98-Big Cost Differences in an Industry – Part 1

The objective of every cost management system is to improve the Productivity of the Input (I) resources used to produce the final Output (O) product. These resources include the Inputs of People, Purchases and Capital. The Output is the unit of product sold. A simple measure of Productivity is Inputs divided by Outputs (P=I/O).

There are several stages in producing a unit of Output, so relatively few employees (one of the key Inputs) actually produce a unit of Output. Instead, most employees produce something else as an intermediate end product on the way to the final product. We call these intermediate end products Intermediate Cost Drivers (ICDs). So, to increase Productivity, you would like to improve the ratio of Inputs needed to produce Intermediate Cost Drivers (I/ICD).

You would also like to reduce the activities, or Intermediate Cost Drivers, you require to produce a unit of final product Output. In ratio form, this means you want to reduce the ratio of Intermediate Cost Drivers in the Output (ICDs/O).

The measure of Productivity then expands into two factors:

Productivity = Inputs/Output = Inputs/Intermediate Cost Drivers x Intermediate Cost Driver/Output
P = I/ICD x ICD/O = I/O

We have studied several thousand cost reduction efforts from the last 25 years. We believe that you can categorize all cost reduction efforts into one of four major concepts:

  1. Reduce the rate of cost for the Input
  2. Reduce the Inputs not producing Output
  3. Reduce unique Intermediate Cost Drivers(ICDs) in products and processes
  4. Spread fixed cost ICDs over new Output

The current issue of The McKinsey Quarterly describes an interesting study that McKinsey has undertaken in the pharmaceutical industry. The study’s conclusions offer us the opportunity to categorize their findings into one of these four cost reduction concepts.

In Part 2, we will describe some of McKinsey’s findings and then tie the findings to the four major productivity improvement concepts above.

Posted 4/23/09

To see some examples of these for cost reduction concepts follow the links below:
reduce the rate of cost for the input
reduce inputs not producing output
reduce unique intermediate cost drivers
spread fixed costs over new output

Your company might use these cost reduction concepts and examples to brainstorm cost reduction ideas for your businesses.




If you face a competitive marketplace, read these blogs. We wrote them to help you make better decisions on segments, products, prices and costs based on the experience of companies in over 85 competitive industries. Much of the world suffered a severe recession from 2008 to 2011. During that time, we wrote more than 270 blogs using publicly available information and our Strategystreet system to project what would happen in various companies and industries who were living in those hostile environments. In 2022, we updated each of these blogs to describe what later took place. You can use these updated blogs to see how the Strategystreet system works and how it can lead you to better decisions.