Cost-Benefit Analysis
Overview
Cost-benefit analysis is the weighing-scale approach to reaching business decisions: all the pluses (the benefits) are put on one side of the balance and all the minuses (the costs) are put on the other. Whichever weighs the heavier wins. If the costs weigh more, the proposal gets the thumbs down; if the benefits weigh more, it gets the thumbs up. A company considering whether to buy new computer systems, for example, might attempt a cost-benefit analysis to help it make up its mind. On the cost side would be things like:
 the price of the computers themselves;
 the cost of hiring people to install them;
 the cost of training staff to use them.
On the benefits side would be things like:
 greater speed in carrying out the company’s operations;
 greater efficiency in organising data;
 a boost to staff morale from using the latest equipment.

All of us do intuitive cost-benefit analyses every day of our lives. For example, “Shall I take a taxi to my next meeting or will I not save enough time for it to be worth my while?” The technique is also used extensively by industry and commerce.

Nevertheless, this comparatively simple idea has complicated ramifications. The pluses and minuses are not all immediately obvious, and many of them are not easily measurable in monetary terms. How, for instance, do you quantify an increase in staff morale?
Moreover, decisions cannot be made in isolation. There are usually several competing options: if you do not invest in a new plant in west Africa you can increase capacity at your existing plant, or you can take over a new business, or you can just leave the money in the bank. It is the proposal with the highest net benefit that gets the go-ahead.

A brief history
Benjamin Franklin, inventor of the lightning conductor and co-author of the American Declaration of Independence, was a practitioner of cost-benefit analysis. In 1772, he wrote:
When difficult cases occur, they are difficult chiefly because while we have them under consideration, all the reasons pro and con are not present to the mind at the same time … To get over this, my way is to divide half a sheet of paper by a line into two columns; writing over the one “Pro”, and the other “Con”. Then … I put down under the different heads short hints of the different motives … for and against the measure … I endeavour to estimate their respective weights; where I find one on each side that seem equal, I strike them both out. If I find a reason pro equal to two reasons con, I strike out three … and thus proceeding I find at length where the balance lies … And, though the weight of reasons cannot be taken with the precision of algebraic quantities, yet when each is thus considered, separately and comparatively, and the whole lies before me, I think I can judge better, and am less liable to take a rash step.
In recent years, cost-benefit analysis has been widely used for analysing public-sector projects, as a tool to help answer questions such as: “Should we subsidise the sale of things like unleaded petrol and solar panels?” or “Shall we turn this busy urban street into a pedestrian zone?” In these examples, the social costs are the most important ones. What are the benefits to human health of reducing the levels of lead in the atmosphere? And can you measure this – in terms, for example, of the medical facilities that will not be required as a result of the better health of the population?

Zero-Base Budgeting
Overview
Once upon a time a business’s annual budget was drawn up on the basis of the previous year’s budget. To each item that appeared last year, managers would add a certain percentage. The percentage would be determined more or less arbitrarily, although it would probably be related in some indeterminate way to the rate of inflation, the company’s overall strategy and the manager’s frame of mind that day.
For many years it was widely recognised that this was not an ideal way to allocate a company’s scarce financial resources. It encouraged managers to focus on the cost increases from year to year rather than on the underlying costs themselves. It also inadequately took account of the rapidly changing environment in which a company operated. For example, increasing last year’s expenditure on IT by the rate of inflation “plus some” was, at some stage, sure to leave a business way behind its rivals.

Nobody came up with anything better until Peter Pyhrr, a manager at the Texas Instrument company in Dallas, developed the idea of zerobase budgeting. Each year he prepared his budgets as if last year’s figures had not existed. Every assumption had to be rethought from scratch and then justified. It was not acceptable to use last year’s expenditure as a benchmark for this year’s budgeted costs, and then only to have to justify the increase in that expenditure. In effect, zero-base budgeting treats all claims on financial resources as if they were entirely new claims for entirely new projects.
A basic requirement of zero-base budgeting is that managers prepare budgets for the cost of running their operations at a minimum level. They are then required to calculate the costs and benefits of making a business decision that would lead to an incremental increase from that level. Breaking the budget down into different decision packages in this way makes it easier for senior managers to make choices among competing claims on scarce resources.
The idea was rapidly adopted by other companies. It has also been used extensively by local and national governments and by health and education authorities, areas where the budgeting process has traditionally rolled over from one year to the next with its underlying assumptions rarely questioned.
Criticism of zero-base budgeting focuses on the practical difficulties of implementation, and on the fact that it is time-consuming. Traditional incremental budgeting retains the great advantage of simplicity. Another author claims that “recent history has indicated that zero-base budgeting is very susceptible to political influence and pressures”.

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