Describe Differential analysis to drop/keep customers
Often managers need to decide if dropping a customer is profitable than keeping him. The manager can use differential analysis with variable cost associated with the customer, the fixed cost directly related to the customer along with any other allocated fixed cost that is not directly related to the specific customer.
For example for an online only bank, the variable costs would include customer support cost, interest / dividend payment to the customer etc and fixed cost would be information technology maintenance cost, employee cost etc. But notice, that these fixed costs are not specific to the customer, these costs would continue whether or not any particular customer is retained or dropped. When the customer makes the company make loss, then the manager would perform differential analysis to determine if it is profitable to drop the customer or to keep him so that the total profit does not drop.
Describe Differential analysis regarding product line offerings
Any company that wants to introduce a new product or wants to decide on – whether of not to continue with existing product from their offering can use differential analysis to determine the most profitable decision for the company.
For example, say a Yogurt company wants to determine if dropping one particular flavor of yogurt that basically makes loss, should remain in their product offering or should it be just dropped to increase overall profit.
Describe Differential analysis regarding Make-or-Buy decisions
Companies making products can determine using differential analysis whether or not manufacturing in house would be profitable or should they just buy that product from a supplier to make a bigger profit.
For example say a café sells cookies, and to make those cookies the café needs the oven, ingredients, baker etc. Differential analysis can help us determine if simply buying those cookies from outside would help them save money or not, provided the café has some fixed costs such as rental of the place, leasing cost of the oven etc and some variable costs such as ingredients, the employees.
Discuss the role qualitative information may have in differential analysis
Differential analysis usually does not focus on qualitative information while making decisions. For example, when I gave the example of a bank customer who is not profitable for the bank, and bank has to spend too much money on him with customer support. Eventually the customer would require less support and he would deposit larger sum of money and the bank would be able to make good profit out of him. Or in the example where I said, the café can decide to outsource the cookies, but considering qualitative information would make the café manager re-consider his decision – the quality of ingredients for the cookies might not meet the café standards, the supplier can deliver late. Firing the baker might have bad effect on existing employees etc.
So qualitative information which does not relate to exact profit figures but it might play a significant part in determining the decision from differential analysis.
Discuss sunk and opportunity costs, why must managers consider these things?
Sunk cost is a cost that had been incurred in past and cannot be recovered in future. Sunk cost should not be considered in differential analysis (Bragg, 2017).
For example, in the previous example where the café manager was deciding whether or not he should buy the cookies from a supplier. Say, the café has already purchase ingredients to bake cookies, and some of them cannot be returned as those have been already used, in this case the cost incurred to obtain these ingredients are sunk cost.
Opportunity cost is when business chooses one specific alternative it misses the benefits or profit from then next alternative, and that mossed benefit/ profit is opportunity cost. It in theoretical cost (https://www.myaccountingcourse.com/accounting-dictionary/opportunity-costs).
For example, when the café manager decided to make cookies instead of cupcakes, the café missed of the opportunity to sell cup cups and missed out the potential profit from sell cupcakes. Say the potential profit from selling cupcake was $100 daily, in that case this is the opportunity cost.
Provide a brief explanation of why a managerial decision may be made, at times, that doesn’t align with the quantitative recommendations of the analysis.
Quantitative recommendations that is often derived from differential analysis can be superseded at times because of the qualitative factors. Before taking any decision to fire an existing employee, a manager considers the effect on moral of current employee. Then customer has a certain expectation from a business, service or quality wise, and the manager often does not want to compromise on that.
And at time brand value might also at risk, for example, if original coke ever becomes loss making product for the company, before eliminating the product from portfolio the company will have to decide if removing original coke from offering will dampen their brand. Same goes for KFC, these brands were built on a certain product. Amazon Prime promises 2 days delivery, if amazon has to decide if they want to continue 2 days delivery or not, they will have to factor in customer sentiment too.
Bragg, S. (August, 2017). Sunk Cost. Retrieved from https://www.accountingtools.com/articles/what-is-a-sunk-cost.html
Retrieved on 2/24/2018 Retrieved from https://www.myaccountingcourse.com/accounting-dictionary/opportunity-costs