27 – Cost Consciousness – Part 3

Mitch Max

Cost Consciousness

Mitch Max expands on developing cost consciousness within organizations. He explores managing cost from an
activity viewpoint instead of a cost category viewpoint.

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In episode 27

Coming up on Performance Management Edge… Mitch Max continues his series on creating a Cost Conscious organization.

Hello, and welcome back to our series on creating a Cost Conscious organization.  In the first part of our series, we discussed that an organization can only become Cost Conscious when it has a strong set of cost analytics to guide its culture in making effective decisions. The second episode introduced the concept of reporting costs by activity, and how to use that information to focus and identify ways of improving costs.

We can do so much to analyze costs when we begin with Activities and Processes as the foundation of our measurement framework.  Today, I want to look further into other ways to use this information.

Here’s the data we looked at last time, with two additional pieces of information added:

In addition to total cost of the activity, we have added the unit volume and unit cost for each activity.  This tells us the total cost each time an activity, like entering an order, is performed.  In this case, it costs just over $23 to enter an order manually.

For those activities that do add value – like order entry – our focus should be on reducing the cost of this activity.  Understanding unit cost – that is, the total cost of the activity divided by the driver – number of orders entered – gives us the ability to focus on improving costs by focusing on productivity, or perhaps identifying alternate ways to perform the activity.  One option is to look at activity substitution – diverting manual data entry to online entry where the unit cost is much lower.

When looking at unit cost, a point-in-time measure is less important than relative measures.  For those, consider unit cost trends over time, or internal benchmarks that compare the cost of this activity over multiple organizational units.  Unit Cost analysis adds a new dimension to our view of costs, and assists our pursuit of Cost Consciousness.

Another way of looking at costs is by examining driver intensity – comparing the rate of cost consumption from one product or customer to another.  In our example, the unit cost of handling a special order is about 13 times the cost of handling a standard order.  By comparing the ratio of special orders to total orders by product, we can identify which products or customers require special handling, and determine how to better price the products, or how to work with product marketing or customers to change the relative amount of special handling.

Lastly, we can look at using activity costs to help us plan costs by driver.  Did you notice that some activities share the same driver?  In our example, two activities – scheduling deliveries and invoicing – are driven by the same measure – Shipments.  This means that we can begin to plan our resource needs by understanding the drivers that cause the activity.  Usually, it’s a much smaller list than the number of activities.  Often, one driver can be related to another – for example, returns can be expressed as a ratio to sales orders.  In this way, we can plan, forecast and communicate costs based on the drivers that are causing costs to be incurred, instead of on the level of resource costs.

To recap, I have identified four separate ways in which Activity Analysis can be used to help create a cost conscious organization.  By measuring and reporting on the cost of activities, managing unit costs or measuring and communicating on driver intensity, you can help to shift discussions from cost authorization to cost consumption.  By planning and forecasting based on activity drivers, we can help to develop a forward view of expenses that is actionable at the front line.

Next time, we will look at ways to bring cost information into your reporting environment so that the company’s culture can begin to sustain a Cost Conscious approach.  See you next time!

Thank you Mitch. This is Alan Stratton your host. Until next time on Performance Management Edge.

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