U3

• Cost object


  The dependent variable in a cost function
• Cost function


  A mathematical description of the relationship between a cost item and the underlying cost driver
• Cost driver


  Any variable that affects the cost level of a particular cost object in a given time span
• Approaches to assess cost drivers

  1. Look for physical relationships

  2. Look for contractual relationships

  3. Look for logical relationships
• Cost function


  • Describes the relationship between output (independent variable) and cost (dependent variable)
• Typical shapes of cost functions

  • Proportional
  • Degressive
  • Progressive
  • Regressive
• Proportional cost function


  Total cost increases, average cost decreases, variable cost increases, fixed cost is constant
• Degressive cost function


  Total cost increases at a decreasing rate, average cost decreases, variable cost increases at a decreasing rate, fixed cost is constant
• Progressive cost function


  Total cost increases at an increasing rate, average cost first decreases then increases, variable cost increases at an increasing rate, fixed cost is constant
• Production function


  Determines input quantities consumed
• Cost function


  Determines costs based on input quantities and prices
• Production function


  • Provides information on production-related cost drivers like production capacity and production process
• In business practice, cost management works via physical inputs, while cost estimation and forecasting is often done directly via statistical methods
• Cost management


  Works via physical inputs: costs are influenced by changing input quantities / mix of inputs / suppliers for different inputs, replacing inputs, etc.
• Cost estimation and cost forecasting

  Often done directly (without referring to production functions) via statistical methods
• Cost management process


  1. Select the cost item and the cost driver

  2. Assess the cost elasticity

  3. Determine the amount of cost that is fixed
• Production function


  • Provides essential information on the production-related cost drivers of the company: production capacity, production process, production technology, depth of vertical integration
• Changing production-related cost drivers

  Changes the production function – and ultimately also the cost function
• Relevant range of a cost function

  The section showing a linear relationship between output and cost
• Cost elasticity


  The degree to which costs change due to an underlying change in the activity level
• Types of cost behaviour

  • Fixed
  • Proportional
  • Degressive
  • Progressive
  • Regressive
• Cost stickiness


  The tendency of a cost item to remain at its current level even when the underlying cost driver volume is reduced
• Learning curve


  Describes how the quantity of a particular input that is required for one additional unit of output changes if the total numbers of output units is increased
• Technology progress ratio


  Describes the new unit cost that would be expected following a doubling in output
• Learning curves lead to degressive cost functions, i.e. the marginal cost is decreasing with increasing output
• Technology progress ratio - the renewable energy example
• There are different approaches available for estimating the function relationship between a cost driver and the resulting cost level
• 49 (0)7121 271-903027, [e-mail]
• Technology progress ratio


  The renewable energy example
• Source: IRENA (2020): Renewable Power Generation Costs in 2019, p. 39
• Prof. Dr. Andreas Taschner, ESB Business School, Hochschule Reutlingen, Alteburgstraße 150, 72762 Reutlingen, www.reutlingen-university.de, T. [phone], F. [phone]-903027, [e-mail]
• Methods of estimating cost

  1. Select the cost item and the cost driver

  2. Assess the cost elasticity

  3. Determine the amount of cost that is fixed
• There are different approaches available for estimating the function relationship between a cost driver and the resulting cost level.
• Cost estimation methods


  • Heuristics
  • Conference method
  • Account analysis
  • Scatterplots
  • High-low method
  • Regression analysis
  • Physical measurement & causal analysis
• Heuristics


  They express general wisdom or rules of thumb developed during one's own professional activity
• Heuristics


  • Rules are of limited help in complex situations
  • Rules are easy to understand and remember
• Conference Method


  It combines individual judgments of several subject-matter experts to arrive at a consensus on the cost pattern
• Conference Method


  • Fostering of cooperation across functions and higher acceptance among decision makers
  • Subjective estimate that runs the risk of misinterpretation and misjudgment
• Account Analysis Method


  The estimation of the cost function can be drawn on the set of different accounts a company uses to track its cost types
• Account Analysis Method


  • Analysis can be performed in a more detailed and reliable manner
  • Not always suitable since a comprehensive set of cost accounts is required