Agenda Today

1
Agenda Today

• Review of mini-test no. 2
• Comment on mini-test no. 3 (Wednesday)
• AZURE problem to illustrate mix/yield effects
• Overview of product control system variances
• Comments about the use of selected variances

2
Contribution Variances

• Remember, the purpose of our variance schemes at
  the management control level is to help to
  explain why actual results differed from planned
  results. We do not presume the plan was optimal
  for either the planned or the realized
  environments. Rather, we are attempting to shed
  some light on the reasons for differences.

3
Contribution Variances

• Once we have developed a variance scheme and
  computed some variances, we still need to have
  some heuristics to guide the process of
  investigating variances in a cost-effective
  manner. Variances are defined as either good or
  bad in terms of their effects on income.

4
Managerial Performance

• No variance scheme can anticipate operating
  conditions, market conditions, the actions of
  competitors, and economic developments. Our
  inability to anticipate the above forces is even
  more limited in a global marketplace that is
  subject to political shocks and natural disasters.

5
Managerial Performance

• What we can hope to do is to isolate some common
  effects that tend to be associated with different
  centers of responsibility and to provide a
  starting point for more in-depth analyses of
  actual performance. Areas in conformance with
  plan receive less attention than those not in
  conformance. We are of the opinion that
  successes should be reviewed along with failures
  to continuously improve.

6
Managerial Performance

• This perspective is entirely consistent with the
  idea organizations should be managed based on the
  data. At some level, performance should be
  analyzed for corrective action and
  problem-solving solutions. The intent is not to
  club managers into conformance, but to pursue the
  continuous cycle of planning, acting, evaluating,
  replanning, etc.

7
Performance Dimensions

• For the most part, we have focused on
• Price realization
• Sales volumes
• Overall sales volume
• Sales mix when appropriate
• Production (cost) variances
• Resource prices
• Efficiency of resource usage
• Idle capacity cost

8
Bentz/Lusch Schema

• We add two additional perspectives
• Planning versus performance separation
• Strategic versus operating emphasis
• The response has been best among those firms most
  concerned with positioning in definable markets
  and concerned with market share.

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Case I (Onion Style)-Plan

• Products Total Plain Deluxe
• Price 11 10 12
• Variable costs 6 6 6
• Contribution 5 4 6
• Planned sales-u 10 5 5 u
• Contribution 50 20 30
• Planned sales mix 50 50
• Total sales - 10 units

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Example - Actual

• Products Total Plain Deluxe
• Price 11.2 10 12
• Variable costs 6.0 6 6
• Contribution 5.2 4 6
• Actual sales-units 10 4 6 u
• Contribution 52 16 36
• Actual sales mix 40 60
• Total sales - 10 units

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Calculation of Variances

• Actual - Plan Variance
• Contribution
• Margin 52 - 50 2
• Quantity Variances Only
• Plain (QA - QB)CB (4 - 5)4 - 4
• Deluxe (QA - QB)CB (6 - 5)6 6
• Total 2
• Total variance sum of the product variances.

12
Decomposition of Variance

• When it is appropriate to consider a mix
  variance, the total contribution margin variance
  is divided into an overall volume effect and a
  mix effect.
• Volume
• (TQA - TQB)CB (10 - 10)5 0

13
P Plain, D Deluxe

• Mix (QAP - QBP)(CBP-CB) (4 - 5)(4 - 5)
• -1(-)1
• 1
• (QAD - QBD)(CBD-CB) (6 - 5)(6 - 5)
• 1(1)
• 1
• Total mix variance 2

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Total Quantity Variance

• Total quantity variance 2
• Two variance system
• Overall volume variance 0
• Mix variance 2
• Total quantity variance 2
• In this very simple case, it is easy to see we
  sold I more Deluxe unit, and 1 less Plain. The
  Deluxe units have a higher contribution margin,
  2.

15
Case II - Plan

• Products Total Plain SoSo Deluxe
• Price 10.9 10 11 12
• Variable costs 6.0 6 6 6
• Contribution 4.9 4 5 6
• Planned sales 10 3 5 2 u
• Contribution 49 12 25 12
• Planned sales mix 30 50 20
• Total sales - 10 units

16
Case II - Actual

• Products Total Plain SoSo Deluxe
• Price 10.8 10 11 12
• Variable costs 6.0 6 6 6
• Contribution 4.8 4 5 6
• Actual sales 11 4 5 2 u
• Contribution 53 16 25 12
• Actual sales mix 36.4 45.4 18.2
• Total sales - 11 units
• Note The above amounts are rounded.

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Case II Quantity Variances

• Actual - Plan Variance
• Contribution
• Margin 53 - 49 4
• Quantity Variances Only
• (Actual Q - Budget Q)Product CM
• Plain (QAP - QBP)CBP (4 - 3)4 4
• SoSo (QAS - QBS)CBS (5 - 5)5 0
• Deluxe (QAD - QBD)CBD (2 - 2)6 0
• Total of quantity variances 4

18
Quantity Variances

• The quantity variances measure the effects on
  income of differences in the sales per the budget
  and actual sales, product by product. There is
  no breakdown as to the major causes of the
  differences. Price differences and cost
  differences are not reflected in the quantity
  variances, just the effect of different
  quantities on total contribution margin.

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Decomposition of Variance

• Volume effect
• (TQA - TQB)CB (11 - 10)4.9 4.9
• Mix effect (QAP - QBP)(CBP-CB)
• Pl (4 - 3.3)(4 - 4.9) .7(-0.9) -.63
• So (5 - 5.5)(5 - 4.9) -.5(0.1) -0.05
• Dx (2 - 2.2)(6 - 4.9) -.2(1.1) -0.22
• Total mix variance -0.9
• Total quantity variance 4.0

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NOTICE!

• Because we cannot clearly point to the
  substitution of one product for another in Case
  II, the most useful measure is the overall impact
  of selling a slightly different mix of products.
  Normally, one can get some overall sense of the
  shifts taking place, and a measure of the overall
  mix variance, but emphasizing individual mix
  variance elements may not be worth the additional
  cost and time.

21
Remember

• Conditions under which the mix variance is more
  likely to be useful
• 1. Contribution margins must vary from product to
  product to get a mix variance.
• 2. The products compete for limited production,
  promotion or distribution resources. Thus, a
  constraint limits total sales in some way.

22
Remember

• 3. The products are substitutes for one another
  in the view of consumers. So if a group of
  consumers choose among cars, small trucks, or
  sport-utility vehicles, then they are substitutes
  for comparison purposes. Substitution is by the
  consumer in this case.

23
Conversely,

• Conditions under which an overall volume variance
  is apt to be useful
• 1. A mix variance is used to estimate the effects
  of shifts in the mix of products sold. The two
  variances must go together to explain the total
  variance.
• 2. Contribution margins vary little across
  products, and managers have little interest in
  individual quantity variances.

24
Market Share Variances

• The addition of market share variances represent
  a small step. The idea is to separate the rising
  (falling) tide effect associated with changes in
  the overall market for a product, and to
  determine how the firm did relative to the
  market. The specification of a market share goal
  is key to this process.

25
Market Share Variances

• In addition, we provide for the possibility that
  other factors may influence the ability of the
  firm to deliver product. There is more
  subjectivity here, but the idea is to estimate
  the effect of production problems or distribution
  problems on profitability. Of course, lost sales
  are not the complete story, if products have
  varying contributions margins.

26
Market Share Variances

• Suppose the goal is to keep 10 of a market. To
  our previous illustration, add the information
  that the market is 100 units, and our target
  share is 10 of the total market. Further,
  assume the market increases to 110 units, but we
  sell 12 units. How well did we perform?

27
Market Share Variances

• Market share performance variance
• (12 - 10110)4.90 4.90
• or (12/110 - .10)1104.90 4.90
• Market size planning variance
• (11 - 10)100 4.90 4.90

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Market share planning

• If subsequent conditions indicate we should have
  planned for a different market share, we can
  calculate a market share planning variance.
• (SR - SP)MRCP
• where SR is the share per the revised plan, and
• SP is the share per the ex-ante plan.

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• Market share performance variance

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