Management by exception definition
/What is Management by Exception?
Management by exception is the practice of examining the financial and operational results of a business, and only bringing issues to the attention of management if results represent substantial differences from the budgeted or expected amount. For example, the company controller may be required to notify management of those expenses that are the greater of $10,000 or 20% higher than expected.
The purpose of the management by exception concept is to only bother management with the most important variances from the planned direction or results of the business. Managers will presumably spend more time attending to and correcting these larger variances. The concept can be fine-tuned, so that smaller variances are brought to the attention of lower-level managers, while a massive variance is reported straight to senior management.
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Example of Management by Exception
A manufacturing company produces and sells furniture. The company sets monthly performance standards for its departments, including production costs, sales revenue, and defect rates. Its key metrics are as follows:
Production costs are expected to be $50,000/month
Revenue is expected to be $200,000/month
Defect rate is expected to be 2% of the total units produced
The company’s January performance is as follows:
Actual production costs are $48,000, which is within the expected range
Actual revenue is $198,000; a minor variance, no action needed
Actual defect rate is 6%, which is a significant deviation and requires investigation
Under the management by exception concept, only the defect rate is investigated, since it is much higher than the acceptable level. The manager investigates the defect rate and finds that a new batch of raw materials was of substandard quality, leading to higher-than-normal defects. The manager works with the procurement team to address the issue by changing the supplier and implementing stricter quality checks.
There were several advantages to using management by exception in this scenario, which are as follows:
Efficiency. The manager focuses only on the defect rate issue, ignoring metrics that are within the acceptable range.
Improved decision-making. Resources were directed to resolving the most critical problem.
Enhanced performance. Addressing the defect issue ensured that product quality and customer satisfaction were maintained.
Advantages of Management by Exception
There are several valid reasons for using this technique. They are:
Reduces review time. It reduces the amount of financial and operational results that management must review, which is a more efficient use of their time.
Efficient reporting system. The report writer linked to the accounting system can be set to automatically print reports at stated intervals that contain the predetermined exception levels, which is a minimally-invasive reporting approach.
Allows employee initiative. This method allows employees to follow their own approaches to achieving the results mandated in the company's budget. Management will only step in if exception conditions exist.
Triggers audit pre-reviews. The company's auditors will make inquiries about large exceptions as part of their annual audit activities, so management should investigate these issues in advance of the audit.
Disadvantages of Management by Exception
There are several issues with the management by exception concept, which are as follows:
Wasteful variance analyses. This concept is based on the existence of a budget against which actual results are compared. If the budget was not well formulated, there may be a large number of variances, many of which are irrelevant, and which will waste the time of anyone investigating them.
Extra corporate overhead. The concept requires the use of financial analysts who prepare variance summaries and present this information to management. Thus, an extra layer of corporate overhead is required to make the concept function properly. Also, an incompetent analyst might not recognize a potentially serious issue, and will not bring it to the attention of management.
Supports centralized management. This concept is based on the command-and-control system, where conditions are monitored and decisions made by a central group of senior managers. You could instead have a decentralized organizational structure, where local managers can monitor conditions on a daily basis, and so do not need an exception reporting system.
Assumes manager oversight. The concept assumes that only managers can correct variances. If a business were instead structured so that front line employees could deal with most variances as soon as they arise, there would be little need for management by exception.