A cost driver is the unit of an activity that causes the change of an activity cost.
The Activity Based Costing (ABC) approach relates indirect cost to the activities that drive them to be incurred.
In traditional costing the cost driver to allocate indirect cost to cost objects was volume of output. With the change in business structures, technology and thereby cost structures it was found that the volume of output was not the only cost driver. Some examples of indirect costs and their drivers are: indirect costs for maintenance, with the possible driver of this cost being the number of machine hours; or, the indirect cost of handling raw-material cost, which may be driven by the number of orders received; or, inspection costs that are driven by the number of inspections or the hours of inspection or production runs.
Generally, the cost driver for short term indirect variable costs may be the volume of output/activity; but for long term indirect variable costs, the cost drivers will not be related to volume of output/activity.
John Shank and Vijay Govindarajan list cost drivers into two categories: Structural cost drivers that are derived from the business strategic choices about its underlying economic structure such as scale and scope of operations, complexity of products, use of technology, etc., and Executional cost drivers that are derived from the execution of the business activities such as capacity utilization, plant layout, work-force involvement, etc.
To carry out a value chain analysis, ABC is a necessary tool. To carry out ABC, it is necessary that cost drivers are established for different cost pools.
"Cost drivers are the structural determinants of the cost of an activity, reflecting any linkages or interrelationships that affect it" (M. Porter), therefore we could assume that the cost drivers determine the cost behavior within the activities, reflecting the links that these have with other activities and relationships that affect them.