What Drives Costs?

What Drives Costs?

          
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What Drives Costs?

The Power of Cost Transparency
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    When the same product costs more to make at one plant than at another, the difference can be explained by the underlying cost drivers. Plants have three categories of cost driver:

    • Scale: the effect of volume on cost per unit made


    • Efficiency: relative productivity, utilization, and process complexity


    • Factor costs: input costs (such as labor), operating costs (such as fuel), and logistics costs (such as shipping)

    A company’s specific cost drivers should be customized on the basis of industry and types of production. A detailed analysis reveals the most relevant cost drivers and the relative effect of each. As shown in the exhibit below, a plant’s cost per unit of production goes up or down depending on the interplay of drivers such as yearly production volume (scale), equipment utilization rates (a measure of efficiency), and local labor rates (a factor cost). Armed with this information, companies can make better decisions about how to structure the optimal manufacturing network.

    A Cost-Driver Analysis in Action

    A European manufacturing company offers a wide array of products ranging from standardized items to high-end, customized models. Before it began to rethink its network, the company had six plants in Europe—most from acquisitions. The plants varied in size from small workshops to large facilities. Each produced complete products, and most components were made in-house. Component specifications differed from plant to plant, so collaboration across plants was minimal.

    The initial data showed that product and component costs varied significantly by plant. Further analysis revealed the source of these differences to be direct and indirect labor and other indirect costs. Material costs were more or less similar across plants.

    exhibit

    A detailed analysis showed that two drivers accounted for the cost differences:

    • Efficiency. Since all the plants were located in Western Europe, the direct labor rate was comparable across plants. But because the small and midsize plants had put much more effort into standardizing components and making products more modular, the workers at those plants were able to work more efficiently and productively than their counterparts at the other plants. As a result, direct labor costs were lower overall.


    • Scale. By contrast, indirect labor and other indirect costs were lower at the larger plants, where the higher volume reduced overhead and production costs. The small and midsize plants lacked dedicated production lines for each component, so they had to switch machine setups more often. This increased tooling times and also affected the types of equipment used: machines were chosen for their flexibility, which further increased costs.


    On the basis of these results, the company closed two small plants and changed its production strategy. It replaced standalone plants with an integrated network of specialized plants, each making specific components. The result was consolidated production lines allowing for greater scale and minimal line changes. These modest footprint changes will save the company 15 to 25 percent of its total component cost (after added logistics costs).

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