A Cost Driver is any expenses that change the price of an offered product or service.
Cost Driver Details
Businesses identify cost drivers to figure out overhead costs per the number of units made. These figures are also used to determine the causes of overhead and how to minimize them.
If you have a factory with any type of machinery you know it will need maintenance. There are different types of maintenance required to keep a factory running. There is work you do when the machine breaks, which is usually expensive, but there is work you can do to keep the machine in good working order so it does not break. The second option is typically cheaper but will require a more consistent cost. Both types will drive how much you charge for your end product.
It's true that maintenance for fixing a broken machine doesn't mean you should suddenly charge more to cover the cost of fixing the machine. However, you can budget that into the price of the product so when the machine does break it is not cutting deeply into your profits.
Types of Cost Drivers
There are many different types of cost drivers. Some of them are unique to the product that you are producing, but there's usually an industry standard you can use as a reference. Here is a list of the most common cost drivers.
- Labor hours worked
- Number of Customer Contacts
- Number of machine-hours used
- Number of product returns
- Price of parts for product
- Price of ingredients when producing food items
- Price of packaging
- Price of shipping
- Price of storage
Each of these items directly influences how much you as a business pay for things and ultimately the price you ask customers to pay for your product or services.
Examples of Cost Drivers
For example, let's say you are running a bakery called Crackle Cupcakes. You sell gourmet cupcakes and desserts, and you charge $3 for a filled cupcake. You decide to purchase a set of decorated wrappers to make your packaging more appealing. The wrappers are $100 more expensive than your current wrappers, but they come with 1000 wrappers in a box.
This means that each wrapper is worth $0.10. Instead of taking a cut to your profits, you increase the price of your cupcakes to $3.10 each. That way you are still making the same amount of profits, and you're still able to afford the wrappers.
Significance of Cost Drivers
The price businesses ask for their products or services is not just an arbitrary number. Prices are carefully thought out and should take time and careful calculations to determine. Cost drivers are one of the key things that affect the price for a product or service and a significant factor when prices change.
If the cost of labor goes up, machines need maintenance or the rent on the warehouse changes, then companies need to sit down and look at the numbers. If any of these cost drivers cut too much into profits, then you might need to consider an increase in prices.
This doesn't mean that prices will go up a significant amount. Increased warehousing costs can be broken down and spread over all the inventory they offer. This is an affordable way to handle frustrating budget increases with just a nominal affect on the customer.