Part 2: Measuring Current Economies of Scale

Creating Countable Measures of Productivity

Capsule: Productivity measures the ratio of cost Inputs divided by Outputs for customers. Productivity is best measured in physical terms by tracking the basic costs of the Company through the cost functions in the organization and their Intermediate and Final Outputs for customers.

For helpful context on this step:

Videos:

• Video #75: Overview of Costs Part 1: How to Look

• Video #76: Overview of Costs Part 2: What to Expect

• Video #77: Overview of Costs Part 3: What to Do

• Video #49: Definition of a Cost Structure and its Components

• Video #62: How to Improve a Cost Structure

Perspectives:

• “Overcapacity: Threat or Opportunity?”

Symptoms and Implications:

• The number of industry competitors is on the decline

• Some competitors are using growth to reduce their costs

To measure and manage Economies of Scale, the Company measures Productivity with the ratio of Inputs/Outputs. In this diagnostic, the Productivity ratio is composed of physical counts of both Inputs, which are costs, and Outputs, which measure customer benefits. There are many definitions of costs. The easiest way to think about them is as a set of links in a continuous chain. The basic Building Block Costs of People, Purchases and Capital make up each functional cost organization in the Company. These functional cost organizations create benefits for customers by producing intermediate end products, called Intermediate Cost Drivers. The sum of these Intermediate Cost Drivers produces the Outputs of the Company for the customer, the measure of customer benefits. This section of StrategyStreet sets up the management of Productivity by creating countable measures of Building Block Costs, Intermediate Cost Drivers and final Outputs for customers in the following sections:

Productivity and Customer Benefits

Capsule: Productivity is a measure of the number of Inputs required to produce the Outputs for customers. The Company may analyze the physical Inputs by evaluating the chain leading from the basic costs of the business through the cost drivers in each organizational unit to the final Output. The best measure of physical Output for customers is usually a customer order.

• Audio Tip #181: Using Physical Measures to Control Costs

• Audio Tip #185: The Physical Measure of Output for the Customer

• Audio Tip #182: Productivity as a Measure of Physical Cost

Building Block Costs

Capsule: Every business is a composite of three ultimate Building Block Costs: People, Purchases and Capital.

• Audio Tip #183: Building Block Costs in 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.

• Audio Tip #184: Functional Cost Organizations and Productivity

Intermediate Cost Drivers

Capsule: The Company’s functional cost organizations produce parts of the final Output. These parts are the Intermediate Cost Drivers of the final Output. The ideal Productivity cost tracking system would establish a direct relationship from the Building Block costs in each functional cost area through the Intermediate cost drivers to the final Output.

• Audio Tip #186: Intermediate Cost Drivers

Components of Productivity

Capsule: Productivity has two separate components. The first, the Efficiency of the Input, is the ratio of Inputs/ICD. The second, the Effectiveness of the Intermediate Cost Driver, is the ratio of Intermediate Cost Driver/Outputs (ICD/O). Productivity is the product of the two components (I/O).

• Audio Tip #187: The Components of Productivity

We begin this diagnostic by creating a measure of Outputs for customers.

Basic Strategy Guide Users Return to: Step 27

Summary Points

Next: Productivity and Customer Benefits