Part 2: Measuring Current Economies of Scale

CREATING COUNTABLE MEASURES OF PRODUCTIVITY

Cost Functions in the Organization

Capsule: The Company is a set of functional cost management organizations. Each of these functional cost organizations of the Company employs the Building Block costs of People and Purchases. Some also employ Capital.

The three Building Block costs do not have an independent existence. They exist only inside the functional cost organizations of the Company. Examples of these organizational units include sales, marketing, finance, operations, customer service, research and development, and so forth. These functional cost organizations manage these Building Block costs.

In the next link in the physical measurement of Productivity, the Company measures the Building Block costs in each of these cost functions. This task is relatively simple for the costs of People and most Purchases. Capital poses another problem. Each functional cost organizational unit knows the number of people it has. Each usually knows the amount of purchases for which it has responsibility. But assets and Capital may be another matter. While some cost functions, such as manufacturing, may have a detailed knowledge of their assets, they may not know the dollar amount of their Capital employed. Other cost functions measure neither assets nor Capital. In most cases, significant amounts of assets and Capital are not allocated to specific cost functions. Instead, they reside in a “corporate center.”

If your Company treats assets and Capital as company-wide costs, it does not allocate these assets or Capital costs back to the cost functions of the organization. If this is the case, concentrate your diagnosis of Building Block costs on the costs of People and Purchases only. You may return to the issues of measuring and managing assets and Capital once the Company becomes effective at measuring the costs of People and Purchases.

A key outcome of this diagnostic is a set of countable measures for the Building Block costs in each functional cost organization:

• The numbers of people (i.e. FTEs) employed. The Company should also count the FTEs by major groupings of salary grade or compensation (i.e. Think Employees, Supervise Employees and Do Employees).

• Audio Tip #193: The Types of People in a Functional Cost Organization

• The units of major purchases, such as kilowatts of energy, tons of paper, tons of steel, number of semiconductor chips, etc.

• The dollars of Net Capital Employed, i.e. assets less Free Liabilities, at the pre-tax cost of Capital. See Measuring Current Economies of Scale/Building Block Costs for an approach to this calculation.

Now that we have counts of the Building Block costs of People, Purchases, and perhaps, Capital, we turn to finding counts of the products of each functional cost organization, the Intermediate Cost Drivers.