Project managers are often called on to make decisions between different opportunities or different ways of accomplishing the goals and objectives of a company. The three types of cost that are used to make decisions are differential cost, sunk cost, and opportunity cost.
Differential cost is simply the difference in cost between choosing one of two or more options to pursue. The other side of differential cost is differential revenue. When considering the different options to pursue, the differential cost and revenue of each option is reviewed, and the option that presents the higher income usually is chosen.
Let's look at an example of how differential cost may be used to choose between two options. ABC Web Company creates and supports Internet web sites for other companies. Often its revenues are tied, in part, to the success of the web sites it designs. ABC Web has been approached to produce a web site that it feels will be very successful, but currently its resources are working over capacity and cannot begin the work immediately.
ABC Web's alternatives are to ask the client to wait three months or to subcontract the work to another vendor that it has worked with in the past. The client has indicated that if ABC waits three months, it will pay a commission on the site's revenues for only 9 months instead of 12. Yet subcontracting is fairly expensive. Here is the differential calculation that ABC Web made:
According to this analysis, the differential ...