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TABLE 1
UNITED INSTRUMENTS, INC.
Budget (1,000s)
Sales $16,872
Cost of goods sold 9,668
Gross margin $ 7,204
Less: Other operating expenses
Marketing $1,856 $1,440
R&D 1,480 932
Administration 1,340 4,676 1,674
Profit before taxes $ 2,528
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Chapter 16 - Operational Performance Measurement: Further Analysis of Productivity and Sales
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Chapter 16 - Operational Performance Measurement: Further Analysis of Productivity and Sales
TABLE 2
ADDITIONAL INFORMATION
Electric Electronic
Meters Instruments
(EM) (EI)
Selling prices per unit
A verage standard price $40.00 $180.00
A verage actual prices, 1987 30.00 206.00
Variable product costs per unit
A verage standard manufacturing cost $20.00 $50.00
A verage actual manufacturing cost 21.00 54.00
Volume information
Units produced and sold–actual 141,770 62,172
Units produced and sold–planned 124,800 66,000
Total industry sales, 1987–actual $44 million $76 million
Total industry variable product costs, 1987–actual $16 million $32 million
United’s share of the market (percent of physical units)
Planned 10% 15%
Actual 16% 9%
Planned Actual
Firm-wide fixed expens es (1,000s)
Fixed manufacturing expenses $3,872 $3,530
Fixed marketing expenses 1,856 1,440
Fixed administrative expenses 1,340 1,674
Fixed R&D expenses
(exclusively for electronic instruments) 1,480 932
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Chapter 16 - Operational Performance Measurement: Further Analysis of Productivity and Sales
TABLE 3
THE “ANNUAL REPORT APPROACH” TO VARIANCE ANALYSIS
Budget (1,000s) Actual (1,000s)
Sales $16,872 (100%) $17,061 (100%)
Cost of goods sold 9,668 (58% ) 9,865 (58% )
Gross margin $ 7,204 (42% ) $ 7,196 (42% )
Less: Other expenses
Marketing $1,856 (11% ) $1,440 (8%)
R&D 1,480 (9%) 932 (6%)
Administration 1,340 (8%) 4,676 (28% ) 1,674 (10% ) 4,046 (24% )
Profit before tax $ 2,528 (14% ) $ 3,150 (18% )
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Chapter 16 - Operational Performance Measurement: Further Analysis of Productivity and Sales
TABLE 4
VARIANCE CALCULATIONS US ING SHANK AND CHURCHILL’S
MANAGEMENT-ORIENT ED FRAMEWORK
Level 2
Sales volu me and mix=$158 U Sales prices and costs=$780 F
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Chapter 16 - Operational Performance Measurement: Further Analysis of Productivity and Sales
TABLE 5
VARIANCE SUMMARY FOR THE PHASE II APPROACH
Overall market decline $ 680 U
Share of market increase 1,443 F
Sales mix change 921 U
Sales prices improved 198 F
EM $1,418 U
EI $1,616 F
Manufacturing cost control 48 U
Variable costs $390 U
Fixed costs $342 F
Other
R&D 548 F
Administration 334 U
Marketing 416 F
Total $ 622 F
We will first define and briefly elaborate the its capital investment needs. Business units with
concept of strategy before illustrating how to link “low market share” in “high growth industries”
strategic considerations with variances for typically pursue a “build” mission (e.g., Apple
management control and evaluation. Strategy has Co mputer’s MacIntosh business, Monsanto’s
been conceptualized by Andrews [1971], Ansoff Biotechnology business).
[1965], Chandler [1962], Gov indarajan [1989], Hofer
and Schendel [1978], M iles and Snow [1978], and HOLD:
others as the process by which managers, using a This strategic mission is geared to the protection
three- to five-year t ime horizon, evaluate external of the business unit’s market share and
environmental opportunities as well as internal competitive position. The cash outflows for a
strengths and resources in order to decide on goals business unit follo wing this mission would
as well as a set of action plans to accomplish these usually be more or less equal to cash inflows.
goals. Thus, a business unit’s (or a firm’s) strategy Businesses with “high market share” in “high
depends upon two interrelated aspects: (1) its growth industries” typically pursue a “hold”
strategic mission or goals, and (2) the way the mission (e.g., IBM in main frame co mputers).
business unit chooses to compete in its industry to
accomplish its goals—the business unit’s competitive HARVEST:
strategy.
This mission imp lies a goal of maximizing short-
Turning first to strategic mission, consulting
term earn ings and cash flow, even at the expense
firms such as Boston Consulting Group [Henderson,
1979], Arthur D. Little[Wright, 1975], and A. T. of market share. A business unit following such
a mission would be a net supplier of cash.
Kearney [Hofer and Davoust, 1977], as well as
Businesses with “high market share” in “low
academic researchers such as Hofer and Schendel
[1978], Bu zzell and Wiersema [1981], and growth industries” typically pursue a “harvest”
mission (e.g., American Brands in tobacco
Gov indarajan and Shank [1986], have proposed the
products).
following three strategic missions that a business unit
can adopt: In terms of co mpetitive strategy, Porter [1980]
has proposed the following two generic ways in
B UILD: which businesses can develop sustainable
This mission implies a goal of increased market competitive advantage:
share, even at the expense of short-term earn ings
and cash flow. A business unit following this
mission is expected to be a net user of cash in
that the cash throw-off fro m its current
operations would usually be insufficient to meet
Manufacturing
Market sizee Market share Sales price Cost
=$724 U =$1,064 F =$1,418 U =$142 U
The above framework allows us to consider strategies. Therefore, no attempt is made to calcu late
explicit ly the strategic positioning of the two a sales mix variance. The basic idea is that even
product groups: electric meters and electronic though a sales mix variance can always be calcu lated,
instruments. Though they both are industrial the concept is meaningful only when a single
measuring instruments, they face very different business framework is applicable. For the same
competitive conditions that very probably call reason, Tables 7 and 8 report the market size and
for different strategies. T-6 summarizes the market share variances for EM and EI separately, and
differing environments and the resulting strategic T-4 reported these two variances for the instruments
issues. business as a whole. Obviously, a high degree of
subjectivity is involved in deciding whether United is
How well did electric meters and electronics
in one business or two. The fact that the judgment is
instruments perform, given their strategic contexts?
to a large extent subjective does not negate its
The relevant variance calculations are given in Tables
importance. T-9 summarizes the managerial
7 and 8. These calculations differ fro m Phase II
performance evaluation that would result if we were
analysis (given in T-4) in one important respect. T-4
to evaluate EM and EI against their plausible
treated EM and EI as two varieties of one product,
strategies, using the variances reported in T-7 and 8.
competing as substitutes, with a single strategy. Thus,
a sales mix variance was computed. Tables 7 and 8
treat EM and EI as different products with dissimilar
Blocher,Stout,Cokins: Cost Management 5e 16-11 ©The M cGraw-Hill Companies, Inc 2010
Chapter 16 - Operational Performance Measurement: Further Analysis of Productivity and Sales
The overall performance of United would Phase I, Phase II, and Phase III thinking yield
probably be judged as “unsatisfactory.” The firm has different imp licat ions for this first step. That is, the
not taken appropriate decisions in its functional areas detailed variance calculations do differ across the
(marketing, manufacturing, R&D, and three approaches. Their implications differ even more
administration) either for its harvest business (EM ) or for the second step. The computational aspects
for its build business (EI). The summary in T-9 identify the variance as either favorable or
indicates a dramatically different picture of United’s unfavorable. However, a favorable variance does not
performance than the one presented under Phase II necessarily imp ly favorable performance; similarly,
thinking. This is to be expected because Phase II an unfavorable variance does not necessarily imply
thinking did not tie variance analysis to strategic unfavorable performance. We argue that the link
objectives. Neither Phase I nor Phase II analysis between a favorable or unfavorable variance, on the
explicit ly focused on ways to improve performance one hand, and favorable or unfavorable performance,
en route to accomplishing strategic goals. This would on the other, depends upon the strategic context of
then imply that management compensation and the business under evaluation.
rewards ought not to be tied to performance No doubt, judgments about managerial
assessment undertaken using Phase I or Phase II performance can be dramatically different under
frameworks. Phase I, Phase II, and Phase III thin king (as the
United Instruments case illustrates). In our view,
CONCLUS IONS moving toward Phase III thinking (i.e., analyzing
Variance analysis represents a key link in the profit variances in terms of the strategic issues
management control process. It involves two steps. involved) represents progress in adapting cost
First, one needs to break down the overall profit analysis to the rise of strategic analysis as a major
variance by key causal factors. Second, one needs to element in business thinking [Shank and
put the pieces back together most meaningfully with Gov indarajan, 1988a, 1988b, and 1988c].
a view to evaluating managerial performance. Putting
the bits and pieces together most meaningfully is just
as crucial as computing the pieces. This is a
managerial function, not a computational one.
TABLE 9
PERFORMANCE EVALUATION SUMMARY FOR PHASE III APPROACH
Marketing
Comments If we held prices and share, decline in We raised prices to maintain margins
this mature business would have cost and to ration our scarce capacity (our
us $ 724 U price was $206 vs. The industry price
of $110). In the process, we lost
But, we were further hurt by price cuts
significant SOM whic h cost us (netted
made in order to build our SOM (our
against $1,616 F from sales prices).
prices was $30 vs. the industry price
$3,773 U
of $50). $1,418 U
1,064 F This is a booming market that grew
57 percent during this period. Then
Net effect $1,078 U
why did we decide to improve
This is a market that declined 29 margins at the expense of SOM in
percent. Why are we sacrificing this fast growing, higher margin
margins to build market position in business?
this mature, declining lower margin
Fortunately, growt h in the total market
business?
improved our profit picture.
We unders pent t he marketing budget. $4,891 F
$ 416 F
We unders pent t he marketing budget.
But why are we cutting back here in $416 F
the face of our major marketing
But why are we cutting back here in
problems?
the face of our major marketing
problems?
Overall evaluation Poor performance Poor performance
Manufacturing
Comments Manufacturing cost cont rol was lousy Variable Manufacturing costs showed
and cost the firm $142 U an unfavorable variance of $248 U
(industry costs of $46 vs. our costs of
If we are trying to be a cost leader,
$54).
where are t he benefits of our
cumulative experience or our scale Does the higher manufacturing cost
economies? (industry unit costs of result in a product perceived as
$18 vs. our costs of $21) better? Apparently not based on
market share dat a.
Overall evaluation Poor performance Poor performance