Cost Benefit Analysis Supporting Army Enterprise Decision Making. 8 January 2010

Transcription

1 Cost Benefit Analysis Supporting Army Enterprise Decision Making 8 January 2010

2 Objective Provide an overview of the Cost Benefit Analysis (CBA) methodology What we will provide you Framework for completing a CBA An understanding of questions that should be asked when preparing or reviewing a CBA Methods for comparing alternatives The value of Cost Benefit Analysis Supplements professional experience and military judgment with sound analytical techniques Ability to make better resourced-informed decisions Results in a strong value proposition a clear statement that the benefits more than justify the costs and required trade-offs 2

3 Cost Benefit Analysis Problem Solving Model Total Costs: (-) Quantifiable costs Direct Indirect Initial/Start up Sustainment Procurement Non Quantifiable costs Life/Safety/Health Perception/Image Opportunity Risk/Uncertainty Political 1. Identify the problem and specified/implied tasks 2. Gather information: identify key facts, assumptions, & constraints 3. Develop criteria 4. Generate possible solutions/cba 5. Analyze possible solutions/cba 6. Compare possible solutions/cba 7. Make and implement a resource informed decision Total Benefits: (+) Quantifiable benefits Cost Savings Time & Materiel Readiness Non-quantifiable benefits Increased Capability Increased Availability Higher Quality Good Will Higher Morale Enabling Commanders to make resource informed decisions 3

4 Department of the Army Directive Cost Benefit Analysis Department of Army has directed that all unfunded requirements and new or expanded program proposals be accompanied by a thorough cost benefit analysis 4

5 Elements of a Cost Benefit Analysis 1. Problem Statement, Objective and Scope 2. Assumptions and Constraints 3. Current State (the Status Quo) 4. Alternatives with Cost Estimates 5. Quantifiable and Non-Quantifiable Benefits 6. Alternative Selection Criteria 7. Comparison of Alternatives Defined by Department of Army Directive dated 30 December 2009 a. Costs and Benefits Comparison b. Trade-offs / Billpayers c. Second and Third Order Effects d. Sensitivity Analysis and Risk Assessment 8. Results and Recommendations 5

6 Step 1: Problem Statement, Objective and Scope The problem statement clearly defines the problem, need, or opportunity that requires a solution and describes what the effort intends to accomplish. The objective of the effort is to improve, reduce, or increase some aspect of a process, procedure, or program. Objectives should be measurable, realistic, achievable, and results-oriented. Simply put, objectives are measurable outcomes. Scope defines the range of coverage encompassed by an initiative or proposal along specific dimensions like time, location, organization, technology or function. Are the objectives consistent with other organizational objectives? Is the requirement temporary or permanent? Has the requirement been evaluated previously or been subject to other forms of analysis, e.g. risk analysis or value management? Is the requirement part of a larger program or strategy? What major stakeholders are likely to be impacted? 6

7 Step 2: Assumptions and Constraints Step 3: Current State (Baseline) Step 2: Assumptions and Constraints Assumptions are factors or conditions that are essential to the success of the solution and are beyond the control of the organization. Assumptions define the ground rules and accepted statements in order to limit the scope of the CBA. They are explicit statements of conditions on which the CBA is based. Constraints usually refer to limits placed on resources to be devoted to the project. Constraints or barriers are normally beyond the control of the analyst and provide limitations within which analyses take place. Step 3: Current State (Baseline) This defines and assesses the current state/ condition. The status quo alternative of the CBA is the "baseline" program or system against which the costs and benefits of all feasible alternatives are compared. 7

8 Step 4: Alternatives with Cost Estimates Alternatives are potential solutions to the problem statement which will be evaluated in the CBA. Alternatives should reflect a review of the mission and strategic goals to verify that the alternative's objectives are consistent with the problem statement. A cost estimate captures the total cost of each alternative over its entire life cycle and is a summation of all relevant cost elements. What are the capital (equipment, facilities, management, construction, decommissioning, etc.) costs? What are the one-time (non-recurring) costs? What is the time frame for capital costs? Are refurbishment or system upgrade costs included? What are the recurring (labor, training, maintenance, utilities, etc.) costs? Will the alternative necessitate implementation costs? Will the alternative hold implications for security and require changes in practices and/or make additional investments? Will readiness be negatively impacted? Will risk to Soldiers and other support personnel increase? (Non-quantifiable) Will morale be damaged or negatively impacted? (Non-quantifiable) 8

9 Step 5: Quantifiable and Non-Quantifiable Benefits Benefits are results expected in return for costs incurred for a chosen alternative. They are the quantitative and qualitative improvements expected or resulting from the implementation of an alternative. Quantifiable benefits are benefits that can be assigned a numeric value such as dollars, physical count of tangible items, or percentage change. Non-quantifiable benefits are subjective in nature and can make a positive contribution to the analysis. Some examples of non-quantifiable benefits are improvement in morale and customer satisfaction. What savings will be realized from improved safety and risk reduction? (Quantifiable) Are there any avoidable capital and recurring costs? (Quantifiable) Will any reimbursements be realized from sales of assets? (Quantifiable) Will there be any materiel and time savings? (Quantifiable) Will there be any positive impacts on readiness? (Quantifiable) Will there be improved capability? (Non-quantifiable) Will there be improved quality of service? (Non-quantifiable) Will morale be improved? (Non-Quantifiable) Will risk to Soldiers and other support personnel be decreased? Will public perception be positive? (Non-Quantifiable) 9

10 Step 6: Alternative Selection Criteria Alternative selection criteria are those standards/bases on which a decision will be based. CBAs must contain documentation that outlines decision criteria and identifies the extent to which each alternative satisfies each of the criteria. What is the analysis base year? Have costs and benefits been adjusted for real inflation? What is the length of the evaluation period? What decision criteria are to be calculated? Benefit-Cost Ratio: Compares the present value of total benefits with the present value of total costs Marginal Analysis: Examines the differences between alternatives and provides an indication of whether differential costs are justified by its benefits Break-even Point (payback period): The point at which the cumulative costs of two alternatives are equal Savings-to-Investment Ratio (SIR): Relationship between savings and the investment costs necessary to effect those savings Benefit-to-Investment Ratio (BIR): Relationship between benefits and the investment costs necessary to produce those benefits Net Present Value (NPV): Computed by subtracting the present value of costs from the present value of benefits Rate of Return (ROR): A form of return on investment, which provides a single value for each investment, permitting ranking of alternatives with respect to their economic desirability Rank Order / Weight Based: Allows for selection to based on quantifiable and non-quantifiable costs and benefits, and allows decision makers to adjust criteria based on perceived importance 10

11 Selection Criteria: An Operational Example Rank Order / Weight Based Criteria Description Importance Weight 1 = Low & 5= High Quantifiable Costs & Benefits: Dollar Costs / Savings Quantifiable dollar costs or savings/avoidance 3 Materiel and Time Increases/decreases stockage levels and delivery time 1 Readiness Impact on theater readiness 2 Non-quantifiable Costs & Benefits: Life/Safety/Health Increases/decreases risk to Soldiers (ANA, US, Coalition) 4 Perception/Image Positive/negative perception and image 3 Opportunity Enhances/reduces future opportunities 1 Risk/Uncertainty Impact on combat operations 5 Political Extent of favorable /unfavorable outcomes 3 Capability Increases operational capabilities 4 Quality Meet or exceed acceptable standards 2 Goodwill Amount of goodwill generated 2 Morale Boosts/damages morale of Soldiers (ANA, US, Coalition) 1 Benefit Cost Evaluation Criteria Rating Criteria Description Rating (++) Significant Positive Impact 2 (+) Marginal Positive Impact 1 ( ) No Impact 0 (-) Marginal Negative Impact -1 (--) Significant Negative Impact -2 Assign importance based on project & command intent 11

12 Selection Criteria: An Operational Example Analysis Using Rank Order / Weight Based Criteria Evaluation Weight Rating Score 1 Quantifiable Costs & Benefits: Dollar Costs / Savings (--)Cost: $116M ( )Avoidance: $ Materiel and Time (++) Reduces excess inventory (-) Additional time required Readiness ( ) No Impact Non-quantifiable Costs & Benefits: Life/Safety/Health (++) Increased protection to forces (-) Increased risk to transporters Perception/Image (++) Demonstrates US support Opportunity (--) Reduces flexibility Risk/Uncertainty (++) Decreases operational risk (-) Requires time and troops (-) Increases stress on GLOC Political (++) Establishes long term bilateral relationship Capability (++) Improves organizational capability Quality (++) Exceeds minimum required standards Goodwill (++) Improves goodwill with population Morale (+) Improves security force morale Total Score = Weight x Rating Score indicates total benefit or cost Legend Scoring: Total Benefits > Total Costs: 34-8 = 26 Cost Benefit 12

13 Step 7a: Comparison of Alternatives Costs and Benefits Comparison The essence of the CBA process is in comparing the costs and benefits of two or more alternatives (including the status quo) in order to select the preferred alternative. As a general rule, the preferred alternative is the alternative that provides the greatest amount of benefits in relation to its cost. The following situations may result when comparing "raw costs and benefits" associated with two or more alternatives 1. When the results yield equal costs and unequal benefits, the recommendation should be the alternative that provides the greatest benefits for a given level of cost 2. When the results yield unequal costs and equal benefits, the recommendation would be simply the alternative that is the least costly 3. When the results yield unequal costs and unequal benefits, there is no single criterion for ranking alternatives. In this situation all alternatives, including the status quo, may be ranked in decreasing order of their benefit/cost ratios 4. When the results yield equal costs and equal benefits the recommendation for the preferred alternative may be based on other factors, such as a fortiori analysis subjective reasoning, and/or point systems Costs Benefits Selection Criteria Equal Unequal Equal Alternative that provides greatest benefits for given cost Subjective reasoning and a fortiori analysis Unequal Unequal Alternatives ranked in order of benefit/cost ratios, or largest to smallest net present value Equal Least costly alternative 13

14 Step 7a: An Example Comparison of Alternatives Costs and Benefits Comparison Using Rank Order / Weight Based Method Rating Score Criteria Weight COA 1 COA 2 COA 3 COA 1 COA 2 COA 3 Quantifiable Costs & Benefits: Dollar Costs / Savings Materiel and Time Readiness Non-quantifiable Costs & Benefits: Life/Safety/Health Perception/Image Opportunity Risk/Uncertainty Political Capability Quality Goodwill Morale Total Legend Cost Neutral Benefit A greater score indicates larger benefit 14

15 Step 7b & 7c: Comparison of Alternatives Trade-offs / Billpayers & Second / Third Order Effects Step 7b: Trade-offs / Billpayers Trade-offs / billpayers are the funding sources that have been identified which will cover (partially or entirely) the costs of an alternative. Step 7c: Second / Third Order Effects Second and third order effects are the results (consequences and/or impacts) stemming from a decision. They include the opportunity costs of pursuing one alternative over another. Second and third order effects identify what a decision maker can do or not do as a result of a decision. 15

16 Step 7d: Comparison of Alternatives Sensitivity Analysis and Risk Assessment Sensitivity analysis explains what the effect is on the cost/benefit model should assumptions change, risks become issues and/or dependencies not be met. Risk assessment describes all risks that can impact the achievement of stated benefits or the cost of solving the business problem. Each risk has an associated mitigation strategy and an assessment of likelihood of occurrence. What happens when discount rates are varied? What are the major areas of uncertainty and risk in the project? How have these been dealt with, i.e. specific analyses? Which assumptions need to be tested? What are the ranges of values which are appropriate for testing? Is there a need for sensitivity analysis based on optimistic and pessimistic estimates of costs and benefits? How are the results affected if different estimates and assumptions are used? What are the plausible upper and lower limits of cost / benefit items subject to uncertainty? 16

17 Step 8: Results and Recommendations Results and recommendations summarize the findings of the analysis and make conclusive statements about the comparisons of alternatives. The conclusions should demonstrate the cost/benefit relationships between each alternative. The results address how the alternatives were ranked using the criteria developed in Step 6. Following a clear statement of the conclusions, there should be a firm recommendation regarding the preferred alternative. All data and other information used in Steps 1-8 must be adequately documented. Supporting information should be identified so decision makers and analysts can understand how Steps 1-8 were developed. Once analysis is complete, prepare a report that includes: 1. Executive summary including problem statement, objective and scope of analysis 2. Background of the requirement including the assumptions and constraints 3. Full definition of the current state or baseline program or system 4. Full description of alternatives with full cost estimates and benefits (quantifiable and non-quantifiable) 5. Complete description of the evaluation and selection criteria 6. A comparison of all alternatives including all cost and benefits, trade-offs, 2 nd / 3 rd order effects, and any sensitivity analysis or risk assessments 7. Discussion of results and conclusive statement about the comparison of alternatives 17

18 Cost Benefit Analysis Model Cost Benefit Analysis Making the case for a resource informed decision Weighing the total expected costs against the total expected benefits over the near, far, and lifecycle timeframes from an Army enterprise perspective. COSTS The total of quantifiable and non-quantifiable costs Quantifiable costs Salary and benefits Procurement Sustainment Non-quantifiable costs Opportunity costs Externalities 1. Problem Statement, Objective and Scope 2. Assumptions and Constraints 3. Current State (Status Quo) 4. Alternatives with Cost Estimates 5. Quantifiable and Non- Quantifiable Benefits 6. Alternative Selection Criteria 7. Comparison of Alternatives 8. Results and Recommendations BENEFITS The total of quantifiable and non-quantifiable benefits Quantifiable benefits Cost Savings Cost Avoidance Non-quantifiable benefits Greater capability Faster availability Better quality Improved morale Benefits should balance or outweigh costs 18