Performance Measurement Using Variances
Managers often use variance analysis when evaluating the performance of their subordinates.
Two attributes of performance are commonly evaluated:
1. Effectiveness: the degree to which a predetermined objective or target is met—for
example, sales, market share and customer satisfaction ratings of Starbucks’ new
VIA® Ready Brew line of instant coffees.
2. Efficiency: the relative amount of inputs used to achieve a given output level—the
smaller the quantity of Arabica beans used to make a given number of VIA packets or
the greater the number of VIA packets made from a given quantity of beans, the
greater the efficiency.
As we discussed earlier, managers must be sure they understand the causes of a variance
before using it for performance evaluation. Suppose a Webb purchasing manager has just
negotiated a deal that results in a favorable price variance for direct materials. The deal
could have achieved a favorable variance for any or all of the following reasons:
1. The purchasing manager bargained effectively with suppliers.
2. The purchasing manager secured a discount for buying in bulk with fewer purchase
orders. However, buying larger quantities than necessary for the short run resulted in
excessive inventory.
3. The purchasing manager accepted a bid from the lowest-priced supplier after only minimal
effort to check quality amid concerns about the supplier’s materials.
If the purchasing manager’s performance is evaluated solely on price variances, then the
evaluation will be positive. Reason 1 would support this favorable conclusion: The purchasing
manager bargained effectively. Reasons 2 and 3 have short-run gains, buying in
bulk or making only minimal effort to check the supplier’s quality-monitoring procedures.
However, these short-run gains could be offset by higher inventory storage costs or higher
inspection costs and defect rates on Webb’s production line, leading to unfavorable direct
manufacturing labor and direct materials efficiency variances. Webb may ultimately lose
more money because of reasons 2 and 3 than it gains from the favorable price variance.
Bottom line: Managers should not automatically interpret a favorable variance as
“good news.”
Managers benefit from variance analysis because it highlights individual aspects of performance.
However, if any single performance measure (for example, a labor efficiency variance
or a consumer rating report) receives excessive emphasis, managers will tend to make
decisions that will cause the particular performance measure to look good. These actions
may conflict with the company’s overall goals, inhibiting the goals from being achieved.
This faulty perspective on performance usually arises when top management designs a performance
evaluation and reward system that does not emphasize total company objectives.
Performance Measurement Using VariancesManagers often use variance analysis when evaluating the performance of their subordinates.Two attributes of performance are commonly evaluated:1. Effectiveness: the degree to which a predetermined objective or target is met—forexample, sales, market share and customer satisfaction ratings of Starbucks’ newVIA® Ready Brew line of instant coffees.2. Efficiency: the relative amount of inputs used to achieve a given output level—thesmaller the quantity of Arabica beans used to make a given number of VIA packets orthe greater the number of VIA packets made from a given quantity of beans, thegreater the efficiency.As we discussed earlier, managers must be sure they understand the causes of a variancebefore using it for performance evaluation. Suppose a Webb purchasing manager has justnegotiated a deal that results in a favorable price variance for direct materials. The dealcould have achieved a favorable variance for any or all of the following reasons:1. The purchasing manager bargained effectively with suppliers.2. The purchasing manager secured a discount for buying in bulk with fewer purchaseorders. However, buying larger quantities than necessary for the short run resulted inexcessive inventory.3. The purchasing manager accepted a bid from the lowest-priced supplier after only minimaleffort to check quality amid concerns about the supplier’s materials.If the purchasing manager’s performance is evaluated solely on price variances, then theevaluation will be positive. Reason 1 would support this favorable conclusion: The purchasingmanager bargained effectively. Reasons 2 and 3 have short-run gains, buying inbulk or making only minimal effort to check the supplier’s quality-monitoring procedures.However, these short-run gains could be offset by higher inventory storage costs or higherinspection costs and defect rates on Webb’s production line, leading to unfavorable directmanufacturing labor and direct materials efficiency variances. Webb may ultimately losemore money because of reasons 2 and 3 than it gains from the favorable price variance.Bottom line: Managers should not automatically interpret a favorable variance as“good news.”Managers benefit from variance analysis because it highlights individual aspects of performance.However, if any single performance measure (for example, a labor efficiency varianceor a consumer rating report) receives excessive emphasis, managers will tend to makedecisions that will cause the particular performance measure to look good. These actionsmay conflict with the company’s overall goals, inhibiting the goals from being achieved.This faulty perspective on performance usually arises when top management designs a performanceevaluation and reward system that does not emphasize total company objectives.
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