DNP 835 Concept of Cost-Based Analysis
DNP 835 Concept of Cost-Based Analysis
Discuss the concept of cost-based analysis. Provide an example of a program where it could be used to show outcomes.
Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives used to determine options which provide the best approach to achieving benefits while preserving savings. For example, in transactions, activities, and functional business requirements.[1] A CBA may be used to compare, completed or potential courses of actions. Also to estimate (or evaluate) the value against the cost of a decision, project, or policy. It is commonly used in commercial transactions, business or policy decisions (particularly public policy), and project investments. For example, the U.S. Securities and Exchange Commission has to conduct cost-benefit analysis before instituting regulations or de-regulations.[2]: 6
CBA has two main applications:[3]
To determine if an investment (or decision) is sound, ascertaining if – and by how much – its benefits outweigh its costs.
To provide a basis for comparing investments (or decisions), comparing the total expected cost of each option with its total expected benefits.
CBA is related to cost-effectiveness analysis. Benefits and costs in CBA are expressed in monetary terms and are adjusted for the time value of money; all flows of benefits and costs over time are expressed on a common basis in terms of their net present value, regardless of whether they are incurred at different times. Other related techniques include cost–utility analysis, risk–benefit analysis, economic impact analysis, fiscal impact analysis, and social return on investment (SROI) analysis.
Cost–benefit analysis is often used by organizations to appraise the desirability of a given policy. It is an analysis of the expected balance of benefits and costs, including an account of any alternatives and the status quo. CBA helps predict whether the benefits of a policy outweigh its costs (and by how much), relative to other alternatives. This allows the ranking of alternative policies in terms of a cost–benefit ratio.[4] Generally, accurate cost–benefit analysis identifies choices which increase welfare from a utilitarian perspective. Assuming an accurate CBA, changing the status quo by implementing the alternative with the lowest cost–benefit ratio can improve Pareto efficiency.[5] Although CBA can offer an informed estimate of the best alternative, a perfect appraisal of all present and future costs and benefits is difficult; perfection, in economic efficiency and social welfare, is not guaranteed.[6]
The value of a cost–benefit analysis depends on the accuracy of the individual cost and benefit estimates. Comparative studies indicate that such estimates are often flawed, preventing improvements in Pareto and Kaldor–Hicks efficiency.[7] Interest groups may attempt to include (or exclude) significant costs in an analysis to influence its outcome.
Public policy
CBA’s application to broader public policy began with the work of Otto Eckstein,[13] who laid out a welfare economics foundation for CBA and its application to water-resource development in 1958. It was applied in the US to water quality,[14] recreational travel,[15] and land conservation during the 1960s,[16] and the concept of option value was developed to represent the non-tangible value of resources such as national parks.[17]
CBA was expanded to address the intangible and tangible benefits of public policies relating to mental illness,[18] substance abuse,[19] college education,[20] and chemical waste.[21] In the US, the National Environmental Policy Act of 1969 required CBA for regulatory programs; since then, other governments have enacted similar rules. Government guidebooks for the application of CBA to public policies include the Canadian guide for regulatory analysis,[22] the Australian guide for regulation and finance,[23] and the US guides for health-care[24] and emergency-management programs.[25]
Transportation investment
CBA for transport investment began in the UK with the M1 motorway project and was later used for many projects, including the London Underground’s Victoria line.[26] The New Approach to Appraisal (NATA) was later introduced by the Department for Transport, Environment and the Regions. This presented balanced cost–benefit results and detailed environmental impact assessments. NATA was first applied to national road schemes in the 1998 Roads Review, and was subsequently rolled out to all transport modes. Maintained and developed by the Department for Transport, it was a cornerstone of UK transport appraisal in 2011.
The European Union’s Developing Harmonised European Approaches for Transport Costing and Project Assessment (HEATCO) project, part of the EU’s Sixth Framework Programme, reviewed transport appraisal guidance of EU member states and found significant national differences.[27] HEATCO aimed to develop guidelines to harmonise transport appraisal practice across the EU.[28]
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DNP 835 Concept of Cost-Based Analysis
Transport Canada promoted CBA for major transport investments with the 1994 publication of its guidebook.[29] US federal and state transport departments commonly apply CBA with a variety of software tools, including HERS, BCA.Net, StatBenCost, Cal-BC, and TREDIS. Guides are available from the Federal Highway Administration,[30][31] Federal Aviation Administration,[32] Minnesota Department of Transportation,[33] California Department of Transportation (Caltrans),[34] and the Transportation Research Board’s Transportation Economics Committee.[35]
In health economics, CBA may be an inadequate measure because willingness-to-pay methods of determining the value of human life can be influenced by income level. Variants, such as cost–utility analysis, QALY and DALY to analyze the effects of health policies, may be more suitable.[36][37]
For some environmental effects, cost–benefit analysis can be replaced by cost-effectiveness analysis. This is especially true when one type of physical outcome is sought, such as a reduction in energy use by an increase in energy efficiency. Using cost-effectiveness analysis is less laborious and time-consuming, since it does not involve the monetization of outcomes (which can be difficult in some cases).[38]
It has been argued that if modern cost–benefit analyses had been applied to decisions such as whether to mandate the removal of lead from gasoline, block the construction of two proposed dams just above and below the Grand Canyon on the Colorado River, and regulate workers’ exposure to vinyl chloride, the measures would not have been implemented (although all are considered highly successful).[39] The US Clean Air Act has been cited in retrospective studies as a case in which benefits exceeded costs, but knowledge of the benefits (attributable largely to the benefits of reducing particulate pollution) was not available until many years later.
Evaluation
CBA attempts to measure the positive or negative consequences of a project. A similar approach is used in the environmental analysis of total economic value. Both costs and benefits can be diverse. Costs tend to be most thoroughly represented in cost–benefit analyses due to relatively-abundant market data. The net benefits of a project may incorporate cost savings, public willingness to pay (implying that the public has no legal right to the benefits of the policy), or willingness to accept compensation (implying that the public has a right to the benefits of the policy) for the policy’s welfare change. The guiding principle of evaluating benefits is to list all parties affected by an intervention and add the positive or negative value (usually monetary) that they ascribe to its effect on their welfare.
The actual compensation an individual would require to have their welfare unchanged by a policy is inexact at best. Surveys (stated preferences) or market behavior (revealed preferences) are often used to estimate compensation associated with a policy. Stated preferences are a direct way of assessing willingness to pay for an environmental feature, for example.[41] Survey respondents often misreport their true preferences, however, and market behavior does not provide information about important non-market welfare impacts. Revealed preference is an indirect approach to individual willingness to pay. People make market choices of items with different environmental characteristics, for example, revealing the value placed on environmental factors.[42]
The value of human life is controversial when assessing road-safety measures or life-saving medicines. Controversy can sometimes be avoided by using the related technique of cost–utility analysis, in which benefits are expressed in non-monetary units such as quality-adjusted life years. Road safety can be measured in cost per life saved, without assigning a financial value to the life. However, non-monetary metrics have limited usefulness for evaluating policies with substantially different outcomes. Other benefits may also accrue from a policy, and metrics such as cost per life saved may lead to a substantially different ranking of alternatives than CBA.
Another metric is valuing the environment, which in the 21st century is typically assessed by valuing ecosystem services to humans (such as air and water quality and pollution).[43] Monetary values may also be assigned to other intangible effects such as business reputation, market penetration, or long-term enterprise strategy alignment.
