Understanding Variances In Multiple Operations

Aug 31, 2015

The other day, I was having lunch with a cost manager from a Fortune 500 company who is a longtime friend and for a number of years, a coworker. His firm is an international manufacturing company with numerous locations both in the US and abroad. He has senior cost responsibilities for all of North America. He spoke of the company’s recent conversion to a more sophisticated computer system and the opportunities and the challenges it presented.

As we talked about some of the bigger challenges, we dived into a discussion about the kinds of questions he fields most frequently from both senior management and plant controllers he collaborated with on a daily basis. From his perspective, many of the questions he receives are reoccurring and have to do with the same basic concepts. His plant managers often have questions regarding variances which are created in their own operations and understanding how they can be managed. Specifically, what is causing them? One of the difficult areas involves identical products being made different plants and on different types of machines. Hence, one identical product is being produced at all of the plants in North America and that product is being produced on a variety of machines at a variety of machine speeds and technical difficulties.

Manufacturing_Machine1As a result, the differing speeds and machine types give rise to variances on this product: some favorable and some unfavorable. The corporation has decided to value all of their products with standards determined using the fastest machine speeds and the most efficient processes in the operation. For example if one plant has machinery that limits product A to 1,000 parts an hour and another plant has technology that allows the same part A to be produced at 2,000 an hour, and 2,000 an hour is the highest and most efficient process in the corporation, then the standards used to set the price of that product are based on 2,000 units per hour. As a result, any of those locations operating at less than 2,000 units per hour, are resulting in negative efficiencies and may be bound to do so for long periods of time. If those restrictions are caused by technological limitations, then the plant managers have little option if they are going to be directed to continue to produce that product.

This logic, I believe, speaks to the sales side and the need to be highlit competitive in a global market. If the corporation were to use the slowest machine speeds to set prices, they might find that they are competitively unable to attract the customers and therefore, are forced out of that business.

As I think back to our cost courses and forums, this was a frequent topic with a whole range of possible solutions. One case is just as I described, pricing your products and inventory using the highest, most efficient process. Some people argue the lowest, least efficient process should be used to value the product. This would create positive variances and profitability on those machines which produce the identical product at a much faster rate. I have also heard others suggest that some sort of a blended average would be the best standard to use so the highest and best rate or the lowest and worst rate, but rather a rate someplace in the middle that makes the slower machines not as bad and more efficient machines not as good.

Since each company, each product line, and each product environment is different, those decisions have to be made on a unit by unit basis by the senior management of the operation with assistance from the cost team.

Categories: Cost Accounting