Learning how to apply marginal analysis skills in your decision-making process can help you to find greater success in your management role
The business world is an inherently competitive environment, which is why companies around the world are always focused on making the best possible decisions to improve their bottom line. One of the most effective ways that they can accomplish that goal is to use marginal analysis to help them assess the potential benefits of any given business decision.
In this post, we’ll explore the concept of marginal analysis and examine why it’s such a valuable tool for any business. We’ll also look at how marginal analysis skills can make you a more effective manager.
A definition of marginal analysis
Marginal analysis is a form of analysis that involves an assessment of how the marginal benefits of a proposed decision compare to its marginal costs. To conduct this analysis, a business will examine the cost of an activity, such as increased production, while also assessing the potential benefits of that decision. This type of analysis is commonly used in enterprises where a difference in unit production can impact profitability in either a positive or negative way, depending on the potential benefits and costs associated with increased production.
Because companies need to ensure that resource allocation is used in the most effective way possible, marginal analysis is a vital tool. Every company has a break-even point at which production costs are equal to the revenue from goods or services. Marginal analysis can be an effective way for a company to plan for expanded production or increased services, by determining how that expansion impacts both revenue and cost.
Why is margin analysis important?
The importance of marginal analysis in business decision-making cannot be overstated. Since this type of analysis is unit-focused, it can be used to effectively forecast the impact of even the smallest changes in a company’s approach to the use of labor and resources. For example, a company that makes frisbees can use this analysis to compare the added cost of producing ten more frisbees a day with the potential revenue of that increase in production.
In a similar manner, a firm might use marginal analysis to determine the benefits of adding two more workers to its team. If the company knows how much revenue and profit each of its employees brings into the firm, management can compare that number to the total cost involved in hiring and retaining new workers.
Of course, to be able to conduct any reasonably accurate marginal analysis, you need to be able to identify a variety of variables. Marginal cost analysis can include things like fixed and variable costs, which both contribute to the marginal cost of any proposed outcome. Naturally, you’ll also need to consider all of the different variables that can contribute to any marginal benefit. Analyzing and comparing how those variables impact any small changes in business activity can help you to forecast how your decisions will likely impact profitability.
How is marginal analysis used in the workplace?
Though most people may not realize it, marginal analysis is a common tool in many businesses. In fact, companies routinely conduct formal marginal analysis before making important decisions about production, hiring, and service expansion. Since growth and expansion plans invariably involve the addition of new services, new workers, new products, or increased production, it’s vital to know whether those changes will have a negative or positive impact on the company’s finances.
For example, let’s say that you run a company that produces pencils. If you’ve been in that business for any length of time, you should know exactly how much it costs to produce each pencil and the profit that you realize from each unit sold. If you want to increase your profits, you’ll need to know how much additional expense you’ll incur by producing an additional pencil. Now, that added cost might be less than the cost for each unit you currently produce, if you can benefit from economies of scale, or it may be the same cost you currently incur.
Assuming that your additional pencils will be sold at the same price as your current merchandise, your potential increase in profit should be fairly simple to calculate. You simply subtract the expected marginal cost from the anticipated marginal benefit of each added unit. That result can give you an idea of the type of additional profit you can expect to earn from each new pencil produced and sold.
How marginal economics can help you in your role as a manager
It is easy to see how important marginal analysis can be for managers and other leaders in a company. Dynamic companies are always looking for ways to increase market share and profitability. A manager who understands how to use this type of analysis can be an invaluable asset in any company’s decision-making process. For these leaders, this analysis can provide many benefits, including:
Assessing the pros and cons of various projects before decisions are made. Well-executed marginal analysis provides important data points that help companies to identify potential areas of opportunity, calculate the cost of lost opportunities, and avoid decisions that might result in a loss of income and profitability.
Maintaining control over the cost and revenue achieved when small unit changes are made in the company’s business activity.
Developing a better understanding of how those micro changes can impact the company’s bottom line on a broader scale, including identifying the maximum potential for gain or loss from any proposed increase or decrease in activity.
Identifying optimal times to increase or decrease the company’s labor force, by analyzing how the addition or subtraction of employees will impact both production and revenue.
The rules of marginal analysis and its basic formula
Like any other effective tool, marginal analysis has some simple rules that must be respected if its benefits are going to be realized. They are:
The rule of equilibrium. This rule is sometimes referred to as the Golden Rule and simply states that businesses should continue a given activity until the point at which marginal cost is equal to marginal revenue – which results in a marginal profit of zero.
The rule of efficient allocation. The second rule is designed to maximize profitability. A business following this rule will continue a given activity until it receives the same marginal return from each unit. When there’s disparity between the marginal profit earned from different product units, the business should shift resource allocation to the activity that provides the maximum profit.
Effective use of marginal analysis also requires a basic understanding of its underlying formula. That formula is used to calculate net benefits and is simply the difference between the marginal cost and marginal benefit of the activity in question. In other words, net benefit equals the marginal benefit minus marginal cost.
Show this aptitude on your resume
Marginal analysis can be a powerful tool for companies that need to manage the cost and benefit implications of production, hiring, and other vital decisions. If you’re a manager or analyst who possesses these analytical skills, you may find yourself in high demand in today’s ever-evolving economy.
If you want to ensure that your market analysis skills are properly conveyed on your resume, be sure to get your free resume review from our team of experts today!