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Let's study that: the real cost of cost-benefit studies.

"Has anyone done a cost-benefit analysis on this?"

The question often comes up in the middle of discussion about a difficult decision. As often as not, the speaker is a well-intended board member looking for guidance. Sometimes it's from someone who is dead-set against the idea and is looking for evidence to support the position.

The related question that never gets asked at these times is a bit more impertinent. "Has anyone ever seen a cost-benefit analysis?"

If your answer is: "Uh ... maybe 10 years ago. Or maybe never," you're not alone. But if cost-benefit studies aren't as plentiful as snowflakes in the Rockies in spite of being called for regularly, there must be a reason.

There is a reason. It's the wrong question. Cost-benefit analyses aren't done more often because they serve a very limited purpose, and even then only if they're done well. Ironically, the costs of cost-benefit analyses often outweigh the benefits.

THE PRIMARY ELEMENTS

To understand why this is so, consider the very idea of a cost-benefit analysis. The phrase sounds so simple, intuitive, and business-like that it's hard to argue with it. But what, exactly, is a 'cost'? The term sounds so proper and scientific that it's difficult to remember that the term here refers to projections, not actual costs that have been incurred.

Most people react negatively to the concept of projections because they're so dependent on judgment, intuition, and hard-to-come-by knowledge. Yet, that is exactly what a cost is in a cost-benefit analysis.

As with any projections, cost-benefit studies must make assumptions about the future. These assumptions are only as good as the individuals making them. Usually it doesn't take much to throw an analysis off in one direction or another depending on the assumptions that are built into it. At the very least, one must know the assumptions the analyst made before being able to judge a study's reliability.

WHAT'S A COST?

The real question is easy to overlook--what is the cost of this proposal? A carefully constructed answer to this question has many facets. The obvious one is the cost directly associated with it. These are the cash outlays and the expenses that those outlays trigger, such as interest, if the project is being financed. But, again, the real cost is easy to overstate because generally one is only interested in the incremental costs. Usually some part of a project is going to be done on some level no matter what else is decided, and the important costs are the ones that exceed that level. Will we buy an eight-person vehicle, or a 12-person vehicle? The larger size is an incremental cost, and so are things like the extra insurance and specialized license and driver training that only the drivers of the larger vehicle might need.

Then there is the difference between operating costs and capital costs. Nonprofits have capital that they can invest in operating assets or revenue-producing investments. If the proposal needs a capital investment, there is a cost involved in tying up that capital instead of using it to produce a return. Finally, one needs to consider the ongoing incremental impact on cash flow if the venture requires financing.

WHAT'S A BENEFIT?

If deciding on the full cost is difficult, figuring out what a benefit could be is even harder. If a benefit is to be considered only when it shows up in monetary terms, getting a fix on the benefits can be even more tenuous. Benefits that can be calculated in fiscal terms are easy enough to handle, assuming one can identify them all. But the truth is that most benefits are speculative and highly subject to behavioral choices. Even if it is possible to determine a directly-attributable benefit, the incremental benefit is almost certain to be impossible to calculate.

AVOIDING THE COST-BENEFIT ANALYSIS PARALYSIS

The solution to this muddle is to be clear about a few things. First, "cost-benefit analysis" is often a code word for things so complicated and unknowable that they are practically impossible to sort out and inherently difficult to compare.

Second, what is important is to know the cost. As shown, determining the cost of a proposal in all its ramifications is largely a matter of being thorough about the various types of costs, whether they are direct or indirect, and how they will behave over time. This is nothing more than an easy-to-moderately challenging financial analytical exercise.

And that's where the financial folks can stop. "Has anyone done a cost-benefit analysis on this?," is a trick question because although the cost part can be gained through disciplined thinking, the benefit part is a different matter. Costs can be quantified, benefits beyond a certain trivial level can not.

Most of the benefits of a proposal cannot be reduced to the same quantifiable basis as can costs. Determining benefit is half calculation, half execution. To suggest that a cost-benefit analysis ought to be the sole--or even the most important--part of a decision is to attempt to turn leaders into spreadsheet jockeys.

This does not mean that major proposals need not be subjected to rigorous scrutiny. They should be. Determining costs is a straight-ahead analytical procedure for the most part, with perhaps a little imagination required when one tries to identify indirect or secondary costs. It also requires discipline to stick to incremental costs only.

Some benefits could be easy to identify. But to achieve the big benefits requires sound leadership in the future. In effect, most benefits can only be promised because they depend on competent execution.

"Cost-benefit analysis" can be shorthand for "we don't want to do this" and a de facto argument for the status qua. In turn, that usually means that there is a gap between the identified costs and the benefits that management is expected to derive from it. Fair enough. But if the costs seem to outweigh the benefits, as they probably will, the real issue is the ability of management to get enough results out of the expected costs, not the brilliance of the analysis.

That benefits can be had is a matter of trust and faith in the people who manage your organization, not in a spreadsheet that can only tell half the equation.

Thomas A. McLaughlin is a national nonprofit management consultant with Grant Thornton in Boston. He is the author of the book "Nonprofit Strategic Positioning" (John Wiley and Sons, 2006). His email address is thomas.mclaughlin@gt.com
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Title Annotation:STREETSMART NONPROFIT MANAGER
Author:McLaughlin, Thomas A.
Publication:The Non-profit Times
Date:Jul 1, 2007
Words:1075
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