Cost-Benefit Analysis: Why the Cheapest Option Is Not Always Best
Cost-benefit comparisons are done on every project, usually in someone's head and usually in about four minutes. The technique is not difficult; what makes it unreliable is that two specific things are almost always missing, and both of them make the cheaper option look better than it is.
Section 5 of the PMBOK® Guide Eighth Edition includes this among the analytical techniques available, and doing it properly takes perhaps an hour on most decisions, which is a small price for a choice that will be lived with for years.
What a comparison has to contain
Costs to the end of the thing's life. Purchase, installation, operation, maintenance, consumables, the cost of removing or replacing it, and the cost of the disruption each of those causes. An option that is cheaper to buy and dearer to run reverses somewhere, and the only question is whether that point falls inside the period anybody cares about.
Benefits with dates attached. A benefit arriving in year four is worth considerably less than the same benefit next quarter, and comparisons that add up undated benefits mislead systematically. Putting a date against each one also exposes the ones that depend on somebody else acting, which are the ones least likely to appear.
Who bears each cost and who receives each benefit. Where those are different parts of the organisation, the comparison is describing a transfer as well as a total, and the party carrying the cost will behave accordingly. A whole-organisation net benefit that impoverishes one department will be resisted by that department, quite rationally, for the life of the project.
The do-nothing option, priced honestly. Continuing as things are is never free, and stating its cost is what turns a comparison of two purchases into a decision about whether to act at all. Where nobody has priced it, the analysis quietly assumes that doing nothing costs nothing, which is rarely true and occasionally the whole of the argument.
Handling what cannot be monetised
State it alongside, in its own units. Safety exposure, staff experience, reputational risk and service quality can sometimes be given a number and usually should not be forced into one. Presenting the monetised comparison with a short statement of the non-monetary differences lets a decision-maker weigh them, which is their job.
Use thresholds where the non-monetary factor is decisive. Where an option falls below a standard that matters, it leaves the comparison, and no amount of financial advantage brings it back. Saying this in advance prevents the familiar situation where a cheaper option wins on paper and is then rejected for reasons everybody knew about beforehand.
One haul road, two specifications
A construction project needed a temporary haul road about six hundred metres long to reach the working area of a site, to be used for roughly fourteen months. Two specifications were considered: a stone-capped road with a geotextile base, and a lighter alternative using site-won material.
On capital cost the lighter option was about forty per cent cheaper and it was selected for the second half of the route, with the first half built to the higher specification because it passed a neighbouring property.
The two halves behaved differently from the first wet month. The capped section required occasional grading. The lighter section rutted, held water, and needed making good repeatedly through the winter, which meant plant, material, labour and, on four occasions, a half-day of restricted access while the work was done. By the following spring the join between the two was visible from a hundred metres: clean graded stone on one side, deep wheel tracks with standing water on the other.
The costs were counted at the end because the commercial manager was curious. Making good the lighter section across fourteen months came to about two and a half times the original saving, and that figure excluded the delay costs from the four restricted-access days, which nobody could agree how to attribute.
The analysis that would have caught it would have taken an hour. Nobody had priced the maintenance of either option, because temporary works maintenance sat in a different budget line and was regarded as an operational matter. The following project's temporary works comparison carried a maintenance allowance for each option, derived from this one, and chose the capped specification for the whole route.
Testing the answer
Vary the two largest assumptions. Usually these are the benefit size and the period over which it accrues. If moving either one by a quarter changes the answer, the comparison is not robust and should be reported as a close call, which is honest and considerably more useful than a spurious winner.
Check the horizon. The period chosen for the comparison frequently decides the result, and it should be justified by the life of the asset or the decision rather than by the reporting cycle. A fourteen-month temporary road analysed over a three-month window is a different question from the one that needed answering.
For a PMP® candidate, the reading that helps is that the comparison has to be whole-life and time-aware, so a scenario offering a cheaper option is asking what is missing from its cost side. A response that takes the saving without the operating and maintenance position has compared purchase prices. A structured PMP exam preparation course works through appraisals where the cheapest option carries the larger total.
Before your next option decision, write down the running costs of each choice for as long as it will exist, and who pays them. If that column is blank for one of the options, the comparison is not finished, and the blank is usually where the difference lives.
Interested in going further?
Most cost decisions on projects are taken with half the cost side missing and everybody acting in good faith. Omega's PMP® Exam Preparation works through appraisal as a whole-life question.
Cost-benefit techniques are among the analysis methods in the PMBOK® Guide Eighth Edition.
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References
A182: Multicriteria Decision Analysis Explained
A161: Expected Monetary Value Explained
A178: SWOT Analysis in Project Management
A180: Facilitation Techniques for Difficult Project Conversations
A184: Trend Analysis vs Variance Analysis
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