Section 4: Cost Analysis

Using Cost Analysis to Make and Influence Decisions

The major purpose of any cost analysis and cost data collection system is to obtain information to help make or influence decisions. These decisions may be internal or external to the organization performing the cost analysis. In these respects, cost analysis is just like any other aspect of program evaluation. However, it is much more common to evaluate the effectiveness of prevention programs and program components than it is to evaluate their costs. It is believed that this is to some extent due to a lack of knowledge about how to conduct and use cost analysis. Most of this section has been concerned with how to conduct a cost analysis. In this section, suggestions are provided about how to use cost analysis by itself, and in conjunction with evaluations of program effectiveness.

• Internal Decisions

Cost information can contribute to a wide array of internal decisions for a single program or for an organization that administers many programs. Four examples are provided below of the types of decisions for which cost information is important.

• Planning budget allocations and projecting resource needs.
  Average and marginal cost information are required in order to know how changes in the number and types of people in each program's target population will affect the needs of various programs for resources. All programs have to attend to changes in the populations they serve. For example, high birth rates will generate large increases in the numbers of families needing early intervention services. However, changes in the definition of the target population can also decrease the number of clients, but the need for accurate answers to the same questions are still needed. The systems that provide early preventive intervention services to young families should be estimating the added costs of serving these families as the number increases. How much money for personnel preparation? How much for annual operating costs? Accurate answers to these questions will be required in order to determine how much additional money must be obtained from various sources.
• Improving the efficiency of program operation.
  In some programs, considerable time may be expended in administrative activities. A cost analysis could be used to develop scenarios to see if more provider time could be expended in direct services for client families. One method would be to examine the time used for administration and find more efficient ways for administration. This would allow for a greater proportion of time to be allocated for direct service.
• Meeting regulatory and licensing standards, and identifying their impact on costs.
  Agencies that regulate and license education programs need to be sensitive to the effects of their regulations and licensing requirements on costs. Some regulations and standards may have little or no impact on costs. Others may have quite large impacts. An agency has to consider its own cost in promoting awareness and enforcing regulations and the likely impacts on service providers.
  
  Administrators and staff of programs that must contend with regulations and licensing standards will want to find the best ways of responding to them, and one aspect of this is minimizing the impact on costs. This might require the reallocation of resources from one type of activity to another, changes in the roles and responsibilities of staff, or other modifications in program activities. In addition, it will be necessary to calculate the effect on costs. Will new resources be needed, and for what parts of the program? How much will fees have to be raised to cover the additional costs?
• Responding to increases or decreases in budgets.
  A program may find that it has been awarded a larger budget than in the past, perhaps for general use, perhaps targeted for specific types of clients or services. A program then has to decide how to allocate those new resources. Cost information can help with the decisions about how much should go to which programs or program components. A cost analysis might be used to decide if a newly proposed project is feasible, or would require more funds than will be available.
  
  In recent years, it has been more common for programs to face budget shortfalls or cutbacks. In this case, the program management may want to make cuts to programs or program components in ways that will minimize the impact on services. More specifically, priorities might be established for categories of clients and services to be cut first. To do this, management must be able to identify the cost savings associated with cuts for each priority.
• External Decisions

Cost information can be used to influence decisions and judgments made by people external to the program and its organization. It may also be that program operators might want to use cost information to influence external decisions about keeping programs or advocating for new approaches. Cost analysis can be an important tool for obtaining information about the potential costs of new approaches as well as comparing them with the costs of existing programs. Cost analysis might even be used to help develop alternative approaches that would accomplish the same goals at lower cost.

• Formulating Economic Arguments

While cost analysis can be useful by itself, it is sometimes more useful as part of a broader analysis that looks at the effectiveness of a program or its components. Earlier, when the use of cost information alone was discussed, the assumption was that no significant tradeoff was being made between costs and the quantity and quality of services or that the effects on services were obvious and easily judged. However, too often this is not the case. For example, when a program chooses between two alternative approaches to early preventive interventions, neither the least or most expensive approach may be the best. On the other hand, it would not be reasonable to choose the approach that produced the greatest improvements in family risk outcomes without any consideration of cost. In such cases, either cost or effectiveness alone is an incomplete and unsatisfactory guide for decision making.

It is relatively common to conduct an evaluation (formal or informal) to determine the consequences of the alternatives for service delivery. Questions are asked about effects on the following: the number and type of persons served; the quantity of services received by the clients; the quality of services received by the clients; and the effectiveness of the services in achieving the program's goals. For example, an evaluation might be conducted to look at the effects of alternative methods of reaching out to high risk families who are difficult to engage in services. It is hoped that with the aid of materials such as those described in this Section, it would be possible for evaluators or managers to add cost analysis to such an evaluation. When the two types of data are combined in this way the result is a cost-effectiveness or cost-benefit analysis that takes all aspects of a program into account. Even when it is not possible to conduct a formal cost-benefit or cost-effectiveness analysis, it can be useful to employ the logic of such analyses in making decisions based on the available information. In the table below, different types of decisions or judgments are described based on categories of external audiences.

Beyond This Section

This section has provided an introduction to cost analysis and its use, including step-by-step procedures that can be used to conduct a cost analysis of a prevention program. It is designed as a practical rather than theoretical guide. Its recommendations are based on the recognition that the human side of cost analysis is as important as the technical side. Those who use this guide to conduct a cost analysis are encouraged to read more broadly about the theory and practice of cost analysis. When resources are available, it may be helpful to consult with an economist who has experience evaluating specific programs. Several excellent sources of further information on cost analysis are available. A good place to begin is Levin's (1983) Cost-effectiveness: A Primer, that provides a brief, highly readable, and easily understood introduction to cost analysis, cost-effectiveness analysis, and related techniques. Levin's clear explanations of key concepts, theory, and potentially difficult problems such as estimation of capital costs make his book an ideal follow-up to this section. Other valuable resources include Thompson's (1980) Benefit-cost analysis for program evaluation, and Sloan's (1995) Valuing health care.