw-Hill Companies 2008
Linkages Among Value Chain Analysis, Strategic
Positioning Analysis and Cost Driver Analysis
 Understanding the value chain helps define the optimal
positioning strategy
 Understanding the value chain and positioning strategy helps
identify the relevant cost drivers
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