Market size variance and market share variance are two ways of using market data to determine its effect on a company's profits. While the two terms are related, they calculate the effects of different changes.
Market size variance
The market size variance can quantify the effects of a change in market size on profitability, assuming that the company's market share stays the same. The formula for calculating market size variance is:
For example, let's say that your company has a 20% share of the market for a certain product, and that when you made your budget, the market for this product was expected to be for 110,000 units. However, the most recent industry projections are estimating that the market has grown to 120,000 units. If your profit per unit is $50, you can calculate a market share variance using the formula:
A couple of notes. First, be sure to convert the market share to a percentage before using it in the formula. Second, it's worth mentioning that a market share variance can be positive or negative. A positive number like the one we calculated implies an increase in profitability, and a negative value implies a decrease.
Market share variance
A market share variance can tell you how an increase or decrease in your company's market share can affect your profitability. As you can see, the formula for calculating this is quite similar to the formula for market size variance.
To illustrate this point, consider the same company we discussed in the market size variance example. We know that the market for the company's product has grown to 120,000 units. However, let's say that the company's market share has fallen from 20% to 18%.
So, for our hypothetical company, changes in the size of the market caused gross profits to be $100,000 greater than expectations, while changes in the company's market share caused gross profits to fall by $120,000. In all, these two variances combined to produce a gross profit that is $20,000 less than the company's expectations.
Using information from the market size variance example, the company expected to sell 22,000 units at a total profit of $1,100,000. However, due to the market size variance and market share variance, the actual profit is $20,000 less, or $1,080,000.
If you're ready to move on from the hypothetical, head on over to our broker center to start investing in real companies today!
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!