Cost/Benefit Analysis: Evaluating quantitatively whether
to follow a course of action.
How to use tool:
You may have been intensely creative in generating
solutions to a problem, and rigorous in your selection of
the best one available. This solution may still not be
worth implementing - you may invest a lot of time and
money in solving a minor problem.
Cost/Benefit Analysis is a relatively simple and widely
used technique for deciding whether to make a change. As
its name suggests, to use the technique simply add up the
value of the benefits of a course of action, and subtract
the costs associated with it.
Costs are either one-off, or may be ongoing. Benefits are
most often received over time. We build this effect of
time into our analysis by calculating a pay-back period.
This is the time it takes for the benefits of a change to
repay its costs. Many companies look for pay-back over a
specified period of time - e.g. three years.
In its simple form, cost/benefit analysis is carried out
using only financial costs and financial benefits. For
example, a simple cost/benefit analysis of a road scheme
would measure the cost of building the road, and subtract
this from the economic benefit of improving transport
links. It would not measure either the cost of
environmental damage or the benefit of quicker and easier
travel to work.
A more sophisticated approach to cost/benefit analysis is
to try to put a financial value on these intangible costs
and benefits. This can be highly subjective - is, for
example, a historic water-meadow worth £25,000, or is it
worth £500,000 because if its environmental importance?
What is the value of stress-free travel to work in the
These are all questions that people have to answer, and
answers that people have to defend.
The version of cost/benefit analysis we explain here is
necessarily simple. Where large sums of money are involved
(for example, in financial market transactions), project
evaluation can become an extremely complex and
A sales director is deciding whether to implement a new
computer-based contact management and sales processing
system. His department has only a few computers, and his
salespeople are not computer literate. He is aware that
computerized sales forces are able to contact more
customers and give a higher quality of reliability and
service to those customers. They are more able to meet
commitments, and can work more efficiently with fulfilment
and delivery staff.
His financial cost/benefit analysis is shown below:
New computer equipment:
10 network-ready PCs with supporting software @ £1,225
1 fileserver @ £1,750
3 printers @ £600 each
Cabling & Installation @ £2300
Sales Support Software @ £7500
• Computer introduction - 8 people @ £ 200 each
• Keyboard skills - 8 people @ £ 200 each
• Sales Support System - 12 people @ £350 each
• Lost time: 40 man days @ £ 100 / day
• Lost sales through disruption: estimate: £10,000
• Lost sales through inefficiency during first months:
Total cost: £55,800
Tripling of mail shot capacity: estimate: £20,000 / year
Ability to sustain tele-sales campaigns: estimate: £10,000
Improved efficiency and reliability of follow-up:
estimate: £25,000 / year
Improved customer service and retention: estimate: £15,000
Improved accuracy of customer information: estimate:
£5,000 / year
More ability to manage sales effort: £15,000 / year
Total Benefit: £90,000/year
Payback time: £55,800 / £90,000 = 0.62 of a year = approx.
Inevitably the estimates of the benefit given by the new
system are quite subjective. Despite this, the Sales
Director is very likely to introduce it, given the short
Cost/Benefit Analysis is a powerful, widely used and
relatively easy tool for deciding whether to make a
To use the tool, firstly work out how much the change will
cost to make. Then calculate the benefit you will from it.
Where costs or benefits are paid or received over time,
work out the time it will take for the benefits to repay
Cost/Benefit Analysis can be carried out using only
financial costs and financial benefits. You may, however,
decide to include intangible items within the analysis. As
you must estimate a value for these, this inevitably
brings an element of subjectivity into the process.