Management’s Use of Variances

Learning Objective 6 Understand how managers use variances

managers use variances to improve future performance

Managers and management accountants use variances to evaluate performance after decisions are implemented, to trigger organization learning, and to make continuous improvements. Variances serve as an early warning system to alert managers to existing problems or to prospective opportunities. When done well, variance analysis enables managers to evaluate the effectiveness of the actions and performance of personnel in the current period, as well as to fine-tune strategies for achieving improved performance in the future. Concepts in Action: Can Chipotle Wrap Up Its Materials-Cost Increases? shows the importance of direct-cost variance analyses to the fast casual dining giant.

Concepts in Action

Can Chipotle Wrap Up Its Materials-Cost Increases?^*

Patrick T. Fallon/Bloomberg/Getty Images

Along with burritos, Chipotle cooked up profitable growth for many years. The company’s build-your-own-meal model and focus on organic and naturally raised ingredients successfully attracted millions of customers in the United States and beyond. With competition and operating costs on the rise, however, Chipotle’s success going forward will depend on its ability to wrap up materials costs.

For Chipotle, profitability depends on making each burrito at the lowest possible cost. The two key direct costs are labor and materials costs. Labor costs include wages for restaurant managers and staff, along with benefits such as health insurance. Materials costs include the “critical seven” expensive food ingredients—steak, carnitas, barbacoa, chicken, cheese, guacamole, and sour cream—and items such as foil, paper bags, and plastic silverware.

To reduce labor costs, Chipotle makes subtle recipe and preparation shifts to find the right balance between taste and cost. For example, it washes and cuts some produce items, such as tomatoes and romaine lettuce, and shreds cheese in central kitchens to ensure food safety and reduce in-store labor costs. Since 2010, these actions have helped limit growth in labor costs from 25.4% of revenues in 2010 to 26.9% in 2017. Materials costs rose from 30.5% of revenue to 34.3% due to the focus on naturally raised ingredients and food safety. Responsibly raised meat and fresh local produce cost Chipotle more than conventional ingredients. To reduce material usage Chipotle aggressively manages portion control. While employees gladly oblige customers asking for extra rice, beans, or salsa, they control the “critical seven” food ingredients.

In 2018, to further manage its materials costs while driving environmental sustainability, Chipotle introduced new measures to reduce food waste during the preparation process. It also began cooking food to match sales to reduce food waste at the end of each day. With future profitability dependent on lowering materials costs, variance analysis will be a critical ingredient for Chipotle to deliver on its promise of “food with integrity.”

Multiple Causes of Variances

To interpret variances correctly and to make appropriate decisions, managers need to understand the multiple causes of variances. They also must not interpret a variance in isolation. A variance in one part of the value chain may result from decisions made in the same or another part of the value chain. Consider an unfavorable direct materials efficiency variance on Webb’s production line. Possible operational causes of this variance across the value chain are shown below:

Poor design of products or processes
Poor work on the production line because of underskilled workers or faulty machines
Inappropriate assignment of labor or machines to specific jobs
Congestion caused by scheduling rush orders placed by Webb’s sales representatives
Webb’s cloth suppliers not manufacturing materials of uniformly high quality

Item 5 offers an even broader reason for the unfavorable direct materials efficiency variance—inefficiencies in the supply chain of cloth suppliers for Webb’s jackets. Whenever possible, managers must attempt to understand root causes of variances.