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The Six Steps In Cost/Benefit Analysis

I am always amazed at the confusion, misunderstanding and ineffectiveness of middle and senior management when it comes to conducting meaningful and actionable cost/benefit analysis.

Either the effort is to high level or mired in too much data which ultimately produces inaccurate and non-actionable outcomes.

We all know it’s easy to make an investment decision when the benefits obviously outweigh the costs, but few people understand what really should go into the analysis. So here are six steps to help you produce a meaningful and actionable CBA.

  1. Understand the cost of status quo. You need this to measure the relative merit of an investment against the “do nothing” option. Sometimes doing nothing is the right decision.
  2. Identify costs. Consider up-front costs as well as any in future years. Almost any initiative will have up front cost. Most people get hammered when they fail to consider the upfront costs or hidden costs.
  3. Identify benefits. Ascertain what additional revenue or return will come in from the investment. This is dicey because you need to define an ROI. The challenge is how to define the ROI. Remember, ROI to one constituency may be efficiency. To another it may be revenue. To another it may be market share, etc. ROI is subjective and you will need to consider all perspectives and ROI definitions to truly get a true benefit picture/metric.
  4. Determine the cost savings. What can you stop doing if you make this investment? Sometimes its a trade-off. If we do X, can we stop using Y. That’s another hidden variable that many forget about. If you stop doing Y because of X that cost savings could exponentially increase the benefits of doing the initiative.
  5. Create a timeline for expected costs and revenue. Map out when the costs and benefits will occur and how much they will be. This is critical for two reasons. One, expectations. By having a defined timeline you can align and define expectations of all interested parties. Two, understanding the timeline allows you to plan for the cost and revenue impacts to your operations thus empowering you to better manage and adjust course accordingly if things change.
  6. Evaluate non-quantifiable benefits and costs. Assess whether there are intangible benefits such as strengthening your firm’s position with distributors, or costs such as creating unnecessary complexity. This kind of goes back to point 2. It’s important to understand the benefits from all perspectives including tangible and non-tangible. Benefits or ROI are subjective understanding and accounting for them are key. Defining non-quantifiable benefits and costs i.e. emotional toll, work load, disruption to the enterprise, client or market confusion, etc. can all impact the overall benefit and cost of the initiative. Even if you don’t include these variables in the actual equation, as a responsible leader you should consider these issues in full to ensure you have a complete grasp of the impact on the project and can manage the initiative effectively and productivity to a successful outcome.

I hope you find these tips helpful but remember, when conducting a CBA be careful of data overload. While considering all the data to make an informed decision is important, you need to balance the effort so you don’t end up with paralysis by analysis. The ultimate objective is to make in informed and actionable decision based on a reasonable and responsible CBA.



Written by David Frederick

July 14, 2011 at 8:47 AM

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