Cost-Benefit Analysis
Cost-benefit analysis is the weighing-scale approach to reaching business decisions: all the pluses (the benefits) are put on one side of the balance and all the minuses (the costs) are put on the other. Whichever weighs the heavier wins. If the costs weigh more, the proposal gets the thumbs down; if the benefits weigh more, it gets the thumbs up. A company considering whether to buy new computer systems, for example, might attempt a cost-benefit analysis to help it make up its mind. On the cost side would be things like:
- the price of the computers themselves;
- the cost of hiring people to install them;
- the cost of training staff to use them.
On the benefits side would be things like:
- greater speed in carrying out the company’s operations;
- greater efficiency in organising data;
- a boost to staff morale from using the latest equipment.
All of us do intuitive cost-benefit analyses every day of our lives. For example, “Shall I take a taxi to my next meeting or will I not save enough time for it to be worth my while?” The technique is also used extensively by industry and commerce.
Nevertheless, this comparatively simple idea has complicated ramifications. The pluses and minuses are not all immediately obvious, and many of them are not easily measurable in monetary terms. How, for instance, do you quantify an increase in staff morale?
Moreover, decisions cannot be made in isolation. There are usually several competing options: if you do not invest in a new plant in west Africa you can increase capacity at your existing plant, or you can take over a new business, or you can just leave the money in the bank. It is the proposal with the highest net benefit that gets the go-ahead.
Benjamin Franklin, inventor of the lightning conductor and co-author of the American Declaration of Independence, was a practitioner of cost-benefit analysis. He wrote: When difficult cases occur, they are difficult chiefly because while we have them under consideration, all the reasons pro and con are not present to the mind at the same time … To get over this, my way is to divide half a sheet of paper by a line into two columns; writing over the one “Pro”, and the other “Con”. Then … I put down under the different heads short hints of the different motives … for and against the measure … I endeavour to estimate their respective weights; where I find one on each side that seem equal, I strike them both out. If I find a reason pro equal to two reasons con, I strike out three … and thus proceeding I find at length where the balance lies … And, though the weight of reasons cannot be taken with the precision of algebraic quantities, yet when each is thus considered, separately and comparatively, and the whole lies before me, I think I can judge better, and am less liable to take a rash step.
In recent years, cost-benefit analysis has been widely used for analysing public-sector projects, as a tool to help answer questions such as: “Should we subsidise the sale of things like unleaded petrol and solar panels?” or “Shall we turn this busy urban street into a pedestrian zone?” In these examples, the social costs are the most important ones. What are the benefits to human health of reducing the levels of lead in the atmosphere? And can you measure this – in terms, for example, of the medical facilities that will not be required as a result of the better health of the population?
Comments