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An activity driver, also called a cost driver, is any event or activity that has a substantial effect on the overall cost of a product. This is used to help businesses determine how much each product should cost so the company makes its money back and reaps a profit. Common activity driver factors include employees’ pay, machine hours and the cost of resources. There also are untraceable costs, but some analysts argue that these costs should be added into the mix. By looking at the activities, analysts can help drive down costs and, therefore, make the product less expensive.
To help assign a fair product price — for both the customer and business — analysts look at activity drivers to figure out the overhead costs for producing a product. Each activity driver is then placed into its own cost object, or a separate measurement of each cost. When looking at the driver, the analyst must ascertain both the frequency and hourly cost of the activity.
Every product will have at least one activity driver. Common drivers are the costs of hiring employees to create the product; the hours a machine is used, which incurs maintenance; the amount of resources and the time spent accruing the resources; and transportation. The more activity drivers and the longer each driver must occur, the higher the product’s price.
Other activity driver costs are thought to be untraceable or have no noticeable effect on product price. This includes the executives’ salary and payment of anyone else not directly involved in making the product. While these are not lumped into the cost driver allotment, the cost still has to be overcome to make a profit. Many analysts, therefore, also estimate these factors to ensure a profitable price is reached.
Along with knowing the activity driver's contribution to price, managers and analysts try to find ways to reduce the price without reducing quality or quantity. For example, if fewer employees are actually necessary to make the product, or if the company can get resources at a cheaper price from another vendor, this will reduce the activity driver contribution. At this point, the business either will reduce the product price or will reap the extra profit.
If a product cannot meet its activity driver cost, the business either will find a way to reduce its price or will stop making it. Conversely, if a product is doing exceptionally well, the company will allocate more resources to ensure the product meets consumer demand. To help control the cost of cost driver analysis, software is usually employed so analysts can work faster.