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Cost effectiveness analysis Description of the technique



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4. Cost effectiveness analysis

Description of the technique

Cost-effectiveness analysis (CEA) is a method that can help to ensure efficient use of investment resources in sectors where benefits are difficult to value. It is a tool for the selection of alternative projects with the same objectives (quantified in physical terms). EA can identify the alternative that, for a given output level, minimises the actual value of costs, or, alternatively, for a given cost, maximises the output level. For example, the evaluator can compare by simple output/cost ratios different projects that aim to lower the fertility rate, or different methods of teaching reading and writing, or different interventions to lower the infant mortality rate.

CEA is used when measurement of benefits in monetary terms is impossible, or the information required is difficult to determine or in any other case when any attempt to make a precise monetary measurement of benefits would be tricky or open to considerable dispute. It does not consider subjective judgments and is not helpful in the case of projects with multiple objectives. In the case of multiple objectives a more sophisticated version of the tool could be used, the weighted cost-effectiveness analysis, which gives weights to objectives to measure their priority scale. Another alternative is a multicriteria analysis. The technique, which looks at the cost of an intervention, and relates it the benefits created, is also closely related to the use of a Value for Money Assessment. Notably, when assessing the value of an intervention, value for money does not necessarily mean achieving outcomes at the lowest cost.




The purpose of the technique


The objective of CEA is to evaluate the effectiveness of a project, that is, its capacity to achieve the desired objectives. The latter should be defined in physical and not monetary terms, e.g. reduction in the morbidity rate through an intervention in the health sector, in relation to the costs incurred to reach them. CEA is best used to decide which alternative maximises the benefits (expressed in physical terms) for the same costs or, vice versa, which one minimises costs for the same objective. The cost-effectiveness ratio allows projects to be compared and ranked according to the costs necessary to achieve the established objectives. Since the objectives cannot be converted into a common numeraire or accounting unit, CEA cannot be used to decide on a project taken in isolation, nor to decide which of two projects would give the better return in two different contexts.

CEA is also used as an alternative to a cost-benefit analysis when social benefits and costs are difficult to monetise, but with strong limitations.

Indeed while a programme may be highly effective at meeting its objectives, it may not to provide good value for money. For example, the programme may be relatively inefficient and the objectives could have been met using fewer resources if an alternative method had been adopted. Assessing the cost effectiveness of a project or programme will not by itself, even when benchmarked against ratios derived from comparable programmes, provide a clear assessment of its social net benefits. It should include additional work to assess the different perceptions of success of different interest groups, as well as an assessment of economy. The value for money approach will often be informed by both top-down and bottom-up analyses. It enables the multiple objectives of a regeneration programme, for example, to be explicitly included, as well as an assessment of the efficient use of resources.



Circumstances in which it is applied


CEA is mainly a tool for the selection of projects within a well defined programme. It has been most commonly used in the evaluation of projects in the health sector, and in all cases where the benefits produced (or the objectives achieved) are difficult to monetise. It is used to make comparisons between alternatives that have the same scope. It cannot be used for projects with different objectives or for a project with multiple objectives. CEA can be used in both ex-ante and ex-post evaluation. It is used when all the expected effects have been defined and are homogeneous and/or can be measured in terms of a key result (e.g. the number of jobs created, the number of trainees, the number of prevented infections). It is used often for evaluating social projects (education, health).

Value for money assessments can be conducted both ex-ante and ex-post. It is used when all the expected effects have been defined and can be measured in terms of a key result (e.g. the number of jobs created, number of business start-ups/survivals). For example, if a Government department were considering the implementation of an initiative that provides assistance to small businesses, they could conduct an ex ante evaluation to identify the likely benefits and the cost per benefit of the scheme, prior to implementing it. The findings of such an evaluation would inform the decision to implement or scrap such a policy. Ex ante, provides the evaluator with the necessary information to assess the cost of the inputs, and the outputs and outcomes of a given policy. This enables them to make a judgment on whether the said scheme provided good returns for the amount of money inputted. Value for Money assessments are common in the UK, closely linked to the UK government's Modernising Government agenda which focuses on the achievement of Best Value for service provision and procurement. Best value is an approach that aims to ensure that public bodies / delivery agents play their part in delivering high quality provisions in a cost-effective manner (both internally and when procuring work).

 Example: Cost effectiveness analysis for the choice of technology

The choice of technology is a common example of a situation when benefits can only be measured in some nonmonetary terms. This is the case of determining the minimum cost for a given output.

Case study: Improvement of boilers in a district heating system.

Three technological alternatives are shown below:


  • Technology A: replacement of all existing boilers with new woodburning ones

  • Technology B: renovation of existing oil-and gas-fired boilers

  • Technology C: essential repairs of existing boilers

Total costs for each projects are:

Total costs

Thousand Euro



Investment cost

Annual fixed maintenance costs

fuel cost

Technology A

6000

150

300

Technology B

3250

100

600

Technology C

500

300

750

Below is shown how discount rate can affect the analysis.












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