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What is relevant cost? How to measure and weigh business decisions

Definition: Relevant cost, also called differential cost, is a management accounting term decsribing costs that pertain to a particular decision. Relevant costs will vary based on the context of the decision, such as an omnichannel business analysis by a multi-platform retailer.

What types of relevant costs are there?

Relevant costs are generally divided into two categories

  • Future Cost- Incurred in the future based on the potential decision made. This should vary from decision option to decision option. If this does not change based on the decision, then it is an irrelevant cost (see below).

  • Opportunity Cost - The cost in lost opportunity depending on the decision made.

Are there irrelevant costs?

Yes, irrelevant costs are those that should not be considered when making a decision because they can not be changed:

  • Sunk Cost - Costs that have already been paid are considered irrelevant.

  • Committed Cost - A future cost that is considered irrelevant. If the future cost must be paid regardless of the decision made then it is irrelevant.

What are relevant costs that online merchants should think about?

Executive management at a company decides that they want to develop a mobile application for Android-based mobile devices. They are presented with two options by the technical team: A web application wrapped to look like a mobile application or a mobile application written for Android. Each decision has several relevant costs:

  • Development Time (Future cost) - How much time will it take to develop each option?

  • Developer Resources (Future cost) - How many people, and at what wage, are required to build each option?

  • Time to Market (Opportunity cost) - How much will a difference in delivery time impact sales, and what is the difference?

  • Perceived Performance(Opportunity cost) - Is one option better performing than the other, and what is the expected abandonment rate based on that performance difference?

  • Omnichannel Marketing(Future & Opportunity cost) - Can one option fit the overall brand experience better than the other, and is there a cost associated with integrating the application into the brand?

There are also irrelevant costs that should be ignored:

  • Existing Website (Sunk cost) - The cost of the current website, even if it were reused for the application, is irrelevant. Any cost mitigation it provides would be accounted for in development time and resources.

  • Testing Software (Committed cost) - Regardless of the option chosen, the same testing software will be used.

  • The cost of the iOS Application (Sunk cost) - Like the existing website, the cost of the iOS application is irrelevant to this decision.

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