Benchmarking and Variance Analysis

Learning Objective 7 Describe benchmarking and explain its role in cost management

• benchmarking compares actual performance against the best levels of performance

Webb Company based its budgeted amounts on an analysis of its own operations. Companies sometimes develop standards based on the operations of other companies. Benchmarking is the continuous process of comparing one company’s performance levels against the best levels of performance in competing companies or in companies having similar processes. When benchmarks are used as standards, managers and management accountants know that the company will be competitive in the marketplace if it can meet or beat those standards.

Companies develop benchmarks and calculate variances on items that are the most important to their businesses. A common unit of measurement used to compare the efficiency of airlines is cost per available seat mile. Available seat mile (ASM) is a measure of airline size and equals the total seats in a plane multiplied by the distance traveled. Consider the cost per available seat mile for United relative to five competing U.S. airlines. Summary data are in Exhibit 7-5. The benchmark companies are in alphabetical order in column A. Also reported in Exhibit 7-5 are operating cost per ASM, operating revenue per ASM, operating income per ASM, fuel cost per ASM, labor cost per ASM, and total available seat miles for each airline. All airlines have positive operating income.

How well did United manage its costs? The answer depends on which specific benchmark is being used for comparison. United’s actual operating cost of 14.60 cents per ASM is above the average operating cost of 13.08 cents per ASM of the five other airlines. Moreover, United’s operating cost per ASM is 35.8% higher than Jet Blue, the lowest-cost competitor at 10.75 cents per ASM $\left[\right(14.60-10.75)÷10.75=0.358]\text{.}$ So why is United’s operating cost per ASM so high? Column (6) suggests that labor cost is one important reason, alerting United management to become more cost competitive in using labor inputs.

Finding appropriate benchmarks is not easy. Many companies purchase benchmark data from consulting firms. Another problem is identifying comparable benchmarks—to make an “apples to apples” comparison. Differences exist across companies in their strategies, inventory costing methods, depreciation methods, and so on. For example, JetBlue serves fewer cities and flies mostly long-haul routes compared with United, which serves almost all major U.S. cities and several international cities and flies both long-haul and short-haul routes. Southwest Airlines differs from United because it specializes in short-haul direct flights and offers fewer services on board its planes. Because United’s strategy is different from JetBlue and Southwest, its cost per ASM is also likely to be different. United’s strategy is more comparable to American and Delta, and its cost per ASM is lower than these airlines. But United competes head to head with Alaska, JetBlue, and Southwest in several cities and markets, so it needs to benchmark against these carriers as well.

United’s management accountants can use benchmarking data to address several questions. How do factors such as plane size and type or duration of flights affect the cost per ASM? Do airlines differ in their fixed cost/variable cost structures? To what extent can United’s performance be improved by rerouting flights, changing the frequency or timing of flights, or using different types of aircraft? What explains revenue differences per ASM across airlines? Is it differences in perceived service quality or differences in competitive power at specific airports? Management accountants are more valuable to managers when they use benchmarking data to provide insight into why costs or revenues differ across companies or plants, rather than simply reporting the magnitude of the differences.