Cost Drivers

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What are Cost Drivers?

Cost Drivers are the structural causes of the cost of an activity performed in the Value Chain. They determine the behavior of costs within an activity.

A cost driver can be completely or partly or not at all under the control of a firm.

A firm's cost performance in all of its major discrete activities adds up to establish its relative cost position.

According to Michael Porter, there are 10 major cost drivers:

1. Economies or Diseconomies of Scale.

2. Learning and Spillovers. The cost of a value activity often declines over time due to learning or improvements that increase its efficiency. Or due to knowledge acquired from suppliers, consultants, former employees or reverse engineering.

3. Pattern of Capacity Utilization. Different ways of configuring a value activity will effect its sensitivity for capacity (under)utlization.

4. Linkages. The cost of many value activities is affected by how other activities are performed within the firm's own value chain or with the value chain of a supplier or a channel ("Vertical Linkages"). Through combining these activities and their linkages, their total cost can be reduced.

5. Interrelationships between business units within a firm in the form of shared activities.

6. Vertical Integration. Doing more activities within the firm.

7. Timing, such as First Mover Advantage or Second Mover Advantage.

8. Discretionary Policies. The strategic choices a firm make, for example being a self-service internet bank or being the fastest courier company.

9. Location. Geographic location where an activity is conducted and the prevailing costs of personnel, materials, energy, etc.

10. Institutional Factors. Government regulation, tax regimes, financial incentives, unionization, tariffs and levies, local content rules also affect the costs of a value activity.

Investigating the cost drivers of each value activity through Cost Analysis allows a firm to gain a deep understanding of the sources of its own cost position as well as relative to its competitors and how these costs may change or be changed by Cost Dynamics. A Competitive Cost Advantage grows when a firm is controlling its drivers better than competitors.

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