Manufacturing Cost Structure

Manufacturing Cost Structure

Source: adapted from UNIDO (2000) Structure of Production Costs in Footwear Manufacture.

Manufacturing costs are usually a measurement for acquiring, transforming, and distributing materials, parts, or finished goods. They commonly involve a monetary exchange (or monetary equivalence) but also include the amount of energy and time being allocated to the process (which are often transcribed into monetary costs). Costs can be fixed, implying that they do not change irrespective of the amount of what is being produced (e.g. lease of factory space, upper management wages), or variable, where they change in relation to the output (e.g. wages, materials, energy). Manufacturing costs come in two main categories:

  • Direct costs (also called full production costs or prime costs) are directly associated with the output. Usually, they include materials and parts, wages and benefits, and operational expenses such as manufacturing equipment costs (lease, energy).
  • Indirect costs (also called nonproduction costs or overheads) include costs (materials, labor, or monetary) that cannot be directly assigned to the output. These include factory overheads (lease, maintenance, cleaning, heating/cooling, taxes, insurance), administrative overheads (management, human resources), selling overheads (marketing, advertising), distribution costs (packaging, transportation) and research and development costs (product design and improvement, compliance).

The compilation of various direct and indirect costs is indicative of the manufacturing cost structure. The factory cost concerns all the direct costs and the factory overheads. It is a proxy for the basic costs necessary to produce a level of output; they are commonly related to a specific facility allocated the production of the output. The total costs, in addition to factory costs, include other overhead costs such as administration, sales, distribution, and R&D. These costs may not necessarily apply to a specific location but could be assumed by the whole corporation, particularly if this corporation is a multinational (R&D could, for instance, take place in a separate facility and the administrative and sales costs incurred by the head office are supported by the whole corporate network). Depending on its geographical strategies and behavior, a manufacturing firm can achieve various economies such as those related to the scale of its output and the clustering with suppliers or customers.

The price is the monetary equivalent paid by the purchaser of the output and is commonly set by contract or by current market value. The net selling price includes the total costs of the manufacturer and the profit it is willing to take. This price does not include taxes that are usually levied on added-value or profit. When international transactions are concerned, various commercial terms can apply in terms of who assumes the distribution costs and the liability while the cargo is in transit. With globalization, distribution is taking growing importance in the manufacturing cost structure, even if logistics costs have not changed much due to improvements in freight distribution.