Indirect Method

And finance Allah shmoop What is differential analysis All right

people Well it's a cost accounting term that asks How

could we do our business differently and better Different version

of you know doing our bidness Okay so you work

in the accounting department of Whisper Whisker the leading provider

of beard hair implants for chin bald millennial men Your

boss comes to you with a project Currently you use

one bad hormone therapy for one of your more popular

procedures because as whisper whiskers states in its brochures the

wombats lustrous hair gives your new beard the inviting pen

ability Your special someone will love However one bats are

on the endangered species list minor detail and lately whisper

whisker has been getting a lot of bad PR from

the pro wombat lobby So your boss wants to make

us switch well there are two options On one hand

you're a boss says that the purchasing department can get

a deal on Angora rabbit glands But on the other

hand the RND department says musk ox glands worked much

better for the hormone therapy you provide He wants to

let you figure out which option costs less on a

per procedure basis Assuming everything else is equal well to

figure it out you're going to use differential analysis Basically

you look at the various potential solutions and see which

one makes the most sense You run the numbers A

musk ox Eagle Land provides enough hormone for seventeen therapy

sessions However they're hard to farm in The special humane

extraction technique is expensive Each gland cost you a grand

for angora as well It's much cheaper They're smaller and

easier to handle Therefore each rabbit gland only cost two

hundred fifty dollars However you get less hormone from each

gland in the hormone is less potent so each angora

gland is only good enough for four therapy sessions So

you're spending two hundred fifty bucks for for therapy sessions

with the Angora and you're spending a grand for seventeen

sessions for the musk ox Well it's Keone differential analysis

to get rid of as much noise as possible so

you reduce the calculations here too The one unit scenario

like compare apples to apples in this guy Jason glands

to glance for this analysis well you're keeping all cost

the same it once the hormone is acquired The procedure

is the same whether musk ox or in glands or

you for the rabbit gland The hormone cost for the

procedure will run sixty to fifty each time There's the

math for musk ox while the cost is about fifty

eight eighty to everything else remaining equal Well you'll be

better off better profit margins that is going with the

musk ox because it's chief for well the price for

the animal glands is called the differential cost It's the

cost that will change as part of the change that's

being made right It's differentiating the analysis here Meanwhile large

number of other cost stay the same The doctor to

perform the hormone insertion the facility where the therapy takes

place the insurance the advertising and so on None of

these costs get impacted by the switch in the source

of the hormone So you let your boss know and

he gets the wheels in motion It's set up the

musk ox farms at least until the musk ox lobby

gets wind of it Oh those musk ox people are

such a pain differential analysis will also let you know

when something doesn't matter like you use a special dye

in some of your premium procedures It makes the beards

whatever color a person wants They can match their you

know natural hair color or go wild Rainbow Wild is

popular feature these days Fire orange however is the most

popular color You also offer a tight teal that's well

not so popular We'll fire orange outsells type deal by

a three to one ratio The problem Fire orange is

significantly more expensive like five times more Should you discontinue

fire orange and have sales people pushed the cheaper tight

Teel Well probably no not really The customer wants With

customer wants right a therapy session is worth five hundred

dollars in revenue The tight he'll die needed for a

session costs a dollar fire Orange costs five dollars Yes

it's five times more but it's nearly negligible on a

relative basis like as a total of the five hundred

dollars in revenue you get It's almost a rounding error

if discontinuing fire orange drop sales even a percent while

the move will end up hurting profit in the long

run The gland switch situation was a pretty simple example

but differential analysis It can get complicated quickly Take this

seemingly straightforward scenario You make a line of branded beard

maintenance products combs and decorative ties You make them in

America with union labor The cost to whisper whiskers all

in is about thirty seven dollars an hour for the

union labor you face competition from China Their products are

about ninety percent as good as yours but they're half

the price Is there a way to be able to

make your product such that you could drop prices by

a third even and still be competitive Alright while the

differential analysis here can you train a foreign labor force

to do about same job is your union workers do

in Chicago and get them to do it for five

bucks an hour And will there be tariffs or import

duties and other frictions like shipping costs and shipping risk

If you do go ahead and make the switch and

you know make him in Mexico or China or the

Philippines or somewhere and oh what about the fine print

in those union contracts How long are you obligated to

keep your expensive union US force Like maybe you have

two years of payroll that you have to get through

so maybe it's not worth is too expensive to switch

Differential analysis divides itself naturally into short term and long

term decisions as well Kind of like a balance sheet

like a short term analysis might revolve around discounting last

year's model of beard ty to clear them off the

shelves and make room for this year's models which now

boast a delicious cappuccino sent will long term Well what

if we used robots to make the combs and beard

ties instead of bothering with a human workforce at all

No robot union right The cap ax to build those

robots is a long term decision like you don't just

make him configure him And in four months get your

money back Well same deal with big distribution decisions like

partnering with Walmart or trying to enter the lucrative Russian

millennial market or China or Somalia while getting into Somalia

Isn't that hard It's you know getting out that compose

it challenge there What