Cost effectiveness is the measure of the relationship between the costs and outcomes of a program, project, or intervention. It is a key consideration in decision-making, as it helps organizations determine whether the resources invested in a particular activity are justified by the benefits or outcomes that are achieved.
There are several ways to measure cost effectiveness, including:
- Cost-benefit analysis: This is a method of evaluating the costs and benefits of a program or project by comparing the total costs to the total benefits. It is often used to compare alternative courses of action and to determine the most cost-effective option.
- Cost-utility analysis: This is a method of evaluating the costs and benefits of a program or project by comparing the costs per unit of benefit. It is often used to compare alternatives that produce different types of outcomes, such as health interventions that produce different levels of quality of life.
- Cost-effectiveness analysis: This is a method of evaluating the costs and benefits of a program or project by comparing the costs per unit of outcome. It is often used to compare alternatives that produce similar outcomes, such as different treatments for the same medical condition.
By considering cost effectiveness, organizations can make informed decisions about how to allocate resources and ensure that they are achieving the greatest possible value for money. The following are some illustrative examples.
The benefit here is usually non-financial as techniques such as cost-benefit analysis or return on investment are used for a purely financial analysis. Cost effectiveness is calculated as the ratio of cost to benefit.
ex. cost effectiveness = cost / benefit
A program to fight infectious disease in a developing country costs $3 million per year and is estimated to save 4400 lives.
ex. cost per life saved = (3,000,000/4400) = $681.82
It might be possible to translate this into health benefits such as increased life expectancy for millions of people with enough data. A program to improve air quality in a city improves average atmospheric particulate matter from 110 PM2.5 to 100 PM2.5. The program costs $40 million dollars.
ex. cost per PM2.5 improvement = 40,000,000 / (110 – 100) = $4 million per PM2.5 improvement
Transportation strategies can be compared with cost effectiveness metrics such as cost per mile. This may include costs such as energy, the value of people’s time, environmental impact and the cost of capital such as trains and roads. For example, a bicycle that costs $200 and can be used for 1500 miles.
ex. cost per mile = ($200 / 1500) = $0.13 / mile
If you include the cost of people’s time at $40 an hour and the assumption a bicycle can travel 13 miles an hour in traffic.
ex. cost per mile = $0.13 + ($40/13) = $3.93 / mile
Bicycles generally don’t cause much environmental damage so this cost is close to zero. Cost per mile can be used to compare bicycles to other forms of transport including all costs related to capital, land, infrastructure, operations, energy, environmental impact, people’s time and quality of life.