24 Cost Effectiveness and Cost Benefit Analysis

Dr Shivarama Rao K

1. Introduction

Both cost – benefit analysis (CBA) and cost – effectiveness analysis (CEA) are useful tools for program evaluation. Cost – effectiveness analysis is a technique that relates the costs of a program to its key outcomes or benefits. Cost – benefit analysis takes that process one step further, attempting to compare costs with the dollar value of all (or most) of a program ’ s many benefits. These seemingly straightforward analyses can be applied anytime before, after, or during a program implementation, and they can greatly assist decision makers in assessing a program’s efficiency (Cellini & Kee, 2010).

The concept of economic accounting originated with Jules Dupuit, a French engineer during 1848. The British economist, Alfred Marshall, formulated some of the formal concepts that are at the foundation of CBA. However, the practical development of CBA came because of the impetus provided by the Federal Navigation Act of 1936. This act required that the U.S. Corps of Engineers carry out projects for the improvement of the waterway system when the total benefits of a project to whomsoever they accrue exceed the costs of that project. Thus, the Corps of Engineers had created systematic methods for measuring such benefits and costs. The engineers of the Corps did this without much, if any, assistance from the economics profession. It was not until about twenty years later in the 1950’s that economists tried to provide a rigorous, consistent set of methods for measuring benefits and costs and deciding whether a project is worthwhile (Watkins, n.d.).

Libraries and information centres are rapidly moving towards cost conscious. In today’s environment of budgetary pressures and financial crunch in libraries and information centres, it has become pertinent to take detailed account of the costs involved in running different services and the alternatives available thereof. In this regard cost analysis approaches are becoming very popular. They not only help in analyzing the costs involved, but also the effectiveness, benefit, utility and the feasibility of such systems. Moreover, data derived from cost analyses can be further used for accounting, budgeting, and performance measurement procedures. A sound and convincing presentation of a budget is generally based on underlying cost analysis of different alternatives.

2. Definition and concept

      Some of the standard definitions for Cost Analysis, CBA and CEA given below;Cost analysis (also called economic evaluation, cost allocation, efficiency assessment, cost-benefit analysis, or cost-effectiveness analysis by different authors) is a basic method for program evaluation. It is a measurement of monetary or time sacrifice made to achieve certain ends. Cost analysis involves measurement of the resource input to the system, understanding the nature of the work carried out, and the labour time needed to carry out the work. At the most basic level, cost allocation is simply part of good program budgeting and accounting practices that allow managers to determine the true cost of providing a given unit of service (Kettner, Moroney, & Martin, 1990). At the most ambitious level, well-publicized cost-benefit studies of early intervention programs have claimed to show substantial long-term social gains for participants and cost savings for the public (Berreuta-Clement, Schweinhart, Barnett, et al., 1984) (as cited in Sewell & Marczak).

“Cost–benefit analysis (CBA), sometimes called benefit–cost analysis (BCA), is a systematic approach to estimating the strengths and weaknesses of alternatives that satisfy transactions, activities or functional requirements for a business” (Wikipedia).

“Cost-effectiveness analysis (CEA) is a form of economic analysis that compares the relative costs and outcomes (effects) of two or more courses of action. Cost-effectiveness analysis is distinct from cost-benefit analysis, which assigns a monetary value to the measure of effect” (Wikipedia1).

The use of this method in library and information centres can lead to a more efficient use of resources, reduce cost of reaching particular objectives, and it can give an idea as to what can be accomplished for any particular budget or other resource constraint. Policy decisions in the library and information centres must be increasingly based on the cost and results of these decisions. Before starting cost analysis it is essential to establish the analytical framework. For effective cost analysis it inessential to define each and every unit that is being bring upon yourself cost. These units are referred to as the cost centre. The steps involved in cost analysis are:

• Identification and quantification of the process: the process to be analysed must be named in a manner which will permit isolation of that particular item throughout the accounting process e.g. acquisition process, circulation process etc.
• Division of the process into smaller component steps: after identification of the process to be analysed, it is divided into smaller units or components to facilitate analysis, for instance, the acquisition process can be divided into book selection, ordering, purchase, accession, classification and cataloguing etc.
• Determination of resource requirements for each step: identification of the resources required for each and every component step is essential for cost analysis purpose. Four resources that are generally associated with any process are – manpower, supplies, supervision and environment. Apart from that another important resource usually needed is equipment. Each resource type has its own typical characteristics that need to be studied thoroughly to see their impact on the cost of the process.
• Identification of time and volume for a process and relate it to cost: the process under analysis needs to be quantified in terms of time required or volume of work done in order to relate it to cost.
• Cost analysis and alternates: cost analysis involves not only the scrutiny of the activities involved in the process but also the alternate methods of doing the job. This way one can correctly judge the benefits derived from a particular process.

There are three types of cost analysis in evaluation, viz. Cost allocation, Cost effectiveness and Cost-benefit analysis. The following sections will discuss some of the basic concepts on cost analysis.

3. Cost allocation

Cost allocation is the assigning of a common cost to several cost objects. For example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that use the system. A company with only one electric meter might allocate the electricity bill to several departments in the company (Bragg, 2013). It means setting up budgeting and accounting systems in a way that allows program managers to determine a unit cost or cost per unit of service. This information is primarily a management tool. However, if the units measured are also outcomes of interest to evaluators, cost allocation provides some of the basic information needed to conduct more ambitious cost analyses such as cost-benefit analysis or cost-effectiveness analysis. For example, for evaluation purposes, you might want to know the average cost per research scholar of providing specialized information services, including the costs of staff salaries, and other overhead costs.

4. Cost Analysis

Most often, cost-effectiveness and cost-benefit studies are conducted at advance level programs and also to check program’s long-term impact. Policy makers and analysts use these methods to make broad policy decisions and problem solving. People often use the terms interchangeably, but there are important differences between them. Some of the important approaches of cost analysis are discussed below:

4.1. Cost-effectiveness Analysis

The concept of cost effectiveness is applied to the planning and management of many types of organized activity. It is widely used in many aspects of life, such as acquisition of military arms, human activity like study of automobile usage etc. Cost – effectiveness analysis seeks to identify and place dollars on the costs of a program. It then relates these costs to specific measures of program effectiveness. The cost effective solution is the one which provides maximum output with the minimum cost possible. Analysts can obtain a program ’ s cost – effectiveness (CE) ratio by dividing costs by what we term units of effectiveness :

Units of effectiveness are simply a measure of any quantifiable outcome central to the program’s objectives. For example, a dropout prevention program in a high school would likely consider the number of dropouts prevented to be the most important outcome. For a policy mandating air bags in cars, the number of lives saved would be an obvious unit of effectiveness. Using the formula just given and dividing costs by the number of lives saved, you could calculate a cost -effectiveness ratio, interpreted as “dollars per life saved.” You could then compare this CE ratio to the CE ratios of other transportation safety policies to determine which policy costs less per unit of outcome (in this case lives saved). Although it is typical to focus on one primary outcome in CEA, an analyst could compute cost – effectiveness ratios for other outcomes of interest as well (Cellini & Kee, 2010).

Cost-effectiveness analysis assumes that a certain benefit or outcome is desired, and t there are several options to achieve it. The basic question asked is, “Which of these options is the cheapest or most efficient way to get this benefit?” By definition, cost-effectiveness analysis is comparative, while cost-benefit analysis usually considers only one program at a time. Another important difference is that while cost-benefit analysis always compares the monetary costs and benefits of a program, cost-effectiveness studies often compare programs on the basis of some other common scale for measuring outcomes (eg. number of students who graduate from high school, infant mortality rate, test scores that meet a certain level, reports of child abuse). They address whether the unit cost is greater for one program or approach than another, which is often much easier to do, and more informative, than assigning a dollar value to the outcome (White, 1988) (as cited in Sewell & Marczak, n.d. ).

The cost effectiveness approach has various advantages, the most important among them is the fact that it requires the cost and effectiveness data which are easily available in systems like library and information centres. Moreover, it takes into account the alternative solutions for a particular goal, making the study more exhaustive. However, the major disadvantage is that it can take into account only those alternate solutions which have similar goals or objectives. It cannot compare alternatives with different goals or objectives. Moreover, one cannot judge the usefulness of the programme in relation to the benefits derived over the costs involved.

4.2. Cost-benefit Analysis

Cost-Benefit Analysis (CBA) estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile. Like cost – effectiveness analysis, cost – benefit, analysis also identifies and places dollar values on the costs of programs, but it goes further, weighing those costs against the dollar value of program benefits. Cost benefit analysis is an important tool used by the welfare economists. It refers to the evaluation of alternatives in relation to their cost and benefits measured in monetary terms. Thus, it tries to evaluate social costs and benefit of a particular project and helps in deciding whether to go ahead with the project or not. The emphasis is more on the social benefit rather than-on economic benefit. Typically, analysts subtract costs from benefits to obtain the net benefits of the policy (if the net benefits are negative, they are referred to as net costs) (Cellini & Kee, 2010):

Net Benefits = Total Benefits – Total Cost

So the basic questions to be answered in a cost-benefit analysis are, “Do the economic benefits of providing this service outweigh the economic costs” and “Is it worth doing at all”? One important tool of cost-benefit analysis is the benefit-to-costs ratio, which is the total monetary cost of the benefits or outcomes divided by the total monetary costs of obtaining them. Another tool for comparison in cost-benefit analysis is the net rate of return, which are total costs minus the total value of benefits. Hence, cost benefit analysis is an essential tool for long-term decision-making, as it is not confined to the immediate impact of the production of goods and services. The advantages of cost benefit analysis are that it helps in:

• ascertaining if any particular alternative has benefits exceeding its costs;
• identifying the set of alternatives with different objectives which have the lowest cost benefit ratio; and
• determination of the set of alternatives among different programme areas e.g. education, health, security, etc. having least cost benefit ratio for an overall analysis of investment for the well being of the society as a whole.

The only disadvantage of this system is that it is difficult to measure the costs and benefits in financial terms.One may face many difficulties in collecting data and the result may not always be accurate.Cost benefit analysis is the most appropriate tool for decision making regarding the resource allocation in public welfare services like library and information centres, where the output derived may not be direct and tangible. While cost benefit analysis is a long-term approach, cost effective analysis is a medium or short-term approach. The cost benefit approach may be used for making a choice between different alternatives and the cost effective approach on the other hand can be used to determine the most cost effective means of production and delivery of goods and services.

5. Methods of cost analysis

Cost analysis is measured in several stages, during analysis phase a series of measurements and observations are carried out around the course of a given process. Such stages are (IGNOU)

• Costing of the input: in this stage, the quantities of various inputs i.e., labour, materials, infrastructure etc. required to carry out the process are identified and their costs are established. Costing of the labour is a difficult task and it is generally done based on the labour time expended at the appropriate labour cost rate. Input cost can be equated to the fixed cost and it provides a basis for the calculation of the minimum cost of a process.
• Costing of the throughput: In general terms, throughput is the rate of production or the rate at which something can be processed. Throughput is the stage in which the actual work of production is carried out. At this stage cost indices are prepared on the basis of the input cost data and they are used to monitor and assess the performance of the process. Throughput cost eventually determines the actual cost involved in carrying out a process and is, therefore, involved with the variable costs of production.
• Costing of the output: Output costing is the final stage of cost analysis. This is calculated on the basis of the summing up of input and throughput costs. Output cost also deals with the volume of production and the productivity of the resources used for a particular process. It further helps in measuring the performance of a process and determination of the price.

There are two basic methods have been used for cost analysis, viz. Work measurement and Estimation or ingredient method.

5.1. Work measurement: It attempts to measure the exact quantities of labour time used to carry out particular tasks under chosen study. It is primarily based on the work and time study and uses various methods of data collection e.g. work diaries, activity log or work sampling etc.

5.2. Estimation or ingredient method: This method is used wherever work measurement is not possible. In this method the quantities of resource inputs required to produce outcomes are first identified either through observation or through discussion with the staff. Monetary costs of these ingredients are then estimated on the basis of the gross annual expenditure incurred for the total system under various headings. Estimation method gives more accurate results for cost analysis and it is commonly used in library and information centres. However, in the long run, the estimation method needs to be complemented with not only the work measurement method but also with other costing methods like budgeting, accounting, performance evaluation etc., in order to get satisfactory results.

The costing of each and every unit is done to proceed with the cost analysis of the system as a whole. The ingredients required for any system can be broadly classified into four types: Personnel, Facilities, Equipments, Materials, and Other inputs. These five basic heads are further divided into smaller units to facilitate the costing process. However, the standard methods of cost analysis cannot be applied as it is to the costing of library and information services because of their non-profit making and service oriented characteristics.

6. Cost analysis in Special Libraries and Information centres

Costing of library service or its activities is one of the essential elements for determination of the prices for library and information services and information products. Apart from the pricing of products and services, cost analysis of various library and information services has the following advantages (IGNOU):

• It helps in the estimation of expenditure for each service or operation.
• Promotes fiscal accountability in programs
• Cost data can be utilised for the measurement of efficiency of an operation and the benefits derived from it.
• Helps set priorities when resources are limited
• It ensures optimal utilisation of the resources of the library.
• It helps in evaluating the efficiency of the staff.
• Library managers can utilise them for decision making to determine the future actions.
• Can be very powerful and persuasive to legislators, policy makers, and other funders
• It helps in controlling the library operations by keeping track of the inputs required and the output derived thereof

Cost analysis for library and information systems can be categorized into two types: macro costing and micro costing. In macro costing the present cost of the system is determined in order to estimate the future trend. In micro costing the system is divided into units and the cost of each unit is determined. The unit costing method facilitates analysis of the cost of a specific unit of service. Some of the library inputs can be classified as below:

A	Human Resources	Supervisor
		Professionals
		Semi-professionals
		Non professionals
		Secretarial staff
B	Facilities	Work desk, Furniture, Pantry
C	Materials and Supply	Stationery
		Books
		Journals
		Catalogue cards
		Non-print media
		Storage devices
D	Equipment	Computers
		Printers
		Scanners
		Servers etc.
E	Other Inputs	Energy e.g. Lighting, Air-conditioning, Heating etc.
		Cleaning and maintenance of the workplace
		Training of the personnel

Hence, the total cost of the library is sum of direct and indirect costs.Examples for direct costs include personnel, equipment, materials etc. Indirect costs on the other hand are those that are not directly related to an operation but are needed to carry out the operation e.g. stationery, cleaning and maintenance of the workplace etc.

Total cost = Direct cost + Indirect cost

The process of cost analysis of a library and information centre can be carried out in the following manner:

Step 1: Determination of the unit of product or service to be measured e.g., circulation service, reference service etc.

Step 2: Determination of the cost centres for each of the library operations. Cost centres can be further divided into: direct programme centres such as reference service, circulation service etc. or support service centres such as acquisition, administration etc.

Step 3: Collection of cost data for each cost centre and its activities.

Step 4: Appropriate allocation of the service costs to the programmes cost centres.

Step 5: Determination of the unit cost by dividing the total cost of a cost centre by its appropriate unit of measurement.

According to Virgo, steps of cost analysis for Total cost approach are mentioned in below box:

On the other hand, cost-finding approach uses available financial data from the budget details, analysis of detailed transactions and interview with staff etc. The steps in this approach according to Virgo are:

The most difficult task in the costing of library operation is the cost of the labour. Calculation of the unit cost through the work and time study can facilitate cost analysis. Thus, work and time study methods should be used for cost analysis for library and information systems which further enables the measurement of effectiveness, benefit and utility of the system. Some of the generally discussed disadvantages of cost analysis include (Sewell& Marczak, n.d.):

• Requires a great deal of technical skill and knowledge. A true cost-benefit analysis requires a solid grounding in economic theory and techniques, which is beyond the training of many evaluators. It may be necessary to hire a consultant if this type of analysis is desired.
• Critics feel that many cost analyses are overly simplistic, and suffer from serious conceptual and methodological inadequacies. There is a danger that an overly-simplistic cost-benefit analysis may set up an intervention to fail, by promoting expectations that are unrealistically high, and cannot really be achieved. This may result in political backlash, which actually hurts future funding prospects instead of helping.
• There are no standard ways to assign dollar values to some qualitative goals, especially in social programs. For example, how do we value things like time, human lives saved, or quality of life?
• Market costs (what people actually pay for something) do not always reflect “real” social costs.
• Sometimes there are multiple competing goals, so we need to weight them or prioritize them in some way.
• Sometimes costs and monetary values are considered less important than other, intangible values or program outcomes.
• The best-known cost-benefit studies have looked at long-term outcomes, but most program evaluations don’t have the time or resources to conduct long-term follow-up studies

7. Summary

One should be clear that cost – benefit and cost – effectiveness analyses are not magic potions that will provide decision makers with the answer to a policy problem. In fact both methods may – be more art than science. Cost analysis is a measurement of monetary or time sacrifice made to achieve certain ends and it involves measurement of the resource input to the system, understanding the nature of the work carried out, and the labour time needed to carry out the work. However, much can be learned about a project in creating a framework to consider benefits and costs: simply attempting to identify them, measure them, and value them can provide important information for the decision maker.

8. References

• Bragg, Steven (2013). What is cost allocation? In Accounting Tools. Retrieved from                  http://www.accountingtools.com/questions-and-answers/what-is-cost-allocation.html
• Cellini, Stephanie Riegg and Kee, James Edwin (2010). Cost-Effectiveness and Cost-Benefit Analysis. In Chapter 21 of Handbook of Practical Program Evaluation, Third Edition, edited by Joseph S. Wholey, Harry P. Hatry, and Kathryn E. Newcomer. San Francisco, CA: Jossey-Bass, 493-530.
• IGNOU Course Material on paper Library Management (Unit 15 – Cost Analysis)
• Sewell, Meg and Marczak, Mary (n.d.). Using cost analysis in evaluation. Retrieved from
• http://ag.arizona.edu/sfcs/cyfernet/cyfar/Costben2.htm
• Watkins, Thayer (n.d.). An Introduction to Cost Benefit Analysis. Retrieved from
• http://www.sjsu.edu/faculty/watkins/cba.htm
• Wikipedia. Retrieved from http://en.wikipedia.org/wiki/Cost%E2%80%93benefit_analysis Wikipedia1. Retrieved from http://en.wikipedia.org/wiki/Cost-effectiveness_analysis