Determining the Drivers of Operating Costs

Traditionally, production volume has been considered the major determinant of cost. As volume increases, total cost increases but unit cost decreases. This concept has been so widespread in industry that many of the tools used to analyze costs are based on production volume as the sole measure of activity and driver of unit cost-fixed and variable costs, cost-volume-price and breakeven analysis, contribution margin, flexible budgets, and others. Clearly, volume is a driver of cost. It is important in both a tactical sense (to the manager at an operating mine) and a strategic sense (as one determinant to the firm's overall cost position). However, many other factors influence costs as well, even though they have not been studied to the same extent. For example, production managers know that their costs will be reduced if the workforce does not have accidents. Safety costs are to a large extent independent of volume. Other cost components increase as volume increases, such as some environmental charges. Some costs may or may not reflect volume changes. Maintenance, for example, may appear as either a fixed or variable cost, as can operating labor in facilities that are highly automated. In the strategic sense, where the firm is selecting a strategy to pursue competitive advantage and increased profitability, all costs are variable. This reflects both the strategic intent and the long-term time frame associated with strategic positioning. Tactically, on a month-by-month basis, some costs are essentially fixed. Cost driver analysis must therefore consider the relevant time frame.