Pros and Cons of Cost Benefit Analysis

 Cost Benefit Analysis (CBA) is often used to determine whether risks are acceptable or not. Thus, we ought to be familiar with its strengths and limitations.  For example, although CBA logic is almost intuitive, it relies heavily on assumptions, projections and guesses which must not go unchallenged.  While admirably open to scrutiny, it focuses on financial matters to the exclusion of important non-monetary values. Statistically intense, CBA data can be manipulated.  Although theoretically objective, it is also amoral and can support activities which many may find morally repugnant.

 The major benefit of CBA is the need to use an open, disciplined, and logical thought process.  Of course, calculations about the future can easily be wrong.  Take GM’s decision not to modify the defective rear axle of the early Corvair, and not to fix the Malibu fuel tank.  Ford did the same with the Pinto fuel tank.  In each case, a CBA done by competent staff said no fix was justified.  Yet, both companies lost hundreds of millions when accidents caused litigation to skyrocket and sales to drop.

 On the other hand, Johnson & Johnson ignored both CBA and legal advice when they recalled Tylenol during the 1982 tampering crisis.  This principle-based decision paid big dividends.  Now used widely as a case study, it enhanced J&J’s reputation for corporate integrity. Tylenol has been a trusted best seller ever since. 

Risk Decisions require CBA and Policy Input

 If you want deeper insight and a defense against future criticism, invite your harshest critics to help design your CBA methodology.  Your final decision should be guided but not dictated by the CBA results, since good risk decisions also need policy input.  Political and moral considerations such as fairness, distribution, reversibility, consistency, etc., must be considered.  Policy can often fill in for the inherent uncertainty in CBA projections.  Poor CBAs invite tort action. Most risk decisions require both CBA and policy input. Ignore either at your peril. 
  

In summary, CBA is a useful step in making risk decisions, but is a tool, not a rule.  The process of going through a CBA is often more useful than the result. CBA alone does not a risk decision make! 

 Next month we’ll study some of the other policy factors that ought to be part of any risk evaluation.

Recommended Reading for Risk Managers  

Risk and Rationality: Philosophical Foundations for Populist Reforms by Kristen S. Shrader-Frechette. This math and philosophy professor at the U of South Florida has assembled a finely crafted and thoroughly researched work - with 80 pages of notes!  Clear prose, profound analytical insights, especially into the limitations of CBA make this a pleasant, stimulating read.  Anyone who is serious about managing public risk should read this book.

 Other worthy CBA/policy titles provided on request.

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