Cost-benefit analysis (CBA) is a technique used to compare the total costs of a programme/project with its benefits, using a common metric (most commonly monetary units). This enables the calculation of the net cost or benefit associated with the programme.
As a technique, it is used most often at the start of a programme or project when different options or courses of action are being appraised and compared, as an option for choosing the best approach. It can also be used, however, to evaluate the overall impact of a programme in quantifiable and monetised terms.
CBA adds up the total costs of a programme or activity and compares it against its total benefits. The technique assumes that a monetary value can be placed on all the costs and benefits of a programme, including tangible and intangible returns to other people and organisations in addition to those immediately impacted. As such, a major advantage of cost-benefit analysis lies in forcing people to explicitly and systematically consider the various factors which should influence strategic choice.
Decisions are made through CBA by comparing the net present value (NPV) of the programme or project’s costs with the net present value of its benefits. Decisions are based on whether there is a net benefit or cost to the approach, i.e. total benefits less total costs. Costs and benefits that occur in the future have less weight attached to them in a cost-benefit analysis. To account for this, it is necessary to ‘discount’ or reduce the value of future costs or benefits to place them on a par with costs and benefits incurred today. The ‘discount rate’ will vary depending on the sector or industry, but public sector activity generally uses a discount rate of 5-6%. The sum of the discounted benefits of an option minus the sum of the discounted costs, all discounted to the same base date, is the ‘net present value’ of the option.
Source: (Prime Minister's Strategy Unit. 2004)
In 2005 the UK Government undertook a value for money analysis of Government investment in different types of childcare. The choice was between higher cost "integrated" childcare centres, providing a range of services to both children and parents, or lower cost "non-integrated" centres that provided basic childcare facilities.
The analysis included both a 'hard exercise' and a 'soft exercise'. The hard exercise identified, quantified and monetised direct costs and benefits. The soft exercise identified and described qualitatively non-monetisable impacts, leading to option ranking.
Source: (Prime Minister's Strategy Unit. 2004)
Advice for CHOOSING this option (tips and traps)
- Cost-benefit analysis should normally be undertaken for any project which involves policy development, capital expenditure, use of assets or setting of standards. Depending on the nature of the issue, it will sometimes be very quick and easy. At other times it will require complex economic analysis best conducted by a professional evaluator experienced in CBA techniques.
- The best cost-benefit analyses take a broad view of costs and benefits, including indirect and longer-term effects, reflecting the interests of all stakeholders who will be affected by the programme. It is thus important to ensure the analysis is as comprehensive as possible.
Advice for USING this option (tips and traps)
- Cost-benefit analysis (CBA) is traditionally based on conventional welfare economics, which provides a utilitarian account of value which relies on individual self-interest. In practice, people express preferences for a much wider set of public goals. Techniques such as CBA rarely give proper recognition to these wider public preferences. Consideration should be given therefore to the prevailing understanding of the public good and how this is best served.
- In carrying out a CBA, it is critical to begin with an exhaustive list of all the different costs and benefits that could arise - even if some are later excluded. Otherwise, important aspects of the analysis could be overlooked.
- Information on costs, benefits and risks is rarely known with certainty, especially when one looks to the future. This makes it essential that sensitivity analysis is carried out, testing the robustness of the CBA result to changes in some of the key numbers.
- Transportation Benefit-Cost Analysis: This guide offers step-by-step guidance on the cost-benefit analysis process.
- Strategy Survival Guide.This guide from the UK Prime Minister's Startegy Unit provides a guide to the use of CBA
- Developing a Cost-Benefit Analysis Tool: Experiences and Lessons from Malawi and Mozambique: This case study shares the experience of Opportunity International in designing a cost-benefit analysis tool to evaluate and compare microfinance delivery channels.
Boardman, A., Greenberg, D., Vining, A., & Weimer, D. (2006). Cost benefit analysis: Concepts and practice. (3rd. ed.). Upper Saddle River, NJ: Prentice Hall.
Prime Minister's Strategy Unit. (2004). Strategy survival guide. Retrieved from Cabinet Office website: http://www.odi.org.uk/resources/docs/7270.pdf
Society for Benefit-Cost Analysis. (2010). The society for benefit-cost analysis. Retrieved from http://benefitcostanalysis.org/