Use this framework to determine priorities for different investments
Use this framework to work out if your strategies or tactics are worth the cost and the effort.
The idea of plotting effort versus reward or cost versus benefit has been around for over 100 years. It was first mooted by Jules Dupuit, a French engineer and economist in the mid-19th century and subsequently formalised by the famous economist Alfred Marshall.
Cost benefit analysis (CBA) is also sometimes referred to as the action priority matrix. It was originally developed to determine the social benefits of projects such as the construction of a road or a bridge. Its applications have been widened to cover almost any type of investment from public policies on health care through to determining the best investments in business. Indeed, most of us use this simple trade-off tool in our heads when we are deciding on any course of action. We want to know "Is it worth it?".
Typically the costs or the level of effort is measured on the horizontal axis. Costs and effort could be determined at a very simple level or an attempt may be made to build in time and other resources into the equation. On the vertical axis is measured in the benefit or the rewards that will be generated by the projects. Again, this could be a simple financial measurement or a more sophisticated analysis could take into consideration social benefits.
The tool is useful in business as it identifies the projects and activities that should receive focus as opposed to those that can be ignored. It can be used on a daily basis to determine how to prioritise a to-do list through to screening major projects that are part of a strategic plan. The more sophisticated analyses may require discounting the costs over time and measuring the risks of things going wrong by using a sensitivity analysis.
Although the principle of cost benefit analysis is simple enough, it does require care and skill in its application:
Beware of value judgements – it isn't always easy to assign monetary values to the costs and the benefits. Different people using the tool may apply different values to the same factors. Some of the costs and benefits are difficult to quantify.
Judging time horizons can be difficult – the cost and the benefits that are under consideration must be seen on a spectrum of time. Will this action yield results over the next 12 months? It is easy to overestimate what can be achieved. Remember the maxim "Things always take longer than expected and cost more than you thought". Given that the payback is in the future, a cost benefit analysis should apply the discount rate as this can significantly influence the present value of future costs and benefits. Selecting an appropriate discount rate is subjective and based on assumptions.
Actions can have unanticipated consequences – a thorough cost benefit analysis may still miss something that could be associated with future outcomes. For example, the actions could have a detrimental effect on sustainability, or ethical issues which were not anticipated.
Some things to think about:
Define the Scope: Clearly define the scope and boundaries of the analysis, specifying what is included and excluded.
Identify Costs and Benefits: Distinguish between tangible (monetary) and intangible factors
Time Considerations: Consider the time value of money by discounting future cash flows to present value.
Opportunity Costs: Recognise and account for opportunity costs, which are the benefits foregone by choosing one alternative over another.
Distributional Impacts: Analyse the distributional effects of the costs and benefits on different stakeholders or groups.
Account for Intangibles: Include intangible factors like brand reputation, employee morale, or community goodwill that may be challenging to quantify but are important considerations.
Legal and Ethical Considerations: Ensure that the proposed action complies with legal and ethical standards.
Consistency with Organisational Objectives: Align the cost-benefit analysis with the broader company objectives and goals.
Communication and Transparency: Clearly communicate the assumptions, methodologies, and results of the analysis. Be transparent about uncertainties and limitations.
Revisit and Update: Regularly revisit and update the cost-benefit analysis as new information becomes available.