Cost-Benefit Analysis– Important Tool for Decision Making: Yet Some Experts Say It’s Flawed, Misleading, Not Reliable…

Cost-benefit analysis: Most of us are familiar with the term ‘cost-benefit analysis’ (CBA), and have a basic grasp of it. It refers to how a project or decision might be evaluated, comparing its costs with its benefits. In many cases, it’s a like a quantified pros-and-cons list… It’s an analysis of the expected balance of benefits and costs…

Cost-benefit analysis sometimes called ‘benefit–cost analysis’ (BCA) is a systematic process for calculating and comparing benefits and costs of a project, decision, government policy… CBA has two purposes: 1. Determine if it’s a sound investment/decision (justification/feasibility); 2. Provide basis for comparing investments, decisions, projects…

It involves comparing the total expected cost of each option against the total expected benefits, to see whether the benefits outweigh the costs and by how much… Cost–benefit analysis is often used by governments, organizations, businesses… to evaluate the desirability of an investment… CBA usually tries to put all relevant costs and benefits on a common temporal footing using time value of money calculations. This is often done by converting the future expected streams of costs and benefits into a present value amount using a discount rate…

The value of a cost–benefit analysis depends on the accuracy of the individual cost and benefit estimates… Cost benefit analysis helps to give management a picture of the costs, benefits, risks… The term ‘cost-benefit analysis’ is used frequently, although it has no precise-standard definition beyond idea that both positive and negative consequences of a proposed action are going to be summarized, and then weighed against each other…

The term also has no universally agreed spelling. It’s written as for example; cost benefit, cost/benefit, cost-benefit, benefit/cost… Because the term cost-benefit analysis does not refer to any specific approach or methodology, the people who are asked to produce one should take care to find out what is expected or needed. The term covers several varieties of  ‘case’ analysis, such as; return on investment (ROI), financial justification, total cost of ownership analysis (TCO)…  

All of these approaches attempt to predict the financial impacts and other consequences of an action, and they have the same structural and procedural requirements for building a strong, successful ‘case’. They differ primarily in terms of; how they define ‘cost’ and ‘benefit’ in practical terms, and the costs and benefits that are included in the analysis…

According to Nicole Gordon; cost-benefit analysis is used to decide if the cost of a solution and the economic benefits that would result from it are worth the risk. The main idea behind this strategy is that the benefits must exceed costs to justify the policy…

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In the article What Is Cost-Benefit Analysis? by Selena Maranjian  writes: Economists apply cost-benefit analysis when they want to estimate the effect of various actions, e.g., government incentive programs to support the housing market, or subsidies for certain industries, or changes in tax rates, or spending on infrastructure…

The analysis can take various forms, and can involve varying degrees of complexity and precision, everything from considering opportunity costs (i.e., what is given up by making a given choice) to applying probability estimates to outcomes, to calculating the net present value of various options (which involves translating future costs and benefits into current dollars).

Assessing the costs and benefits helps focus in on the action that offers the most bang for the buck. It’s good to remember, though, that these analyses are not necessarily precise, as they often include estimates, especially for qualitative factors… When pondering big decisions (or even some small ones), using cost-benefit analysis can help you be a bit more rigorous in your decision-making process and more confident in the final decision you make. It comes in handy in all sorts of situations, such as when you’re:

Weighing different career or job options; deciding whether to rent or buy a home, and what kind of home, too; deciding whether to attend a particular function; making financial decisions… Even if you can’t quantify all the factors involved in a decision, you might still include them on a list to help you come up with a final decision…

In the article Performing a Cost-Benefit Analysis by Stanley E. Portny writes:  Whether you know it as cost-benefit analysis or benefit-cost analysis, performing one is critical to any project. When performing a cost-benefit analysis, you make a comparative assessment of all the benefits you anticipate from your project and all the costs to introduce the project, perform it, and support the changes resulting from it. Cost-benefit analyses help you to:

  • Decide whether to undertake a project or decide which of several projects to undertake.
  • Frame appropriate project objectives.
  • Develop appropriate before and after measures of project success.
  • Prepare estimates of the resources required to perform the project work.
  • Everything gets a dollar value in a cost-benefit analysis.

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In the article Advantages & Disadvantages of Cost-Benefit Analysis by Renee O’Farrell writes: The main advantage of cost benefit analysis is its simplicity. You are simply looking at whether benefits outweigh costs. When you do this quantitatively, measuring the dollar amount of the benefits and the costs involved in a project, the cost benefit is very easy to see. This clarity means that everyone involved will understand the monetary nature of the project and the question of its continuance. Its simplicity also means that doing a CBA is easily possible for various scenarios, locations and more.

However, the simplicity of cost benefit analysis can paradoxically lead to complications; to gain this simplicity, you have to use a common measurement– one of the disadvantages of CBA. Determining the quantitative benefits of a project is relatively straightforward; you basically add up the costs and profits (benefits) and compare the two. However, when you factor in qualitative benefits, the picture can become more complicated. For example, if you are considering implementing an employee bonus program, you will obviously incur costs. In exchange, you may receive benefits like increased employee satisfaction, decreased turnover and greater productivity.

The benefits are significant but difficult to compare– apples to apples– to the costs involved… A frequently made mistake is the use of non-discounted amounts for calculating costs and benefits; typically the cost is tangible– hard and financial– while the benefits are hard and tangible, but also soft and intangible. Caution should be taken here against people who claim that ‘if you can’t measure it does not exist/it has no value’… Especially in more strategic investments, frequently the intangible benefits clearly outweigh the financial benefits…

In the article Cost-Benefit Analysis: Build a Model, Not a Number by Niel Nickolaisen writes: My frustration with this process is two-fold: First, costs and benefits often do not capture all of the things we should consider in making a decision. Second, this approach forces us to try to make decisions before we have learned enough to do so successfully… So, rather than trying to predict a number, we need to recognize that estimated benefits are highly uncertain. Even if we are good at guessing, the benefits are often beyond our control…

So break projects into pieces that do two things: first, deliver some intermediate, yet measurable value; second, allow you to better quantify the costs, considerations and benefits… So, rather than build a number, built a model… ask ourselves what you can learn, in stages, to discover whether or not you were achieving the desired benefits. Taking this approach, you established intermediate deliverables and benefits…

Not only did the piecemeal approach reduce risk, but it also gave the group the opportunity to kill the project if the decision model about the next phase did not prove accurate… Traditional cost-benefit works well for straightforward projects, but as costs or benefits become less precise and considerations become more important, I have found that building a model leads to better decisions…

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In the article Myth of Cost-Benefit Analysis by Denise Caruso writes: Cost-benefit analysis in government has long been extolled as the best method for stripping regulatory decisions of bias and anchoring them with objective, real-world economic consequences. To that end, President Bill Clinton signed a law in 1993 requiring that every regulatory proposal– even those mandated by Congress– undergo at least one cost-benefit analysis before being submitted for approval. This policy assumes that cost-benefit analysis is unbiased, but that is not the case in practice.

The flaws of cost-benefit analysis, which has gained momentum over the past 40 years, have become more apparent. Sometimes it gives government agencies or corporations a disproportionate influence over what goes into the analysis and therefore what comes out of it. Other times, it skews the results in unexpected ways simply because of hidden bias or unintentional misapplication of the data. Even when conducted with best of intentions the method is still problematic because it substitutes calculation for informed-considered judgment.

Although we need not abandon such analysis altogether, we must recognize how and why it’s subject to misuse and abuse… The main problem with cost-benefit analysis is that it requires translation of all value of a given proposal into economic terms. To proponents, this is its chief asset because the cost-benefit approach uses economic value as a universal metric; they say it’s a neutral tool that monetizes risk and benefit in least bias way to judge the impact of regulatory decisions.

But quantitative analyses are never neutral. To be useful, any data, including economic data, must be considered in the context of the decision that is being made. Also, no matter how clever the mathematics, certain key inputs in a cost-benefit analysis cannot be translated into economic value… For example; security and safety, the preservation of wildlife and open spaces, the reduction of fear in a community and scientific uncertainty in fields that spawn technology innovation… are all economic intangibles, and omitting them when they are clearly important factors should invalidate the analysis. But it never does…

Cost-benefit analysis can be an effective tool to analyze simple, one-dimensional problems, such as; whether to install dividers on dangerous stretches of highway, where relatively unambiguous data is in abundant supply and there is little controversy. It also is a good way to elucidate the trade-offs for a given policy or regulation, or to produce a summary statistic about its economic efficiency... But the cost-benefit method loses its authority when it’s used to assess more complex decisions. It’s inadequate for evaluations of interventions that will affect many different dimensions, such as; markets, economies, health, environment, endangered species…

Cost-benefit analysis is also inappropriate for products or processes over which there are disagreements about benefits or about which outcomes are important, such as; new medical technologies like genetic testing… And, it should never be used as the basis for regulation in the presence of scientific uncertainty or value conflicts, or in an area where there are no authorities one can trust to know all the answers, as is the case with biotechnologies, e.g., genetic engineering, stem cell research…

Decisions like these require a more expansive methodology– one that isn’t dependent on the affectation of translating all value into economic terms– that is more transparent and responsive to outside criticism– and pragmatically represents the interests of everyone involved: industry, government, citizenry…