Cost Effectiveness

COST EFFECTIVENESS Meaning Cost-effectiveness analysis (CEA) is a form of economic analysis that compares the relative expenditure (costs) and outcomes (effects) of two or more courses of action. Cost-effectiveness analysis is often used where a full cost-benefit analysis is inappropriate e.g. the problem is to determine how best to comply with a legal requirement. Typically the CEA is expressed in terms of a ratio where the denominator is a gain in health from a measure (years of life, premature births averted, and sight-years gained) and the numerator is the cost of the health gain. The most commonly used outcome measure is quality-adjusted life years (QALY). Cost-utility analysis is similar to cost-effectiveness analysis.

CEA in Infrastructure Asset Management Cost-effectiveness analysis is commonly used in Infrastructure Asset Management instead of a full cost-benefit analysis where the objective is to sustain the existing standard of service. The replacement or refurbishment of an existing Infrastructure Asset is a good example of this. In effect, the benefits side of the equation is held constant at some pre-determined standard of service, and various options for providing that standard of service are then compared, with the least-cost method identified as the preferred option. The use of CEA is supported by the benefits identified in the Asset Management Plan where the whole-life cost is also detailed. As such, an indicative benefit-cost ratio is contained within the Asset Management Plan - allowing individual assets to be justified as part of a system of assets. This provides a framework for the safe use of CEA for individual assets.

COST BENEFIT ANALYSIS A cost benefit analysis is done to determine how well, or how poorly, a planned action will turn out. Although a cost benefit analysis can be used for almost anything, it is most commonly done on financial questions. Since the cost benefit analysis relies on the addition of positive factors and the subtraction of negative ones to determine a net result, it is also known as running the numbers. A cost benefit analysis finds, quantifies, and adds all the positive factors. These are the benefits. Then it identifies, quantifies, and subtracts all the negatives, the costs. The difference between the two indicates whether the planned action is advisable. The real trick to doing a cost benefit analysis well is making sure you include all the costs and all the benefits and properly quantify them. Should we hire an additional sales person or assign overtime? Is it a good idea to purchase the new stamping machine? Will we be better off putting our free cash flow into securities rather than investing in additional capital equipment? Each of these questions can be answered by doing a proper cost benefit analysis.

Example Cost Benefit Analysis As the Production Manager, you are proposing the purchase of a $1 Million stamping machine to increase output. Before you can present the proposal to the Vice President, you know you need some facts to support your suggestion, so you decide to run the numbers and do a cost benefit analysis. You itemize the benefits. With the new machine, you can produce 100 more units per hour. The three workers currently doing the stamping by hand can be replaced. The units will be higher quality because they will be more uniform. You are convinced these outweigh the costs. There is a cost to purchase the machine and it will consume some electricity. Any other costs would be insignificant.

You calculate the selling price of the 100 additional units per hour multiplied by the number of production hours per month. Add to that two percent for the units that aren't rejected because of the quality of the machine output. You also add the monthly salaries of the three workers. That's a pretty good total benefit. Then you calculate the monthly cost of the machine, by dividing the purchase price by 12 months per year and divide that by the 10 years the machine should last. The manufacturer's specs tell you what the power consumption of the machine is and you can get power cost numbers from accounting so you figure the cost of electricity to run the machine and add the purchase cost to get a total cost figure. You subtract your total cost figure from your total benefit value and your analysis shows a healthy profit. All you have to do now is present it to the VP, right? Wrong. You've got the right idea, but you left out a lot of detail.

Accurate Cost Benefit Analysis Once you have collected ALL the positive and negative factors and have quantified them you can put them together into an accurate cost benefit analysis. Some people like to total up all the positive factors (benefits), total up all the negative factors (costs), and find the difference between the two. I prefer to group the factors together. It makes it easier for you, and for anyone reviewing your work, to see that you have include all the factors on both sides of the issues that make up the cost benefit analysis. For the example above, our cost benefit analysis might look something like this:

Cost Benefit Analysis - Purchase of New Stamping Machine (Costs shown are per month and amortized over four years)

Items 1. Purchase of Machine includes interest and taxes 2. Installation of Machine including screens & removal of existing stampers 3. Increased Revenue net value of additional 100 units per hour, 1 shift/day, 5 days/week 4. Quality Increase Revenue calculated at 75% of current reject rate 5. Reduced material costs purchase of bulk supply reduces cost by $0.82 per hundred 6. Reduced Labor Costs 3 operators salary plus labor o/h 7. New Operator salary plus overhead. Includes training 8. Utilities power consumption increase for new machine 9. Insurance premiums increase 10. Square footage no additional floor space is required Net Savings per Month

DIFFERENCES BETWEEN CBA AND CEA

Price (in $) -20,000 -3,125 27,520 358 1,128 18,585 -8,321 -250 -180 0 $15,715

Many studies claim to be to be CBAs, but are in fact CEAs CEA calculates the direct financial cost of reaching specific outcome/output levels and requires one other alternative for comparison CBA compares all benefits to all costs and can "stand alone." If the benefit/cost ratio exceeds 1, the program is socially valuable CBA – typically prospective and used for major capital investments CEA – typically retrospective and useful for evaluating discrete interventions CBA – a macro (societal) view CEA – a micro view of program activities, outputs, or outcomes

CASE STUDY: MobiPro Team

Problems Faced by the Company WDC Solutions, a software company in Bangalore, has 5 sales executives selling software products. These executives are on the move at least 5 hours in a day. Like any other sales executives, they need to be in touch with the office for the usual reasons like discussing the outcome of sales calls, pricing, special offers, discounts, technical queries, checking on the availability of a product, scheduling follow-on demonstrations or calls, etc. The sales team therefore uses mobile phones to make calls while out of office. The office also calls sales executives on their mobile phones in order to update or seek updates from them. The mobile sales team typically faces some of the following problems in communicating with the office:  The person they wished to speak with is not available at his desk  Messages left with the front desk are passed late to the concerned person.  Although multiple calls are made, the right person and the right information are not reachable or available in time. These problems, although normal in every sales organization, hamper the sales and decision taking capabilities of the mobile sales team. It delays the sales cycle, as the executive does not have immediate answers to the customers’ needs and questions. While the use of mobile phones for voice communications does address some of the above issues, it does result in increasing the cost of communications for WDC Solutions. After these company has various software tools as an option to solve these problems. Company had decided to solve the issue with the following

The solution and Implementation WDC Solutions has therefore started using MobiPro Team a cost effective solution that bridges

the communication gap between the mobile sales team and the office staff using this tool, the mobile work force can contact any individual in the office using Short Messaging Service (“SMS”). Messages sent by mobile sales executive are pop-up on the desktop of individuals working in the office. These individuals can reply to the message, or send messages to any other individual or group of individuals (whether in office or traveling) from their desktops. The front office person can also send messages to the traveling team (broadcast), or to specific individuals on the field without disturbing them while they are in meetings or traveling. A key factor is that the sender of a message need not be aware of whether the recipient is in the office, or is traveling and hence reachable by mobile. If any member of the sales team is in the office, they would receive the message on their desktop—the front office would not need to separately intimate sales executives in the office, nor would the organization need to spend on SMS charges for messages sent to sales executive who are not travelling.

Benefits of the tool: The key benefit from using the solution is the reduction in the sales cycle and increased call conversion ratio. Another significant benefit has been the major reduction in communication costs that the solution has brought about. The analysis and cost comparison of communication cost in the table below reveals that MobiPro Team is an ideal tool for sales organizations like WDC Solutions to embrace. The analysis has been prepared assuming that all sales take place locally and that therefore, no long distance telephone charges need to be paid. If sales take place at a regional, national or international level, the costs of not using MobiPro Team are much higher. Before successful implementation of the above mentioned tool company did Coast Benefit Analysis to know; whether implementing the mentioned tool will make any reduction in cost or not. The following data was obtained by the company regarding the costs from the various sources.

Sr. No.

Items

Before using

Using MobiPro

MobiPro Team

Team

1

Total daily cost of outgoing calls from

210.00

50.00

2

office` Total daily cost of incoming messages

420.00

50.00

630.00 15,750.00 1,89,000.00

100.00 2,500.00 30,000.00 1,59,000.00

3 4

to office Total daily costs Total monthly costs Total annual costs Gross savings

Based on the above cost benefit analysis company had decided to implement MobiPro team.