Incremental cost is the extra cost associated with manufacturing one additional unit of production. It can be useful when formulating the price to charge a customer as part of a one-time deal to sell additional units. For example, if a company has room for 10 additional units in its production schedule and the variable cost of those units (that is, their incremental cost) is a total of $100, then any price charged that exceeds $100 will generate a profit for the company.
The concept can also be applied to cost reduction analysis. For example, it can be of interest to determine the incremental change in cost when:
- A person's employment is terminated
- A production line is shut down
- A distribution center is closed
- A subsidiary is sold off
An incremental cost analysis only reviews those costs that will change as the result of a decision. All other costs are considered irrelevant to the decision.
Incremental cost is also known as marginal cost.