BASIC STRATEGY GUIDE: STEP 27
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Activity Four:
Manage the Company’s cost structure to create Economies of Scale while offering good value to Core customers.
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Step 27: Create countable measures of Productivity.
What:
This step creates physical counts of costs and customer benefits. The measures of cost include measures of Inputs of basic Building Block Costs (i.e., People, Purchases and Capital) and Intermediate Cost Drivers (ICDs), which are the activities of the functional cost organizations. These Inputs and Intermediate Cost Drivers produce the Outputs of the organization. The basic measure of Output for the customer is a customer order.
Why:
These physical Productivity measures complement the Company’s management cost information system. They establish a physical link between Input costs, the activities of the functional cost organizations and the final Outputs. By measuring these physical units of cost, the Company is able to measure its Economies of Scale and manage Productivity.
Economies of Scale improve when the Productivity of costs increases. The improvement in Productivity, through an improvement of either Efficiency or Effectiveness, reduces costs that do not help the customer.
What to Watch For:
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The Company should not undertake a cost reduction effort without, first, establishing the benefits that each functional cost department is responsible for providing the customer.
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Audio Tip #194: The Primacy of the Customer Considering Cost Reduction
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Productivity, the ratio of number of Inputs divided by number of Outputs, should be an easy measure for the Company and each functional cost organization to create. This is the beginning step in the assessment of Economies of Scale and of effective cost control.
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The most effective measure of Outputs is number of customer orders. Other measures, such as customer accounts or customer shipments which might form other bases for measuring Outputs, are less effective and less comprehensive than customer orders. More Information >>
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Audio Tip #185: The Physical Measure of Output for the Customer
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The Company should concentrate its analyses on the People Input of the basic Building Block Costs. After it gains experience in measuring People and their activities, the Company can move on to measuring the Productivity of Purchases and Capital. More Information >>
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An activity must be countable in order to form a useful Intermediate Cost Driver. In the early stages of this effort, relatively few activities may have actual counts. However, with time, the Company will be able to count and include more measures of ICDs. More Information >>
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Audio Tip #184: Functional Cost Organizations and Productivity
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Productivity has two major components, the Efficiency of the Input, measured as Input/ICD, and the Effectiveness of the ICD, measured by ICD/Output. More Information >>
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Companies achieve Efficiency of Input advantages by achieving either lower rates of cost or higher utilization of Inputs through elimination of unproductive time and activities.
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Companies achieve Effectiveness of ICD advantages either by eliminating unique ICDs or by spreading the remaining ICDs over more Output.
Action:
Measure the Productivity and its two major components as deeply as possible within each functional cost organization. Use these measures to improve Productivity.
More Information on Creating Countable Measures of Productivity on the Advanced Site>>
For helpful context on this step:
Videos:
Perspectives:
Symptoms and Implications:
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