Incremental analysis is a methodology utilized by managers in order to make business decisions that will result in profit. The basic steps are:
identify and categorize the current revenue and costs
determine which revenues and costs are relevant to the decisions
total all the relevant revenues and costs
calculate the differential income (or loss) from the decision
consider qualitative (non-monetary) factors and make a decision
A great example of this, especially this time of year, is cell phone manufacturers. It is going to cost them the same to manufacturer them no matter what; however, the different service providers like Tmobile, Sprint, and Verizon are going to compete to offer the best deals to attract (and retain) customers. This brings into incremental analysis (should the manufacturer of the phones offer lower prices to the different service providers, based on the volume they wish to purchase, and then could the other service providers find out…and would it matter). This also brings my thought process to opportunity of costs; one the service providers have the phones, they want to give them away (the cost of the phone) in order to lure them into expensive, long term contracts.
I found the following five uses for incremental analysis. Incremental analysis provides a systematic approach to decide if we should:
- Accept an order at a special price.
- Make or buy component parts or finished products.
- Sell products or process them further.
- Repair, retain, or replace equipment.
- Eliminate an unprofitable business segment or product.
It seems to me that we do some level of incremental analysis in our personal budget, also. For example, if my washing machine breaks, I may compare the cost of a service call in addition to the cost of labor and part replacement to the cost of purchasing a new machine.
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