Cost beniefit analysis training for decision makers and manager step7 8

AMERICA’S ARMY: THE STRENGTH OF THE NATION

Cost-Benefit Analysis (CBA)
Four-Day Training Briefing

Step 8: Report Results and Recommendations

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Step 7: Compare Alternatives

Version 3.0 (Draft)
Last Updated: 10 November 2011

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Step 7: Compare Alternatives

1.
1. Define
Define the
the Problem/Opportunity
Problem/Opportunity and
and Objective

Objective

7a.

Compare alternatives using the selection criteria to identify the preferred
alternative.

2.
2. Define
Define the
the Scope;
Scope; Formulate
Formulate Facts
Facts and
and Assumptions
Assumptions

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3.
3. Define
Define Alternatives
Alternatives

4.
4. Develop
Develop Cost
Cost Estimate
Estimate for
for each

each Alternative
Alternative

7b.

Identify the billpayer if there is a bill associated with the recommended alternative.

7c.

Identify the positive and negative impacts of the 2

7d.

rd

order effects. What

Determine the robustness of the conclusions.

7e.

If anything changes (i.e., assumptions, costs, benefits) would the recommendation change?

Identify the high-risk aspects of the recommended alternative and define
appropriate risk mitigation measures.

6.
6. Define
Define Alternative
Alternative

Selection
Selection Criteria
Criteria

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and 3

must be done to manage the negative impacts?

–
5.
5. Identify
Identify Quantifiable
Quantifiable and
and
NonNon- Quantifiable
Quantifiable Benefits
Benefits

nd

7. Compare Alternatives

8.
8. Report
Report Results
Results and
and Recommendations
Recommendations

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Step 7: Compare Alternatives

Compare alternatives by:
Concepts
Comparisons of costs with benefits
Decision support tools and methods (bringing the CBA together)
Sensitivity analysis and Risk assessment

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•
•
•
•

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Concepts for Comparing Costs with Benefits

The CBA process is essentially comparing the costs with the benefits between all alternatives
The preferred alternative provides the greatest amount of value
Risk and second- and third-order effects should be included in the comparison of alternatives

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•
•
•

Value = Benefit – Costs

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Aid for Completing - Step 7a

Costs

Benefits

Selection Criteria

Unequal

Alternative that provides greatest benefits for given cost

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Equal

Equal

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Unequal

Subjective reasoning and a fortiori analysis

Alternatives ranked in order (based on benefit/cost ratio, net present value, or other relevant
criterion)

Unequal

Equal

Most likely CBA Scenario

Least costly alternative

CBA may not be appropriate

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Overly Complex Final Recommendation

Production

Risk of shutdown

Local Taxes

Competition for

Cost

Alternative 1

20 widgets/yr

5%

8%

30 competitors

$25

Alternative 2

15 widgets/yr

8%

6%

20 competitors

$15

Alternative 3

10 widgets/yr

12%

7%

10 competitors

$10

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Employees

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Comparative Methods

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Method

Description

When Used

Net Present Value (NPV)

Converts future cash flows into present equivalent values and then adds them together

When alternatives have the same economic life

Benefit/cost ratio (BCR)

Compares present value (PV) of benefits with present value of costs

When competing alternatives have unequal costs and unequal benefits

Break-even Point

Identifies point at which cumulative cost of two alternatives equal the cumulative benefits

When projects are high-risk, to show when investment costs need to be recovered
quickly

Subjective reasoning

Applies professional judgment as a complement to, or to the exclusion of, quantitative data.

When professional judgment is considered to be more important

Point System

Applies objective values to subjective criteria.

When decision makers wish to narrow the list of alternative solutions to the few that

are most suitable

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Decision Matrix

Allows for multiple criteria to be used to compare alternatives

It is a very flexible tool that can be used under many circumstances. It can even
account for other decision support methods described in this table.

A Fortiori Analysis

Determines whether a strongly favored alternative is still the best choice even when assumptions are

When generally accepted intuitive judgment strongly favors one alternative

formulated that put that alternative at a disadvantage.

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Best Practices

•

Compare the incremental costs with the incremental benefits

•

Compare the one or two most relevant benefits with the costs

•

Find the “knee in the curve” or optimal value solution

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Practices:

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Common Mistakes

•

“Over-averaging” for sake of simplification:

–

Example:



•
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that should have been rejected in step 2.

Assuming away cost:

–

Examples:






•

“Fort Hood data is representative of all bases.”

These are examples of flawed assumptions

“Year-end funds will be available,” when that’s not the case
“Higher headquarters will pay for it.”
“Other organizations will pay for it.”
“Military personnel are free.”

Assuming away the problem:

–

Example:





“Unused office space is available.”
“Chief of Staff said we need this.”
Adding a layer of oversight will increase process efficiency

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Common Mistakes: Over Simplification

Cost ($M)

Benefit

Status Quo

30

Good

Added capability (Alternative 1)

45

Very Good

Greatly added capability (Alternative 2)

55

Excellent

Which alternative has the best value?

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The Cost of a Green Chiclet

•

“Green (fill in blank, i.e., funding, status…) for $55M is the preferred alternative” is

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the value statement.

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This should help in making a decision.

Cost ($M)

Benefit

Alternative 1

55

Good

Alternative 2

45

Average

Alternative 3

30

Critical

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Effects of Over simplification

•

Metric

Benefit

Score/Rank

Cost

Alternative 1

20 widgets/yr

Good

3

$25

Alternative 2

15 widgets/yr

Average

2

$15

Alternative 3

10 widgets/yr

Bad

1

$10

What happens when using a per cost or per benefit metric?

CBI

BCI

Alternative 1

8.3

0.12

Alternative 2

7.5

0.13

Alternative 3

10

0.10

Best Case: COA 2 is best?

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“Cost Free” Analysis

• In some cases, new programs or requirements will be supported entirely by resources that are already funded. This
could be described as “cost free” in the sense that there no additional costs in terms of the budget.

• Nonetheless, a “cost free” analysis must still consider cost in terms of opportunity cost: what the already-funded

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resource could have been used for if it had not been applied to the new requirement.

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“ Cost Free” Analysis

•

Example: the Organization of the Joint Chiefs of Staff is planning a holiday party for itself. The

Chairman of the JCS must assign three current employees to serve on the Holiday Party
Planning Committee, which requires a commitment of 16 hours of work per member. CJCS is
presented with two courses of action:

–

COA1: Appoint the Chief of Naval Operations, the Chief of Staff, Army, and the Chief of Staff, Air

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Force, to the Holiday Party Planning Committee.

–

COA2: Appoint Intern #1, Intern #2, and Intern #3—three GS-05 recent college graduates—to the
Holiday Party Planning Committee.

•

The additional budgetary cost of this new Holiday party requirement is equal for both COAs: it
is “cost free” because the salaries of current employees will be paid regardless of whether the

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Holiday party gets planned. Determine which COA has the lower opportunity cost.

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Common Mistakes: Assuming Away the Problem

All COAs proposed within a CBA must be solutions to the problem/opportunity statement.

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Assumptions should not solve the problem.

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Non-Quantitative Methods

Subjective Reasoning

•

Uses informal criteria to rank alternatives

A Fortiori Analysis
Used when intuitive judgment strongly favors an alternative

–

Assumptions are the basis in choosing which alternatives are preferred

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•

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Decision Matrix

Decision Matrix:
A tool that compares benefits with costs to produce a single value score

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•

One of the best ways to elucidate the resource-informed decision to
senior leadership is to include a Decision Matrix in the Decision Brief.

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Decision Matrix Merits

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Pros

•
•
•
•

Easy to use
Normalizes costs and benefits
Is a familiar tool
Flexible

Cons

•
•
•
•
•

Error prone
Highly judgmental
Loss of information via normalization
Results not definitive
Scoring is subjective

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Cost $M
Cost

perinBenefit
BY-2011

Example - Decision Matrix

$20
$3.33

COA-1

$16
$2.78

COA-2

COA-3

Cost = $ quantifiable cost – $ quantifiable benefit or saving

 Decision Matrix
Weight

COA-1

COA-2

COA-3

Lethality

30%

9

6

2

Safety

45%

4

6

6

Survivability

25%

6

5

3

6.0

5.8

4.1

Benefit Criteria

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Rating or Ranking

 Score :

Rating: 1 (worst) to 9 (best)

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Benefit = $ non-quantifiable benefit and $ non-quantifiable risk
COA-1

COA-1 highest benefit

COA-2 best value

COA-2

COA-3

COA-3 lowest cost

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Decision Matrix

Note: If calculating Cost-Benefit index, the benefits criteria for each COA should be rated, not ranked.

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Otherwise, the Cost-Benefit index calculated would be meaningless.

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Questions for Steps 7c and 7d

1.

How sensitive is the recommendation to possible changes in costs, benefits, assumptions, etc.?

•.

2.

If the recommendation is highly sensitive, can deeper analysis be done?

Which elements of the CBA require sensitivity analysis?

•

Only test elements with significant uncertainty or risk.

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–

3.

Address sensitivity from one or both perspectives:

•.
•.

4.

Elements may include assumptions, constraints, costs, benefits, weighting of selection criteria, etc.

What is the impact of a change of such and such magnitude?
How large a change can occur before the recommendation changes?

Have all probable risks and their respective impacts been identified?

•.
•.

Can the risks decrease future benefits?
Can the risks increase future costs?

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Risk Assessment and Mitigation

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The goal of risk assessment is to answer questions like:

•
•
•
•
•
•
•

What risks may occur?
What is the likelihood that risks will occur?
Are the source of these risks internal or external?
What causes these risks?
What are the consequences if the risks go unresolved?

–

What assets, operations, activities, functions, etc. will be affected as a result?

How much risk is tolerable?
What should be done to anticipate and limit risks?

Always measure the risk by the potential adverse impacts on alternatives.

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Types of Risks

Business/Programmatic Risk:

•

Affect the budget and viability of a program

Operational Risk:

•

Affect the ability to perform a mission

Process Risk:

•

Associated with failing to meet standards and performance benchmarks in a newly established process

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Technical Risk:

•

Associated with failing to develop or implement technology

Schedule Risk:

•

Associated with allocating time to perform and manage tasks

Organizational Risk:

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Associated with management changes

All risks need to be reflected in Costs and/or Benefits of COAs
Risks must factor into the decision-making process

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Ways to Measure/Address Risk

Methods of measuring and/or addressing risk in a CBA include, but are not limited to:

–
–
–

Effective Mean
Cost of Risk Mitigation
Sensitivity Analysis

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•

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Effective Mean (Expected Value)

•

The effective mean, or expected value, of a measurable quantity is the sum of all possible outcomes multiplied by
their corresponding probabilities.

•

Example: if the cost of a new ground combat vehicle is judged to be $1.4M with 50% probability, $2M with 25%

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probability, and $1.2M with 25% probability, then the effective mean (expected cost) is $1.4M x 0.5 + $2M x 0.25
+ $1.2M x 0.25 = $1.5M.

•

Example: if inter-theater transit time for a sustainment brigade is projected to be 5 days with 90% probability and

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4 days with 10% probability, then the expected transit time is 5 x 0.9 + 4 x 0.1 = 4.9 days.

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