Management by Exception (MBE)
Management by exception (MBE) is a practice where only significant deviations from a budget or plan are brought to the attention of management. The idea behind it is that management's attention will be focused only on those areas in need of action. When they are notified of variance, managers can hone in on that specific issue and let staff handle everything else. If nothing is brought up, then management can assume everything is going according to plan. This model is similar to the vital signs monitoring systems in hospital critical care units. When one of the patient's vital signs goes outside the range programmed into the machine, an alarm sounds and staff runs to the rescue. If the machine is quiet, it's assumed that the patient is stable, and they will receive only regular staff attention.
Process of Management By Exception
The process requires just a few objectives: setting the objectives or norms, assessing the performance of the chosen objectives, analyzing the possible deviations, and solving the exceptions. Let’s look at each section on its own:
- Setting Objectives or Norms: The process begins by establishing the norms for the chosen procedures. Consider you are running a hamburger shop and you’d like to monitor things such as sales, expenses and so on. You would need to establish the norm or the objective for each task and procedure. The norm should be something easily quantifiable and achievable. It could be the general number of burgers you sell each month, for instance. This would be the number you need to sell in order to meet the expenses and grow at a steady rate. So, you would set up the norm, which in this instance could be 15,000 burgers sold. When you are setting the objective and the norm, you want to focus on predictable and estimated results. You shouldn’t just pick a number or other norm from thin air. You can’t say “I’ll set the norm at 20,000”, if you can realistically only sell about 10,000. Finding the right norms and objectives won’t be easy, and you should spend enough time analyzing data to understand what the baseline for management and operations could be. As well as setting up the norms, you are also outlining the deviations. What constitutes as an exception? You now have the norms, but what would be a variance that would cause you to investigate it further? You might initially think, “any exception is surely worth looking into”. But that’s not the case, as explained above. You wouldn’t have time to do anything as a manager, if you examined each change in performance. The key is to understand the variances that require attention. For example, you might notice that on a hot day, the workers don’t produce quite as many finished cakes. This little occurrence might cause a change in sales for the month, but it’s probably not big enough to cause alarm. On the other hand, if the electricity price goes up and the expenses go up by 3% for the whole month, you definitely have a situation at hand. The deviations worth noticing depend on your business and the norms. As a general clue for financial exceptions, a variance of less than 0.1% of the norm is not a significant change. To find out the right deviations, you need to use mathematical formulas, such as statistical control charts, and study your business metrics carefully.
- Assessing the Performance and Comparing it with the Norm: Once you’ve established the norms, you can begin using management by exception. The most crucial part of the process is monitoring the relevant data sets and assessing whether the actual performance matches with the norms. You need to ensure you are gathering all the relevant data and monitoring systems in real time. The monitoring process can be different depending on how big your business is and what type of data you are monitoring. You can use automated monitoring programs that collect and compress data for you, providing you insight into the results. On the other hand, you could manually check the reports to notice the deviances. As you start gathering data regarding the current performance, you can start comparing it with your chosen norms. You want to do this to ensure you notice any deviations from the norm and can then move on to dealing with them.
- Analyzing the Deviation: There are two possible outcomes to comparing your performance data with the norms. You either:
- Find no significant deviation, in which case you don’t take any action. As mentioned above, you don’t need to respond to small changes.
- Find a significant deviation, in which case you take the following step of informing the appropriate management level about the issue. This could be the manager right above you or a high-level manager. If you are a manager, you need to either respond to the deviation or report it higher up in the chain, depending on the procedure.
Deviations shouldn’t just be accepted as they show and corrective action should only be taken once you are clear about the reasons behind the exceptions. You need to remember two things. First, a human error might have been behind the problem or other anomaly changed the results. This might mean the deviation is not actually as acute as it might seem. The second thing to keep in mind is that deviations are not necessarily always to be corrected. In certain instances, the variance might occur because of improvements in a specific procedure. So, never start solving your problem without analyzing the root causes behind the deviation.
- Solving the Exception: It then becomes an issue for the responsible management to deal with the deviation and to respond appropriately. As I just mentioned, understand what is behind the deviation before you solve it. Did the sale of hamburgers drop just because there was a human error in entering the sales on one day? Did the burger sales decline, while chicken nuggets suddenly went up? As a manager, you need to know the root causes for the anomalies before you can solve them. Remember that in certain instances, you might need to tweak your norms. For example, if you include a new product to your product line, the expenses have to up and so on. So don’t just implement your management by exception formulas, but continually review them.
Principles of the Management by Exceptions
The Principles of the Management by Exceptions influences on the following below given points:-
- Follow the Policy of the Organization: This principle states that the Top Levels of Management basically determines the Objectives & Policies of the organization and other levels of management must achieve these as per the instruction and expectations.
- Systematic Approach: This principle gives a systematic approach which states that all organizations needs to analyze facts & data’s, maintain the standards, collect, classify, draft and interpret reports and make decisions as per the requirements of the predetermined objectives to achieve the supposed goals.
- Self Control: According to this principle full freedom is given to different Levels of Management in taking decision as per the requirement. This basically attempts to solve as many possible problems at their respective levels. This frees & helps the top management to involve itself with policy & guidelines formulation.
- Knowledge of Exceptions: As per the principle Top Levels of Management should be able to understand & judge exceptional problems and activities and be prepared to give an amicable solution instantly.
- Differentiate Between Routine & Exceptional Activities: According to this principle Top Levels of Management should have clear & thorough understanding of Routine & Exceptional Activities. Proper procedure should be adopted for the execution of these activities with the help of concerned managers & management staff. It means that Exceptional Activities should be taken care by Top Levels of Management while Routine Activities by middle or lower levels of Management and subordinates.
- Delegation of Authority: This is an important principle which states that managers & subordinates should have required powers and authorities to discharge the necessary functions and duties efficiently.
- Hard Labor & Discipline: This principle states that all Levels of Management, subordinates and employees should perform hard labour in a disciplined manner in an organization.
- Invite Co-partnership: This principle states that employees of the organization must be invited to take part in various activities. The Top Levels of Management should offer co-partnership for better achievement of objectives or goals.
- Continuous Supervision: Another important principle is Continuous Supervision which is for the subordinates & junior staffs for better performance and understanding of given directions.
- Develops Subordinates: According to this principle subordinates should be given enough opportunities and facilities for developments. When proper arrangement is made for training and other activities, the employees get motivated and look for better job performances and rewards. Their personal interest and wholehearted effort gives positive result towards the achievement of organizational goals.
Management by Exception using Variance Analysis
The accounting department is responsible for the forecasting of budgets and cost performance reports. The difference between the estimated and actual figures is defined as variance. To understand the cause of the difference, managers need to investigate the questions how the variance differs from last period and what are the causes for not reaching the estimated figures. Analysts consider two types of variances: adverse variance and favorable variance. Adverse variance “exists when the difference between the budgeted and actual figure leads to a lower than expected profit”. Favorable variance “exists when the difference between the budgeted and actual figure leads to a higher than expected profit”. Rather than considering all variances, managers establish criteria to determine which variances are significant to focus on. Management by exception focuses mainly on large adverse variances, to find the areas of business, which deviates from predetermined standards in a negative way.
Advantages and Disadvantages of Management by Exception
Advantages There are several valid reasons for using this technique. They are:
- It reduces the amount of financial and operational results that management must review, which is a more efficient use of their time.
- 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.
- 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.
- 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 There are several issues with the management by exception concept, which are:
- 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.
- 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.
- 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 could monitor conditions on a daily basis, and so would not need an exception reporting system.
- 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.