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Incremental Analysis: Definition & Examples

Incremental Analysis: Definition & Examples
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  • 0:02 What Is Incremental Analysis?
  • 0:53 Incremental Analysis in Action
  • 2:05 Other Common Usages
  • 3:59 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Companies often have to make decisions based on vast amounts of data. Incremental analysis allows them to focus on the important information only. In this lesson, we'll learn how to use incremental analysis.

What Is Incremental Analysis?

If you've ever found yourself looking at a pile of reports and spreadsheets, wondering if there was a clear-cut way of slicing through everything and getting to the main differences between two courses of action, then look no further. What you need is a method of analysis called incremental analysis.

Incremental analysis allows for companies to weed out extra information, focusing instead only on what is important when considering a potential decision. You can remember it by thinking of the tiny increments upon which choices, that are often quite similar, may be different. Costs that are the same are simply disregarded, as are any sunk costs. Sunk costs are costs that cannot be changed. In this lesson, we'll look at how incremental analysis is used, as well as the areas of business practice where it is especially common.

Incremental Analysis in Action

Remember that incremental analysis only focuses on the differences between two courses of action. Now let's say that your lease is up at your office, and you are considering two different locations. One has a minimum space of 40,000 square feet, but rents at $10 a square foot. However, the other space has a minimum space of only 10,000 square feet, but rents at $20 per square foot. So which do you take? In this case, you need to know just how much square footage your office requires. If you need 40,000 square feet or more, then clearly the first office at $10 a square foot is the better deal. If you need less than 20,000 square feet, you'll pay less getting the office that rents for $20 a square foot.

However, there is some space in between, and this is where incremental analysis comes into play. As long as all the added costs of utilities are cheaper, you should still go with the $10 a square foot location. However, there may be points that, due to increased utility costs, push the decision in the other direction. Notice that we are only making comparisons based on those aspects which are different. We are not getting bogged down in areas of similarity.

Other Common Usages

This sort of quick analysis is obviously of great use to companies. Not only can it make decisions on a new office location, but the same reasoning can be applied to plans to start a new product, end a product line, repair equipment, or even enter a new practice area that is related to one that a company is already familiar with. Anytime the static of similar costs can be stripped away, incremental analysis allows managers to focus only on the substantial differences between separate courses of action. Let's see how incremental analysis could be used to find the best solution across a number of common business problems:

1. Manufacturing vs. Upgrading

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