A critical part of managing a company is making good decisions. While long‐term decisions are obviously important – by virtue of the fact that they often involve committing large sums of money to a project – using the correct techniques to make short‐term decisions is even more important. In management, short‐term decisions are made repeatedly in many different areas, such as pricing, purchasing, maintaining inventory and staffing levels, establishing which products to sell and which to discontinue.

For example, a business may have to decide whether to make components itself or buy them; whether to accept or reject an order; whether to further process a product or sell it at its split‐off point; or how to best use resources when one or more of them becomes scarce.

There are four basic steps involved in making these kinds of operating decisions:

1. Becoming aware that a decision needs to be made
2. Identifying the available alternatives
3. Evaluating the alternatives
4. Making the decision.

One of the most common ways to evaluate alternatives is by using a technique called “differential analysis” which is just as it sounds – analyzing the difference between two or more alternatives and then making a decision based on that quantitative analysis, considering qualitative issues as well.

For example, let’s say Carl Less is president of Tuff Boots, Inc., a manufacturer of hiking boots that boasts 100% Made in the USA right on every box. Due to rising costs of raw materials and labor, Tuff Boots’ profits have declined steadily over the past few years. Carl is concerned about declining profits and has instructed Abby Kerr, the vice president of operations, to do whatever it takes to reduce costs. Carl has agreed to pay Abby a bonus equal to 25 percent of any production cost savings the company achieves during the coming year.

The average unit product cost to produce a pair of boots is $90, and the company makes 10,000 boots each year, selling them for $129 each. Abby believes the company could save substantial amounts of money by having an outside supplier make the boots rather than doing it in-house. A supplier in China has made an initial commitment to provide boots for $70 each.

Tuff Boots is facing a decision common to many organizations: whether to make its own product or to have another company mass-produce the product under the Tuff Boots brand. We will come back to this scenario after describing how companies facing such decisions can use differential analysis to make wise business decisions.