Structure breakdown for costs

cost Structure
Anonymous A asked on Sep 23, 2020

Hi, I have seen many ways to break down cost (whether it might be for a profitability case or brainstorming question). Some of the most common ways I have seen include: (1) fixed & variable, (2) direct & indirect and (3) number of units x cost per unit.

I am wondering if there are any 'guidelines' as to when I should be thinking about which cost structure breakdown to use (i.e. how do we know which breakdown is appropriate in a case)? Thanks!

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on Sep 24, 2020
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Hi,

Honestly, it depends! You need to think about the industry/business context, the company context, and the situationally/problem context. Only then can you create an appropriately tailored cost breakdown.

The 3 ways that you've seen are all "correct" and are situational.

In general, for determining cost issues, you need to break down the problem into a tree/root-cause analysis and ask the highest level (but specific) questions first! In this way, you essentially move down the tree.

How do you identify where to look? Well, you need to look into whichever of the following 5 make the most sense based on where you are:

  1. What's the biggest? (i.e. largest piece of the pie...most likely to change the end result)
  2. What's changing the most? (I.e. could be driving the most and most likely to be fixable)
  3. What's the easiest to answer/eliminate? (i.e. quick win. Yes/No type of question that eliminates a lot of other things)
  4. What's the most different? (differences between companies, business units, products, geographies etc....difference = oopportunity)
  5. What's the most likely? (self-explanatory)
Was this answer helpful? 19

I haven't seen any guidelines on this. I my eyes, the best tactic for this would be to develop a hypothesis during the upfront discussion on the case. This does not need to be right at the end of the case.

You then lay out a framework and clearly state your hypothesis inlcuding a fitting cost break down. You can mention that this is what you want to start with, but you could also see other possible break downs if your hypothesis turns out to be wrong.

Usually when you get to that part, the interviewer will either tell you that the break down you have in mind is not avaialble, but they have a different data set - which then allows you to adjust your hypothesis, and also state that explicitly - or they will engage in a brainstorming that will lead you to the right break down naturally. However, this will not be based on a strict if-then-else guideline, but more on your general business judgement.

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Interesting question!

I'll give a straightforward answer. The structure should be a tool for developing and testing hypotheses.

So, if your hypothesis (or hunch) is that there's an issue with fixed or variable costs, a structure that breaks these down will be helpful. Likewise, use unit cost x # of units if you believe those are likely to be relevant numbers in the case.

Typically you can test for some of this before you take a few moments to structure.

Does that help?

Best, Allen

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Hi there,

Any of the structures you mentioned could work in theory. However:

  1. For brainstorming: fix and variable and value chain split usually work best
  2. For understanding where the problem is or fixing the problem: number of units and cost per units usually works best

Hope this helps,

Francesco

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Dear A,

Your structure should serve you as a tool to build you hypothesis around. It may be different to every case. So ask yourself, which of the structure serves better in this specific case.

If you have any further questions, feel free to reach out.

Best,

André

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Ian gave the best answer

Ian

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