Strategy Survival Guide

Defining cost buckets
Costs can be broken out according to a number of different splits. For example, a childcare provider’s costs
might be broken out according to age of child, or function, such as staff, child costs (food and consumables),
property costs, administrative overheads etc. It is important to find a mutually exclusive split – where each
cost can be placed in only one of the categories. A logic tree may help in this process.
Gathering evidence
In some cases, detailed management accounts from existing suppliers might be available. In other cases,
estimates might need to be pulled together from a range of different sources. Be aware that you are
attempting to analyse costs for one example supplier – it cannot and will not reflect everyone in the market.
Thus the need to run sensitivities and sense checks later in the process.
Constructing a spreadsheet model
Theoretically, you could stop after the previous step and still gain insights into the likely operation of the
market. However, by pulling the estimates of costs in different categories together into a spreadsheet, further
analysis can be conducted on the sensitivity of costs and supply on particular elements. This, in turn, allows
one to predict likely reactions to policy options or new regulations. The spreadsheet itself should be as
adjustable as possible to allow sensitivities and scenarios to be run easily. Refer to the modelling section for
advice on the construction of spreadsheet models.
Investigating sensitivities
The spreadsheet model will allow adjustment of the cost variables to investigate the overall effect on the cost
of supply or the profitability of a supplier (if the revenue side has been added). In many cases, there will be
numerous variables that can be changed. It is important to alter one at a time, in a methodological fashion, in
order to derive the results from changes in one variable at a time. A second approach is to run specific
scenarios on the model – changing all the variables at once according to one view of the world.
Sense checking
The cost structure analysis conducted will have been based on a series of assumptions. However well these
assumptions have been grounded in hard evidence, it is crucial to check that the results of the assumptions
acting altogether make sense. Results can be checked with experts in the field, existing suppliers and other
business plans that are available. This triangulation of results in important to ensure confidence in the
messages being drawn from the analysis. This also brings up a limitation to the analysis conducted: however
sophisticated the modelling, it can only be based on a series of assumptions. It does not reflect an actual
outcome. It can therefore give insights into key drivers and likely reactions, but is not "the answer".
Strengths
• The structure, conduct, performance model provides an overarching framework for assessing the
industries being studied. It provides a useful insight into the context within which a department or
industry has been operating.
• The forces at work model provides a comprehensive checklist for analysing the structure of
industries and sectors. It can be used to identify what further analysis is required.
• Cost structure analysis is potential very powerful since it can feed into a better understanding of
market functioning and likely reactions to changes in policy.
• In areas where evidence has tended to be based on anecdote, cost structure analysis and modelling
can bring significant new insight to the debate.
Weaknesses
• A model of costs or profitability can only give a simplified indication of the way the world works. It
must not be viewed by the team (or stakeholders) as "the answer". Key messages can be drawn
from running sensitivities or scenarios on the model, but should be carefully sense checked.
• Attempts to allocate overhead (shared) costs – such as administration – between different products,
people or plants are fraught with difficulty and should be approached with caution. Each stakeholder
will have an opinion on how such costs ought to be allocated.
• Cost structure analysis and profitability analysis will involve many variables and the team may wish
to run sensitivities on most if not all inputs. This makes it crucial that key messages are drawn out for
communication to stakeholders, without getting bogged down in technical details. The right insights
need to be communicated in an effective way. This may mean significant lengths of time spent
interpreting results within the team prior to communication to stakeholders.
Strategy Survival Guide – Strategy Skills
Page 139