Towards a theory of manufacturing overhead cost behavior: A conceptual and empirical analysis
Authors: Raffi Farshad , Swamidass Paul M. 
Published: October 2002

Manufacturing overhead cost (MOHC) in an average U.S. manufacturing firm is about two and one half times the direct labor cost, yet it has not received much attention from researchers; it is practically a neglected area of research. In the competitive scenario of the 1980s, the need for understanding and controlling any and all costs including MOHCs is greater than ever before. In an attempt to understand and explain MOHC behavior, this study proposes a conceptual model of MOHCs and validates the model with field data collected as part of the 1983 North American Futures Survey of the Manufacturing Roundtable, School of Management, Boston University, Boston. The model visualizes MOHC to be a function of a hierarchy of variables. In the proposed hierarchy, industry type is the most important determinant of MOHC followed by order‐filling method (i.e., make‐to‐stock, make‐to‐order and assemble‐to‐order), strategy variables, and operational variables, in that order. The higher the level of the variable, the greater its impact on MOHCs.

To validate the model, four propositions concerning MOHCs derived from the model were subjected to statistical tests using the data collected from hundreds of manufacturers who participated in the 1983 North American Futures Survey. In the process of conducting the survey, a questionnaire was sent to senior manufacturing executives from 1100 large manufacturing firms in the U.S., Canada, and Mexico including all firms in the Fortune 500 listing of industrial firms. A total of 209 responses was usable. The average 1982 sales of the responding business units was $751 million.

As hypothesized in the model the findings showed that the higher level industry type variable so profoundly influenced MOHCs that it overshadowed the influence of all lower level variables.

Among the five industry groups studied (namely, basic, consumer products, industrial, machinery, and electronics), there was a tendency among the industries to form low or high MOHC clusters. Basic and consumer industry groups were part of a low‐cost cluster and the rest were part of a high‐cost cluster. The MOHC in industries in the high‐cost cluster was nearly 50% more than the MOHC in the industries forming the low‐cost cluster.

An important finding of this study was that several strategy‐related variables were associated with MOHCs. For example, firms showing a high rate of sales growth and those emphasizing a strategy of dependable delivery to customers were associated with relatively high MOHCs.

This study also showed that whereas the MOHC in the electronics industry was most sensitive to strategic decisions, the MOHC in the machinery industry was least sensitive to strategic decisions. Given the state of our understanding, it is unclear why some industries are more sensitive to strategic decisions than others. In the interest of MOHC control, practitioners in all industries should watch for the effect of strategic decisions, if any, on MOHCs and look for ways to control the adverse effects of strategic decisions on MOHCs. More studies are needed to identify the factors that make certain industries relatively more sensitive to selected strategic decisions.