Cost beniefit analysis training for decision makers and manager step7 8

AMERICA’S ARMY: THE STRENGTH OF THE NATIONCost-Benefit Analysis CBA Four-Day Training Briefing Step 7: Compare Alternatives Step 8: Report Results and Recommendations... Define the Probl

AMERICA’S ARMY: THE STRENGTH OF THE NATION

Cost-Benefit Analysis (CBA) Four-Day Training Briefing

Step 7: Compare Alternatives Step 8: Report Results and Recommendations

6 Define Alternative Selection Criteria

5 Identify Quantifiable and Non- Quantifiable Benefits

5 Identify Quantifiable and Non- Quantifiable Benefits

4 Develop Cost Estimate for each Alternative

3 Define Alternatives

2 Define the Scope; Formulate Facts and Assumptions

1 Define the Problem/Opportunity and Objective

Step 7: Compare Alternatives

alternative.

must be done to manage the negative impacts?

– If anything changes (i.e., assumptions, costs, benefits) would the recommendation change?

appropriate risk mitigation measures.

Step 7: Compare Alternatives

• The CBA process is essentially comparing the costs with the benefits between all alternatives

• Risk and second- and third-order effects should be included in the comparison of alternatives

Concepts for Comparing Costs with Benefits

Value = Benefit – Costs

Aid for Completing - Step 7a

Equal

Overly Complex Final Recommendation

Employees

Cost

Net Present Value (NPV) Converts future cash flows into present equivalent values and then adds them together When alternatives have the same economic life

Benefit/cost ratio (BCR) Compares present value (PV) of benefits with present value of costs When competing alternatives have unequal costs and unequal benefits

Break-even Point Identifies point at which cumulative cost of two alternatives equal the cumulative benefits When projects are high-risk, to show when investment costs need to be recovered

quickly

Subjective reasoning Applies professional judgment as a complement to, or to the exclusion of, quantitative data When professional judgment is considered to be more important

are most suitable

Decision Matrix Allows for multiple criteria to be used to compare alternatives It is a very flexible tool that can be used under many circumstances It can even

account for other decision support methods described in this table.

A Fortiori Analysis Determines whether a strongly favored alternative is still the best choice even when assumptions are

formulated that put that alternative at a disadvantage.

When generally accepted intuitive judgment strongly favors one alternative

Best Practices

 “Fort Hood data is representative of all bases.”

• Assuming away cost:

 “Year-end funds will be available,” when that’s not the case

 “Higher headquarters will pay for it.”

 “Other organizations will pay for it.”

 “Military personnel are free.”

• Assuming away the problem:

Common Mistakes: Over Simplification

Which alternative has the best value?

the value statement.

The Cost of a Green Chiclet

Effects of Over simplification

• Example: the Organization of the Joint Chiefs of Staff is planning a holiday party for itself The

Chairman of the JCS must assign three current employees to serve on the Holiday Party

Planning Committee, which requires a commitment of 16 hours of work per member CJCS is

presented with two courses of action:

Force, to the Holiday Party Planning Committee.

Holiday Party Planning Committee.

• The additional budgetary cost of this new Holiday party requirement is equal for both COAs: it

is “cost free” because the salaries of current employees will be paid regardless of whether the

Holiday party gets planned Determine which COA has the lower opportunity cost

“ Cost Free” Analysis

All COAs proposed within a CBA must be solutions to the problem/opportunity statement

Assumptions should not solve the problem.

Common Mistakes: Assuming Away the Problem

Non-Quantitative Methods

One of the best ways to elucidate the resource-informed decision to

senior leadership is to include a Decision Matrix in the Decision Brief.

• Loss of information via normalization

• Results not definitive

• Scoring is subjective

Decision Matrix Merits

Example - Decision Matrix

COA-1 highest benefit COA-2 best value COA-3 lowest cost

Cost = $ quantifiable cost – $ quantifiable benefit or saving

Benefit = $ non-quantifiable benefit and $ non-quantifiable risk

Rating: 1 (worst) to 9 (best)

Note: If calculating Cost-Benefit index, the benefits criteria for each COA should be rated, not ranked

Otherwise, the Cost-Benefit index calculated would be meaningless

•. If the recommendation is highly sensitive, can deeper analysis be done?

• Only test elements with significant uncertainty or risk

– Elements may include assumptions, constraints, costs, benefits, weighting of selection criteria, etc.

•. What is the impact of a change of such and such magnitude?

•. Can the risks increase future costs?

Questions for Steps 7c and 7d

The goal of risk assessment is to answer questions like:

– What assets, operations, activities, functions, etc will be affected as a result?

Risk Assessment and Mitigation

Always measure the risk by the potential adverse impacts on alternatives.

All risks need to be reflected in Costs and/or Benefits of COAs

Risks must factor into the decision-making process

Types of Risks

probability, and $1.2M with 25% probability, then the effective mean (expected cost) is $1.4M x 0.5 + $2M x 0.25 + $1.2M x 0.25 = $1.5M.

• Example: if inter-theater transit time for a sustainment brigade is projected to be 5 days with 90% probability and

4 days with 10% probability, then the expected transit time is 5 x 0.9 + 4 x 0.1 = 4.9 days

Effective Mean (Expected Value)

Cost of Risk Mitigation

If a cost can be associated with reducing risk,

then risk can be measured by that monetary

value

Example: If for $22K extra, the risk of a

schedule over-run can be reduced from 15%

to 3%, then $22K can be a measure for the

difference in risk

1 Divide analysis into two groups of factors:

– Those outside an agency’s control (i.e., assumptions)

– Those agencies that have a degree of influence or control

2 Choose several elements (costs, assumptions, benefits, etc.) that have greatest impact and are most likely to change

–. Vary each element over a reasonable set of values while holding the other variables constant relative to each other

–. Ranking of alternatives

example, the production rate or learning curve

congressional mandate or changes in functional responsibilities

organizational responsibility at the site, installation, base, or Army

command/direct reporting unit/Army service component command level

communications, prime support equipment, and other facilities

inflation rate, residual value of equipment, and length of development

28

Suggested Steps to Conduct Sensitivity Analysis

• Crystal Ball software may be used to

perform sensitivity analyses.

• In the example to the right, “Cost of

Revenues %” has the greatest effect on

Net Present Value, while “Year 4 Units

Sold” is the least sensitive.

Example: Sensitivity Analysis

• Perform a sensitivity analysis

on the weight of Lethality in

this Decision matrix Test for

Exercise: Sensitivity Analysis

COA-1 highest benefit COA-2 best value COA-3 lowest cost

Cost = $ quantifiable cost – $ quantifiable benefit or saving

Benefit = $ non-quantifiable benefit and $ non-quantifiable risk

• Alternatives will compete with other developments for funding if no billpayers are identified

Paying for Alternatives

Note: This does not guarantee funding.

Identify billpayers to fund alternatives!

values, or priorities will affect the recommendation

Quick Review

• In a rented garage at 58 Bagley Street in Detroit, Henry Ford completed his first gas-powered car on the morning

of June 4, 1896 He had spent $250 FY1896 dollars on equipment to build the car, and $100 on labor The garage cost $15 per month to rent After the car was assembled, it was clear that it would not be able to fit through the door of the rented garage The car was to be used as a model for the two-year long test-driving phase of his R&D process, with the final goal of arriving at a model for mass production and sale

Review Exercise: Henry Ford

• Identify selection criteria and compare each of the following Courses of Action:

– COA1 (Status Quo): Leave the car in the garage, do nothing else

– COA2: Disassemble the car and reassemble it outside the garage

– COA3: Obtain permission of garage landlord to widen the garage door

Review Exercise: Henry Ford

CBA Decision Package:

• Preferred format is a narrative or PowerPoint

• Accompany with a decision briefing

• Write it in such a way that a layman can understand the topic

Results and Recommendations:

• Summarizes the analysis

• Makes conclusive statements about each of the alternatives

– The recommended alternative should follow

• Results address how the alternatives were ranked using the criteria developed in Step 6

• Document all data and information used in Steps 1-8

– Provide supporting information so reviewers can understand how Steps 1-8 were developed

Step 8: Report Results and Recommendations

Questions for the Reviewer:

- Does the package contain all key elements that are accompanied with supporting documentation?

- Does the recommended alternative address the problem, and is it consistent with the assumptions and constraints?

- Does the analysis explain how the recommended alternative is the best one to satisfy the selection criteria?

Key Elements for Documentation

– This is just a suggestion The actual briefing for a CBA (or any briefing, for that matter) should be determined based on the briefer’s style, the known preferences of the individual being briefed, and the subject matter.

• It is not a substitute for a well documented CBA in narrative form.

– The CBA coordinator, the decision makers, and stakeholders should collaborate to determine the content and format of the CBA decision brief as they will have differing preferences.

Briefing the Results of the CBA

• Make resource-informed decisions

• Validate and approve requirements

• Resource approval forums use CBAs to make resource- informed decisions

• Identify tradeoffs and billpayers

• Decide funding approval decision

• Proponent organizations:

• Register CBA online

• Develop and submit CBAs online with value proposition linked to command’s strategic priorities

• Proponent leadership endorses submission online

• Organization validates the CBA methodology

• Accuracy and completenessCBA Workflow Automation Tool

CBA Registration, Development and Submission

• Document the CBA narrative and share the results with stakeholders for approval.

• CBA templates are optional tools that can be used to brief the results of the CBA.

• Include all documentation and calculations in back up.

• Ensure that the CBA clearly describes the value proposition, and highlight how the benefits outweigh the cost, risks, and trade offs.

Quick Review

Chief of Staff, Army, and Team Leaders in the field during highly sensitive counter-terrorism missions The link provides video and voice transmissions that are typically delayed by 30 seconds Currently, $2M per month is spent on operating and maintaining the communications link: mostly consisting

of payments to the National Security Agency for “satellite bandwidth.” The NSA has recently launched into orbit a new satellite that promises shorter transmission delays: typically 10 seconds, but with a 20% risk of 20 second delays The satellite takes advantage of recently developed technology: costs to the Army for the first month are set at $10M, and are projected to decrease based on an 85% learning curve ($10M for the first month, 0.85 x

$10M per month for the next two months, 0.85 x 0.85 x $10M per month for the next four months, 0.85^3 x $10M per month for the next eight months, 0.85^4 x $10M per month for the next sixteen months, etc.), though there is a 40% risk that costs will only decrease according to a 90% learning curve.

weight to signal delay time The benefit score will be determined by the function , where t is the expected time delay in seconds.

Mini-case Exercise #7

or “can you hear me now?” or “what’s the expected value?”

for 1885 hours annually, on a government contract costing $1.2M per year The

battalion commander would like to evaluate the option of insourcing the labor to Army civilians The total burdened cost per civilian is $85,209 and the estimated annual productivity is estimated at 1740 hours each Determine whether insourcing would be more cost effective than the status quo.

Mini-case Exercise #8

or “to insource or not to insource, that is the question”

Mini-case Exercise #9

or “I’ll gladly pay you Tuesday for air conditioning today”

optimal number of rowboats to deploy to pursue a whale sighting As defined by the Commander, the selection criteria are manpower, stealth, and ease of sustainment, with weights of 0.5, 0.3, and 0.2, respectively You have been told as a rule of thumb that the total mission cost can be estimated at $2200 for each rowboat involved in the hunt Each rowboat can transport 15 fishermen.

Mini-case Exercise #10