5.4 The hierarchy of cost drivers

In activity-based costing (ABC), cost drivers can be organized into a hierarchy known as the cost driver hierarchy. The cost driver hierarchy classifies cost drivers based on their level of influence and their ability to explain variations in costs. The hierarchy typically consists of the following levels:

1. Unit-level drivers: These are cost drivers that vary with the number of units produced or the level of output. Unit-level drivers directly affect the cost of producing individual units. Examples include direct materials, direct labor, and machine hours per unit. Unit-level drivers have a strong correlation with the volume of production.
2. Batch-level drivers: These cost drivers relate to activities performed for a group or batch of units rather than for individual units. Batch-level drivers capture costs that are incurred each time a batch is processed or produced, regardless of the number of units within the batch. Examples include setup costs, equipment changeovers, or production scheduling costs.
3. Product-level drivers: These drivers are associated with activities that support the production or delivery of specific products or product lines. Product-level drivers allocate costs to individual products or product lines based on factors other than the number of units produced. Examples include product design costs, product development costs, or costs associated with maintaining product-specific machinery.
4. Customer-level drivers: These drivers are related to activities and costs incurred to serve specific customers or customer groups. Customer-level drivers allocate costs based on the unique demands and requirements of different customers. Examples include sales visits, customer support costs, or costs associated with tailored services for specific customers.
5. Organization-level drivers: These drivers represent costs that are not directly tied to specific products, batches, or customers but are necessary to sustain the overall organization. Organization-level drivers allocate costs that benefit the entire organization as a whole. Examples include facility rent, executive salaries, or administrative costs.