Profitability and Cost Structure Analysis: Internal Data Analysis Frameworks

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Management Consulting Training
Profitability and Cost Structure Analysis:
Internal Data Analysis
Frameworks
Other
Infrastructure
Support
Design /
R&D
Sourcing
Manufacturing
3% 33% 4% 6%54%
15% 5% 18% 2% 5% 9%

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Contents
Presentation Overview
Cost Driver Analysis
Activity Based Management
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04

There are many frameworks for conducting profitability and cost structure
analysis—this deck focuses on 2 such frameworks using internal data
Profitability and cost structure analysis provides many invaluable insights.
Obvious examples include identifying profitable products and projects and
identifying key cost driving activities and resources—which lead to better
strategic decisions.
There are a number of business frameworks to conduct profitability and cost
structure analysis. In this consulting training series, we will 4 common
frameworks split into 2 categories:
External Data Analysis
Internal Data Analysis
This deck will focus on Internal Data Analysis only.
04

Contents
04

Cost driver analysis looks at the underlying cost base and identify
opportunities to improve
Cost Driver Analysis Overview
Cost driver analysis is closely linked to Activity Based Management as it seeks to explain
the main drivers of costs.
Cost driver analysis seeks to identify the underlying drivers of a company’s
cost base
Given basic data or industry expertise, we can ‘quantify’ major costs drivers
without access to internal data
However, access to internal information increases the value, and potential
insight, that this analysis will derive:
− Also allows much better validation and comparison
An understanding of the underlying cost position allows better quantification of
strategic opportunities and allows clients to better anticipate strategic
decisions:
− Also can improve pricing and production decisions
04

The first step in conducting the cost value analysis is to gain a better
understanding of the cost base
Value Chain – Assigning Costs
The first step is to assign costs to each step of a value chain
We may also want to identify the major activities within each step of the value
chain
CLIENT VALUE CHAIN (ILLUSTRATIVE EXAMPLE)
Other
Infrastructure
Support
Design
/ R&D
Sourcing
Manufacturing
3% 33% 4% 6%54%
15% 5% 18% 2% 5% 9%
04

Within each stage of the value chain, we can then identify the major cost
driver for the associated costs
Value Chain – Cost Drivers
We would clearly start our focus on the largest ‘buckets’ of costs
For each value chain element or major activity, the primary cost drivers should
be identified :
− This requires knowledge of industry and client specific performance
Analysis of cost drivers often becomes a ‘quick and dirty’ activity based
costing exercise:
− Analysis should focus on costs to produce and deliver relevant product(s) or service(s) under
analysis
− Additional costs related to other products and services should be ignored
We can use clients workshops to validate the allocation of costs and the
associated cost drivers
04

Based on our understanding of the client and its industry, we can then
identify relative differences in overall costs
Value Chain – Cost Drivers
There are a number of generic drivers that could lead to differences in costs:
– Scale
– Experience
– Technology
– ‘Factor’ costs, e.g. raw material, labour costs
– Location
– Complexity
– Capacity utilisation
– Supply chain linkages
These drivers can then be compared to competitors to identify potential
structural differences in their industry
04

Contents
04

Activity Based Costing can be more useful than conventional cost systems
in evaluating activity costs
Activity Based Costing Overview
Activity based costing evaluates the cost of activities in a company:
– “Activities” are the major processes in the company associated with serving customers or with
supporting the business
– The cost of the activity is calculated by analysing the time and resources spent on it
– Activity costs can also be assigned to products and customers, giving a better picture of
product and customer profitability
This information is often more useful than conventional costing information:
– Conventional systems track all costs to organisation units rather than to activities
– Activity based costing is particularly appropriate for evaluating the profitability impact of
decisions relating to:
Changing the product portfolio
Re-pricing
Re-engineering processes
Focusing on certain customer segments
04

Example: which customers are profitable for a company?
Process of Serving Customers
This information is not automatically available—it must be calculated using activity based
management.
Different customers make different demands on the company:
– Service level requirements: quality checks, frequency of order, information requests, etc
– Product range: standard products, bespoke services, big orders/little orders
To meet these demands, a company must perform activities in varying amounts:
– Different types of activities cost different amounts (e.g. receiving orders vs. responding to enquiries)
– Different combinations and levels of activities required by any one customer group make some groups
more costly to serve than others:
E.g. one group orders 2 standard items once a month, another orders 6 special items every day
– Depending on the revenue collected from that customer group, it may or may not be profitable
Customer requests a product /
service
Company take actions to
satisfy the customer
Actions consume resources
(people time / machine
capacity)
Cost Object Activity Resource
04

Activity Based Costing differs significantly from a conventional costing
approach
Activity Based Costing vs. Conventional Costing
Conventional Costing Activity Based Costingvs
Focuses on cost centers.
Focuses on business activities and
corresponding activity drivers.
vs
Is typically limited to direct costs.
Encompasses indirect overhead costs as well
(if scoped accurately).
vs
Distinguishes between variable and fixed
costs.
Treats all costs as variable in the longer term.vs
Uses volume as a basis for overhead
allocation.
No allocations—attributes overhead costs to
products on the basis of resources actually
consumed.
vs
04

ABC is merely the use of a model tracing the flow of resources to products
and services
ABC Model
ABC MODEL
RESOURCES
RESOURCE
DRIVERS
ACTIVITIES
ACTIVITY
DRIVERS
COST OBJECTS
RR RR RR RR
AAAAAAAA
COCOCOCOCOCOCOCO
General LedgerGeneral Ledger
RR
ABC TRACES
The cost of the resources…
... that spend time…
... doing activities…
... that are the result of…
... a customer request for a product or service
04

Resource drivers apportion resources’ time to activities
ABC Model – Resource Drivers
ABC MODEL
RESOURCES
RESOURCE
DRIVERS
ACTIVITIES
ACTIVITY
DRIVERS
COST OBJECTS
RR RR RR RR
AAAAAAAA
COCOCOCOCOCOCOCO
RR
We identify how much time each resource pool spends
on the activities it supports
Account
Managers
Visit
Customers
Set-up
proposal
Maintain
Relations
35%
These
percentages
are known as
‘resource
drivers’
25% 40%
04

Activity drivers are events which initiate activities
ABC Model – Activity Drivers
ABC MODEL
RESOURCES
RESOURCE
DRIVERS
ACTIVITIES
ACTIVITY
DRIVERS
COST OBJECTS
RR RR RR RR
AAAAAAAA
COCOCOCOCOCOCOCO
RR
Activity drivers trigger the use of activities by cost
objects
Authorization
W proposals
X proposals
Y Proposals
These are
‘activity
drivers’
Product 2
Product 1
Product 3
04

Useful information emerges at various levels of the model
ABC Model – Insights
RESOURCES
RESOURCE
DRIVERS
ACTIVITIES
ACTIVITY
DRIVERS
COST OBJECTS
RR RR RR RR
AAAAAAAA
COCOCOCOCOCOCOCO
RR
How much do we spend on each
group of people:
– What is the fully loaded cost of each group?
Who in the organisation spends time
on these activities:
– What is the value of that time?
What is the total cost of activity X?
What is the cost per “unit” of the
activity?
How much does process N cost us?
Which activities are not directly
supporting customers and services?
– How much do they cost?
Which services are most profitable/
unprofitable?
What does it cost to sustain our
business?
04

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1
Flevy (www.flevy.com) is the marketplace
for premium documents. These
documents can range from Business
Frameworks to Financial Models to
PowerPoint Templates.
Flevy was founded under the principle that
companies waste a lot of time and money
recreating the same foundational business
documents. Our vision is for Flevy to
become a comprehensive knowledge base
of business documents. All organizations,
from startups to large enterprises, can use
Flevy— whether it's to jumpstart projects, to
find reference or comparison materials, or
just to learn.
Contact Us
Please contact us with any questions you may have
about our company.
• General Inquiries
support@flevy.com
• Media/PR
press@flevy.com
• Billing
billing@flevy.com

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