The CEO was coming to visit, and the senior plant manager at a large biotech production facility was uneasy. The latest numbers from the Finance Department hadn’t been good: the plant’s labor costs were rising, while margins were slumping. When the CEO asked what was going wrong, the manager could only describe his difficulties getting his hands around the problems.

As he explained, standard accounting measures based on the cost of goods sold meant that he couldn’t tell for sure whether margins were declining because fluctuating production volumes were reducing operating efficiency or because variations in the mix of high- and low-margin products were bringing down the plant’s average margins—or both. He thought the numbers should be better, given his knowledge of what was happening on the plant floor, but he had no way to dig into the operating details to explain quarter-on-quarter changes in productivity. That would require a much finer-grained understanding of the many components of product costs. The CEO gave the plant executive three months—until the next operating review—to come up with a better answer.

The plant manager knew he faced a devil of a time parsing the many activities of the biotech facility. For starters, the plant had seven distinct production areas and thousands of stock-keeping units (SKUs). In one laboratory-like section, PhDs mixed customized chemical products by hand. Elsewhere, fermentation and cracking lines processed biologic inputs. In another wing, staffers surveyed a continuous stream of capsules and vials as they passed through a fully automated production line. An assembly line for medical instruments occupied one wing; other areas housed testing and packaging lines. Some product families had hundreds of SKUs because of slight differences in key ingredients or concentrations. Swings in the monthly volumes and mix of production compounded the difficulty of pinpointing cost problems.