The document outlines a framework for conducting cost drivers analysis as part of competitive cost analysis, detailing techniques, phases of analysis, and benefits and limitations. It emphasizes identifying key cost drivers within a company's value chain, comparing them to competitors to uncover advantages, and quantifying these drivers for a clearer understanding of costs. The analysis involves selecting critical cost drivers, assessing structural differences among competitors, and validating hypotheses through detailed data examination.

1. Cost Drivers Analysis
Business Strategy Framework
May 24, 2012

2. Contents
• Competitive Cost Analysis
- Overview
- Techniques & Level of Effort
- Cost Drivers Analysis – Benefits & Limitations
• Approach
- Phase 1
- Phase 2
- Phase 3
- Phase 4
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3. Cost Drivers Analysis is the focus of this document—and requires
moderate effort to perform
Competitive Cost Analysis – Techniques & Level of Effort
FINANCIAL RATIO ANALYSIS VALUE CHAIN ANALYSIS COST DRIVERS ANALYSIS
DETAILS
• This is a useful starting point for • This is a framework for analyzing value- • This analysis is related to Value Chain
understanding the company’s current adding activities of a company Analysis in that:
economic position • It requires identification of the company’s • Cost drivers are structural causes of
• It provides perspectives on 3 key processes and activities—and costs of a business activity
corporate performance measures: understanding how these activities impact • Cost Drivers Analysis starts with a
• Current profitability and are impacted by other players in end- high-level identification of the
customer’s ―value delivery system‖ company’s value chain
• Sustainability of profits
• Once the value delivery system (i.e. • It does not consider interaction of the
• Financial risk
industry value chain) is mapped, cost company’s cost structure with strategic
• It is difficult to perform this analysis at the drivers at each stage of the value delivery actions of other companies in the industry
relevant business unit level system must be identified
• Quantifying the cost drivers gives analysts
• The company’s value delivery system is significant insight into the cost structure of
then compared to the value delivery our company and of competitors
system of competitors to identify
• Analysis should focus on cost drivers with
advantages and improvement
highest likelihood of having significant
opportunities
impact on cost structure of the industry
Low Effort High Effort Moderate Effort
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4. Contents
• Competitive Cost Analysis
- Overview
- Techniques & Level of Effort
- Cost Drivers Analysis – Benefits & Limitations
• Approach
- Phase 1
- Phase 2
- Phase 3
- Phase 4
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5. Phase 1. Select the critical cost drivers
1 2 3 4
Phase 1 – Overview (1 of 2) Select Identify Quantify Refine
• To identify critical cost drivers, construct a ―high-level‖ value chain and assign costs to each
―value activity‖ (i.e. relevant business processes)
4% Firm Infrastructure
3% Human Resource Management
6% Technology Development
7% Procurement
Inbound Operations Outbound Marketing / Service / After
Logistics Logistics Sales Sales Support
3% 17% 5% 30% 25%
Typically, Cost Drivers Analysis is most effective when the
5-10 critical cost drivers are focused on.
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6. Here is a list of ten major cost drivers, as suggested by Michael Porter
1 2 3 4
Phase 1 – Cost Drivers Select Identify Quantify Refine
• Facility size
Scale • Production
• Technology • Government Regulations
• Operating Efficiency Institutional • Unionization
Factors • Taxes
• Run Length
• Factor Costs • Tariffs
• Local Content Rules
• Scope:
Interrelationships • Other Business Units • First-to-Market
• Shared Activities Timing • Timing to Input
• Shared Learning • Purchases
• Product Complexity • Output Level
Discretionary • Product Variety Capacity
• Facility Utilization
Policy • R&D / Marketing Spend Utilization
• Seasonality
• Delivery Time, Inventory Levels • Cyclicality
• Segments Served • Forecast Accuracy
• Production Technology Used
• Plant Layout Efficiency • Outsourcing
Integration
• Vertical Integration
Learning • Experience (cumulative output)
• Internal Process Linkages:
• Transportation Cost Linkages • Quality
• Labor Cost • Output Linkages (Mfg / Distrib)
Location
• Raw Materials Cost • Vertical Linkages:
• Energy Cost • Supplier Imposed Costs
• Supplier Timeliness
Source: Michael Porter, 1985
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7. Cost drivers having a significant cost impact should be review for
structural differences
1 2 3 4
Phase 1 – Cost Driver Competitive Analysis Select Identify Quantify Refine
• Cost drivers determined to have a
POTENTIAL STRUCTURAL DIFFERENCE AMONG COMPETITORS
significant impact on company’s
cost structure should be reviewed COMPETITOR PERFORMANCE
• Determine if potential structural Product
Scale Learning Technology
differences exists between our Complexity
company and competitors
Competitor A SAME BETTER WORSE BETTER
• Could these structural differences
result in a competitive advantage Competitor B SAME SAME WORSE BETTER
for us?
Competitor C WORSE SAME WORSE BETTER
• This requires knowledge of
industry leading practices and
company-specific performance—
POTENTIAL
may need to consultant 3rd parties STRUCTURE Moderate Moderate High High
DIFFERENCE
for this information
Structural differences may lead to uncovering true competitive advantages (or
disadvantages!).
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8. “Critical” cost drivers can now be selected
1 2 3 4
Phase 1 – Conclusions Select Identify Quantify Refine
• Two cost drivers selected for further analysis from the running example in the previous slides would be
technology and product complexity, because…
• The product complexity and technology cost drivers have large impact on the company’s cost
structure
• These two costs drivers are most likely to exhibit structural difference among competitors
• In this example, we expect that product complexity represents a potential competitive advantage for
our company, whereas technology represents a potential competitive disadvantage
• The next three phases in Cost Drivers Analysis seeks to verify these hypotheses through a more
detailed competitive cost analysis
At this stage, identified critical cost drivers are only hypotheses—which need to be
validated with further analysis.
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9. Phase 3. Quantify competition position on these critical cost drivers
1 2 3 4
Phase 3 – Overview Select Identify Quantify Refine
• Using the company’s detailed cost data, develop a cost driver model to quantify expenditures on each
production cost component
• Use the ―Method of Differences‖ to estimate the cost structure of each competitor
• Assess the production ―differences‖ experienced by competitors on each cost driver component
• Estimate how the production process of each competitor might differ from the company’s own
processes (e.g. machine technology, labor productivity, plant location, delivery costs, etc.)
• Based on these differences, the quantity of each cost driver component used can be estimated
• The price paid by each competitor for these cost driver components can be estimated
• These prices and quantities should be entered into the cost model for each competitor
A key, underlying assumption is that competitive firms have similar inputs to production
process, although quantities may differ significantly.
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