First Cut Analysis of Costs

The allocation of costs and assets will produce a value chain that illustrates graphically the distribution of a firm's costs. It can prove revealing to split the cost of each value activity into three classes: human resource costs, purchased operating inputs, and assets by main category. The proportions of value chain can be drawn to reflect the sharing of costs and asset between activities.

Yet the initial allotment of operating costs and assets to the value chain might suggest regions for cost improvement. Purchased operating inputs will frequently symbolize a larger proportion of costs than generally perceived, for illustration, since all the purchased inputs in the value chain are rarely cumulated. Other insights can result from grouping value activities into direct, indirect and quality reassurance activities, and cumulating costs in each category. Managers frequently fail to identify burgeoning indirect costs and have a tendency to concentrate almost exclusively on direct costs. In many firms, indirect costs not only represent a large proportion of total cost but also have grown more rapidly than other cost elements. The introduction of sophisticated information systems and automated processes is reducing direct costs but boosting indirect costs by requiring such things as sophisticated maintenance and computer programmers to prepare machine tapes. In valve manufacturing, for illustration, indirect cost symbolizes more than 10 percent of total cost. Firms can also find that the total of all quality assurance activities in the value chain is noticeably large. In most of the industries, this has led to the rising conclusion that other approaches to quality assurance in addition to inspection, adjusting, and testing can result large cost savings.