Variance Analysis: Study Questions and Answers Are On Page 4 and Pages 5-11

Variance Analysis
Comparing actual performance to expected (planned/budgeted) performance*

Study Questions and Answers are on Page 4 and Pages 5-11.
A first vital step in marketing planning and improving marketing processes is performance gap analysis, the difference
between planned and actual performance. The fundamental steps in all planning processes, quality improvement
processes and also in all cost control systems, are (1) variance analysis that identifies high variance results;
(2) diagnosing the reason for them; and, (3) making improvements in processes and your marketing mix cost control.
The spreadsheet on page 3 presents a variance analysis that compares actual to planned performance and the
effect on the bottom line of miscalculations in planning, such as estimating market size and market share on the
demand side, and selling prices and costs on the supply side. But first let us define some terms:
Variances on the size of the market and market share are called Volume variances. For example,
Expected Actual Variance
Market Size ### ### 10,000,000
Market Share 50.0% 44.0% -6.00%
Sales quantity in units ### ### 2,000,000
Variances between expected (sometimes called standard costs) and actual costs and prices are called Contribution
Variances (or price-variable cost variances). For example:
Expected Actual Variance
Price $ 0.500 $ 0.480 -$0.02
Unit Variable Costs:
Materials cost/unit $ 0.150 $ 0.170 $0.02
Production labor cost/uni $ 0.050 $ 0.040 -$0.01
Distribution cost/unit $ 0.050 $ 0.030 -$0.02
Sales commission/unit $ 0.050 $ 0.050 $0.00
Total variable cost/unit $ 0.300 $ 0.290 -$0.01
Contribution Margin $ 0.20 $ 0.19 -$0.01
Fixed costs:
Marketing program costs $ 100,000 $ 150,000 -$50,000
Manufacturing & general overhead cost $ 400,000 $ 500,000 -$100,000
The purpose of studying market size variance, market share variance, contribution variance and fixed cost variance
is to disentangle how they explain the performance gap as we shall see below.
Managers can then manage the variances that are under their control such as various costs and, to a limited extent, price.
For example, the cause of increased distribution costs or reduced distribution costs can be explored by studying the
distribution process actually used rather than planned and by identifying the activities in the process that drive the costs.
By studying the cost drivers, managers can then focus on reducing the cost of these activities through innovation (e.g.
how orders are packed). In this way, variance analysis leads to process improvements and is therefore a process
improvement tool.
* This spreadsheet is an extension of the approach proposed by Hulbert, J. M. and N. Toy (1977), "A Strategic Framework for
Marketing Control," Journal of Marketing, 41, (April), p. 12-21.
Page 1 of 11
The common variances studied by management accountants are manufacturing material cost variances, manufacturing
labor cost variances and manufacturing cost variances. Today, unexpected variances in sales costs and distribution
costs are often very important new drivers of profitability in the Global marketplace as new distribution systems are
launched and bedded-down (like bedding-down a manufacturing process) to reach new foreign markets.
Bedding-down is a term that means retraining workers and ironing out the kinks in the new manufacturing process by
learning-by-doing. Foreign markets also require new selling systems and processes (such as selling to new distributors
or Internet selling) that have to be bedded-down. During this process, unexpected performance variances often occur.
As the pace of product development has increased (such as in the cell phone market), and as foreign competition
increases, more new models have to be launched, new manufacturing processes designed and bedded-down.
Thus, global competition often means more unexpected variances in costs that have to be detected and diagnosed.
The activity drivers of the unexpected costs in the new processes have to be identified and then fixed or eliminated
if the variance is unfavorable (higher than expected costs). The activity drivers should be imitated elsewhere if the
variance is favorable (for example, lower than expected costs because of the unexpected effectiveness of the new
process such as a new Internet selling process).
By imitating we mean the management says, this is a great idea, let's use it in our manufacturing and marketing of other
products and services. The cost saving innovation is then diffused across the company by management decree and
training. So, variance analysis is a crucial system control tool for the process thinker as it identifies where in the set of
added-value processes are there unexpected costs that have to be managed. Variance analysis is an important step or
activity in all total quality management systems such as six-sigma. It may have been around for a very long time but
it is a totally modern, cool tool to use in modern management.
With all this in mind we construct the following illustrative variance spreadsheet.
Page 2 of 11
Variance Analysis
Expected (exp) Actual(act) Variance
Market Size (Mexp and Mact ) ### ### 10,000,000
Market Share (SHexp and SHact ) 50.0% 44.0% -6.00%
Sales quantity in units (Qexp and Qact ) ### ### 2,000,000
Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Unit Variable Cost
Contribution Margin (CMexp and CMact$) 0.20 $ 0.19 -$0.01

Gross Contribution ### ### $180,000
Fixed costs:
Profit ### ### $30,000
Variances:
Contribution (price/cost) variance: -$220,000
[(CMact-CMexp) x Qact]
Market share variance -$600,000

[(SHact-SHexp) x Mact x CMexp]
Market size variance $1,000,000
[(Mact-Mexp) x SHexp x CMexp]
Total Volume Variance $400,000
[(Qact-Qexp) x CMexp]
Fixed cost variances
Marketing program costs -$50,000
Manufacturing & general overhead costs -$100,000 -$150,000
Total Variance $30,000

Key:
CMact = actual contribution margin per unit, CMexp = expected/planned contribution margin per unit,
SHact = actual share, SHexp = expected/planned share,
Mact = actual market size, Mexp = expected/planned market size
Qact = quantity actually sold, Qexp = expected/planned quantity sold,
Numbers in blue have to be entered. Numbers in black are computed.
Page 3 of 11
To demonstrate the value of variance analysis over and beyond its use in controlling costs, let us assume that the
company we are looking at is marketing in a rapidly developing, very large economy such as China and the market
growth is far more rapid than expected, leading to an actual market size of 80 million, twice that expected (see E140).
This is Q. 26 in Sample Exam. The new total variance is $2,538,000.
Variance Analysis

Unit Variable Cost

Gross Contribution ### ### $2,688,000
Fixed costs:
Profit ### ### $2,538,000
Variances:

Total Volume Variance $3,040,000
Total Variance $2,538,000
Page 4 of 11
In this spreadsheet we notice in E158 that the actual profit of $6,038,000 is far better than expected . Great! The
manager would likely be congratulated by Head-office for his or her performance, if they did not see the full variance
analysis. If they did, they might ask what is happening? We have lower market share than expected. Is it our product?
If so then pull the alarm and let us fix the product. Is it our inadequate distribution? Instead of congratulating the
manager they may want to fire the manager! The Price/cost variance is not so important. The positive market size
variance says we should have made $4 million more than we did. But because of our market share slip from an
expected 50% to an actual 44% we lost $960,000 of that potential extra $4 million. We lost a further $502,000:
$150,000 in fixed cost over-runs and $352,000 in contribution shortfall. Who is minding the store? But the big
problem is that the market is growing far more than we are growing and that means we are losing our dominant share.
We had better fix things now before we completely miss the opportunity and become a minor player. This is a good
illustration of the value of teasing out the separate effects of market size variance, market share variance, variable cost
variance, fixed cost variance and price variance from expected.
Study Questions
1. The performance gap is market size variance + market share variance + contribution variance + fixed cost variance.
a) True b) False
The answer is true as should be evident from your understanding of the spreadsheet presented on page four above
(see rows 160-174), and your understanding of the following, quoted from the opening page (rows 34-35):
"The purpose of studying market size variance, market share variance, contribution variance and fixed cost variance
is to disentangle how they explain the performance gap as we shall see below."
Answer to Q 28 in the sample exam is False - market share variance is missing.
2. Contribution variance is variable cost variance plus price variance.

a) True b) False
It is True as Contribution is Price - Variable Cost so the price variance and variable cost variance combine
to create contribution variance.
3. Volume variance is market size variance plus market share variance.

a) True b) False
The answer is True as your sales volume is your share of total market size. Your volume variance is therefore
produced by the variance in total actual market size and total expected market size, and the variance in actual market
share and expected share. See rows 164-168 above.
4. Senior management decides the marketing team should not be held responsible for the loss of a major distributor that,
if accounted for in the planning and expected sales, would have reduced expected market share to 45%. What is the new
total variance that has to be explained? Change expected market share in C226 to 45% and answer is $2,938,000 in cell
G259. If you then increase planned distribution cost/unit to 6 cents answer is $3,118,000 (see SE Q. 27).
Page 5 of 11
Variance Analysis

Unit Variable Cost

Fixed costs:
Profit ### ### $2,938,000
Variances:


Page 6 of 11
5. To counter a further loss of distributors, senior management also had agreed to increase expected spending on
distribution costs from five cents per unit to six cents per unit. What is the new total variance that has to be
explained? You change expected variable distribution costs in cell C279 from $0.05 to $0.06 below. Please do it.
Variance Analysis

Unit Variable Cost
Contribution Margin (CMexp and CMact$) 0.19 $ 0.19 $0.00

Fixed costs:
Profit ### ### $3,118,000
Variances:
Contribution (price/cost) variance: $0


Page 7 of 11
The answer is $3,118,000. What you should also notice is that there is no contribution variance now. Does this mean
we do not need to worry about contribution variance? If you say yes you are making a very big mistake! Why?
Because material costs at 17 cents a unit were two cents higher than expected. What can be done about this?
Are they going to go up even higher in the future? Our labor costs were lower than expected. Is this a genuine saving
or does it represent a cost saving that is the result of labor taking short cuts in the manufacturing process and lowering
quality of construction? And look at distribution costs, only half of what was expected and senior management
wanted to spend more rather than less. This may not be a favorable variance if it reduces distributor goodwill. On the
other hand, it may reflect using a much cheaper shipper using new shipping technology. You need to find out and
report to management. What is still driving the profit increase is the market size being much bigger than expected.
Thus the result is a marketing mistake made by marketing management in underestimating the size of the market.
They should be criticized for the result rather than congratulated!
6. The actual amount spent on distribution costs was three cents per unit. Is this a good result? The correct answer
is we cannot tell because with further diagnosis, facts may be revealed that managers skimped on quality customer
service by switching to a low cost/low quality shipper. Whenever there are unexpected variances from expected,
whether favorable or unfavorable they should be studied, diagnosed, understood and explained.
Please proceed to Study Question 7, below.

Page 8 of 11
7. If the actual amount spent on distribution had been $0.06/unit. what would the Price/Cost variance have been?
You change the actual variable cost for distribution in cell E367 below from $0.03 to $0.06 and the Contribution
Price/cost variance changes to a negative $1,056,000 - bad news.
Variance Analysis

Unit Variable Cost
Distribution cost/unit $ 0.060 $ 0.060 $0.00
Total variable cost/unit $ 0.310 $ 0.320 $0.01

Fixed costs:
Profit ### ### $2,062,000
Variances:
Contribution (price/cost) variance: -$1,056,000


Page 9 of 11
8. New competition also entered the market and if this had been able to be planned and expected then the expected
market share would have been only 40% and expected and approved marketing fixed costs would have been
increased to $200,000 to counter the competitor's sales push. What is the new total variance? You change the expected
market share in cell C405 down from 45% to 40% and fixed marketing costs (C419) up from $100,000 to $200,000.
The answer is $2,542,000 (see cell G438).
Variance Analysis
Market Share (SHexp and SHact ) 40.0% 44.0% 4.00%

Unit Variable Cost
Distribution cost/unit $ 0.060 $ 0.060 $0.00
Total variable cost/unit $ 0.310 $ 0.320 $0.01

Fixed costs:
Marketing program costs $ 200,000 $ 150,000 $50,000
Profit ### ### $2,542,000
Variances:
Contribution (price/cost) variance: -$1,056,000
Market share variance $608,000

Marketing program costs $50,000

Page 10 of 11
Now market share variance is positive because we earned an extra $608,000 in profits by gaining four more points of
market share than expected. Congratulations team, or did a major competitor screw up and you got some of their
unhappy customers? Again we need to dig deeper to get the answer.
Variance analysis is an important part of the measure-learn-improve-set new expectations-measure process

improvement process of the firm, and is essential in total quality management.
Another lesson we learn from variance analysis is that managers should be held responsible
for the things they can manage and effect, such as costs. If they cannot control market size or price
then they should not be held responsible for market size or price variance effects on the bottom-line.
But please note, this means they should also not be congratulated and rewarded for profit performance that
was the result of unexpectedly high market size or price that they had no control over!
You cannot claim responsibility when it makes you look good and claim no control or responsibility when it makes
you look bad. But this often happens. It is human nature to do so.
To sum up, significant differences from budget expectations can come first, from market conditions changing or being
different from expected (that may reflect poor market research and analysis); second, from the budget not having been
prepared with the correct standard or expected costs or other reasonable assumptions; and third, managers may have
performed their jobs very well or poorly.
Geek Zone
For those of you who are math inclined we check the correctness of these formula the following way:
(the following will not be tested on the Certification Exam)
The variance between Actual Profit and Expected Profit is Contribution Margin variance plus Total Volume variance
minus Fixed Cost variance.
= (CMact - CMexp)*Qact + (Qact - Qexp)*CMexp - (FCact - FCexp)
= CMact*Qact - CMexp*Qact + Qact*CMexp - Qexp*CMexp + FCexp - FCact
(as the second term - CMexp*Qact and the third term + Qact*CMexp cancel each other out)
= CMact*Qact - Qexp*CMexp + FCexp - FCact (now reorganizing these terms)
= (Qact*CMact - FCact) - (Qexp*CMexp - FCexp)
(quantity times contribution margin minus fixed costs equals profit, so)
= Actual Profit - Expected Profit
= Variance between Actual Profit and Expected Profit
QED
Page 11 of 11

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Variance Analysis

Comparing actual performance to expected (planned/budgeted) performance*

Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Contribution Margin (CMexp and CMact$) 0.20 $ 0.19 -$0.01

Profit ### ### $30,000

Market share variance -$600,000

Total Variance $30,000

Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Contribution Margin (CMexp and CMact$) 0.20 $ 0.19 -$0.01

Profit ### ### $2,538,000

Market share variance -$960,000

Total Variance $2,538,000

2. Contribution variance is variable cost variance plus price variance.

3. Volume variance is market size variance plus market share variance.

Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Contribution Margin (CMexp and CMact$) 0.20 $ 0.19 -$0.01

Profit ### ### $2,938,000

Market share variance -$160,000

Total Variance $2,938,000

Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Contribution Margin (CMexp and CMact$) 0.19 $ 0.19 $0.00

Profit ### ### $3,118,000

Market share variance -$152,000

Total Variance $3,118,000

Please proceed to Study Question 7, below.

Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Contribution Margin (CMexp and CMact$) 0.19 $ 0.16 -$0.03

Profit ### ### $2,062,000

Market share variance -$152,000

Total Variance $2,062,000

Price (Pexp and Pact ) $ 0.500 $ 0.480 -$0.02

Contribution Margin (CMexp and CMact$) 0.19 $ 0.16 -$0.03

Profit ### ### $2,542,000

Market share variance $608,000

Total Variance $2,542,000

Variance analysis is an important part of the measure-learn-improve-set new expectations-measure process

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