Cost Benifit Analysis in HRM

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Center for Advanced Human Resource Studies

(CAHRS)

CAHRS Working Paper Series

Cornell University ILR School Year 1990

Cost-Benefit Analysis Applied to

Personnel/Human Resource ManagementDecisions

John W. BoudreauCornell University

This paper is p osted at DigitalCommons@ILR.

http://digitalcommons.ilr.cornell.edu/cahrswp/383


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"COST-BEN EFIT" ANA LYSIS APPLIED TOPER SONNEL IHUMAN RESOURCE MANAGEMENTDECISIONSAnsw ers to C ommo n Questio ns, an d a C ase-S tu dy App licatio n

Working P aper # 90-18by

John W . B oudreau, P h.D .Associate ProfessorC enter for A dvan ced Hum an R es ou rce S tud ies

Schoo l o f I ndus tr ia l Rela ti on sCornel l University393 Ives H allIthaca, New York, 14851-0952 USA(flJ7) 255-7785

P re se nt ed t o:I ns titu te f or Per sonnel Managemen t- -New Zea la ndAsia-Paci fic Conference"Beyond Restructuring"Auc kla nd , New Z ea la nd1 2-1 4 S ep temb er, 1 99 0

This paper has not undergone form al review or approval of the faculty of the ILR School. It is intended tom ak e resu lts of C enter research , con feren ces, an d p ro jects av ailable to o th ers interested in h um an resou rcem an ag emen t in p re lim in ar y fo rm to en co ura ge d is cu ss io n a nd s ug ge stio ns .

Copyright (c) 1990 by John W . B o u d r e a u


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Q ue stio ns a nd A ns we rs a bo ut C os t-B en efit A na ly sis a nd E va lu atio n Page 1

Wha t is "Cost-B en efit" A na ly sis?Cos t-b en efit an aly sis is a d ecisio n-mak in g te ch niq ue th at in vo lv es ex plic itlyconsidering the position outcom es (benefits) as w ell as the negative outcom es (costs) ofdifferent decision alternatives. It is used to m ake decisions more consistently,system atically and correctly. It is also useful in communicating about decisions w ithothers.Traditionally, such analysis has been used in m any areas of m anagem ent (such asMarketing, Finance and Operations), but has received much less attention in H umanR esource M anagem ent (HRM ). O ften, this m eans that decisions about HRM program s arepresented in less quantitative tenns than decisions in other m anagem ent areas. Faced w ithlim ited resources, top m anagers m ay allocate resources to the m anagem ent functions thatcan "com e up with the numbers." This may m ean that resources are not allocated to HRMprogram s even when they offer very attractive organizational payoffs. R ecently, H umanR esource Managem ent professionals and scholars have begun to develop approaches forevaluating the payoff or usefulness of hum an resource m anagem ent program s and decisions.Though m any of these techniques focus on dollar values, the m ain purpose of cost-benefit analysis is to im prove decisions and to use inform ation m ore effectively. Thus,cost-benefit analysis is sim ply any technique that helps to identify the positive as w ell asnegative outcomes o f decisio n o ption s to improv e d ecisio n quality, efficien cy an dcomm unicabi li ty.

What kinds of questions does cost-benefit analysis attem pt to answ er?Though the approaches vary, m y own view is that HRM m anagers m ake decisionsabout hum an resources. They are the stewards of one of the largest and m ost im portantresources available to accomplish organizational goals. It is their responsibility to help line

m anagers m ake decisions that m anage this resource in a businesslike w ay, to accomplishs trateg ic goal s.Cost- bene fit a na ly sis add re ss es que stions lik e:

* Is the return to our expenditures on HRM program s adequate to justify theseinvestments?* Is it w orth investing som e resources to im prove the quality of our hum an resources?* H ow can a m anager choose betw een different options for m anaging hum an resources(such as training versus selection, or tw o different compensation system s) in a w ay

that m axim izes the return to the investm ent?* H ow can we m anage with uncertainty about program outcom es, and yet avoidbecom ing paralyzed by our reluctance to take risks in our hum an resourceprograms?* How can we better determine when we know enough to m ake a decision, and whento inv est reso urce in better measu ring /fo recastin g human resou rce programoutcomes?

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Questions a nd A ns we rs a bo ut C os t-B en efit A na lys is a nd E va lu atio n Page 2A re these co st-ben efit m od els compa tible w ith fin an cial an alysis?

Yes. Just like any m anagem ent decision, hum an resource m anagem ent decisionsinvolve using organizational resources (such as m oney, tim e and facilities) in the hopes ofaffecting em ployee productivity (or som e other desired outcom e). Just as w e can analyzean investm ent in a new tool or plant in term s of the expenditures necessary and theexpected change in productivity that results, so w e can analyze investm ents in hum anresources in term s of the expenditures necessary to develop and im plem ent program s, andthe expected resulting effect on work force value.In fact, one can apply a "cash-flow " analysis to hum an resource decisions thatparallels trad ition al cash-flow analy sis in fin ancial manag ement. O ften , h uman resou rceprogram s em erge as lucrative investm ent opponunities. Such analysis is compatible w ith"va lue -based management. "

Is cost-b enefit a na lysis different from human resou rce a ccou ntin g?

Y es. C ost-benefit analysis focuses on hum an resource m anagem ent decisions. It isdesigned as a tool for m anagers to organize and communicate their decisions m oresys tematica lly and rat ional ly .H um an resource accounting typically focuses on com puting the "value of hum anassets" or on "putting hum an assets on the balance sheet." This has proven to be difficult,and no generally acceptable procedures have em erged. M oreover, even if such estim atesw ere available, hum an resource accounting provides no fram ework for using suchin fo rma tio n in d ec is io n mak in g.In contrast, cost-benefit analysis begins w ith the decision. It focuses on determ iningwhich alternative is the best resource investm ent by specifying the alternatives to be

considered, the resources each alternative requires, and the likely changes in w ork forcevalue that each alternative w ill produce. T hus, cost-benefit analysis focuses on thedecisions to be m ade, and their effects on a dynam ic w ork force, rather than on proceduresfor estim ating the value of hum an assets at one point in tim e.

Don't you need very precise inform ation to do cost-benefit analysis?Managem ent decision inform ation is never perfect. Every m anagem ent decisioncontains educated guesses and ranges of possible outcom es. This has long been acceptedin fin an cial, mark etin g a nd ope ra tio ns d ec is io ns.The key is to focus on the decisions being made, and the value of inform ation forsuch decisions. If im precise inform ation is likely to lead to w rong decisions aboutim ponant issues, then it m ay be appropriate to invest in better m easurem ent. H ow ever, ifcost-benefit analy sis b ased o n existing (and imperfect) information su gg ests that thedecision would be the sam e for a wide range of values, it probably doesn't matter as m uchif yo ur in formatio n is imperfect.

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Q u e s t io n s a n d A ns w e r s a b o u t C o s t - B e n e f i t A n a ly s is a n d E va lu a t io n Page 3How does cost-benefit analysis fit w ith "Q uality" enhancem ent?

Every m odel for im proving quality in m anufacturing or service em phasizes the needto understand custom er or client needs, m easure achievem ents in term s of those needs, anduse m easurem ents to adjust processes so that the needs are better m et. For m any clients ofthe personnel functions, such as line m anagers and shareholders, m eeting their needs m eansdem onstrating com petitive return on investm ent. In a very real sense, the resources used tosupport hum an resource program s/processes could also be used to buy new equipm ent, paystock dividends, or purchase raw materials. T hus, the results of personnel investm entsmust produce enough value to justify shifting the resources from these other purposes.Cost-ben efit an aly sis pro vides a framework an d sy stem fo r u nd erstan din g what info rmationbest reflects the needs of clients, and how to organize and use that inform ation so thatprogress tow ard m eeting client needs is clearly evident. C ost-benefit analysis shifts thefocus aw ay from simply im proving personnel processes an d toward improv in g personnelbusiness ou tcomes .

W hat does cost-benefit analysis im ply for autom ated personnel inform ation system s?First, autom ated inform ation system s allow us to gather, process and dissem inatepersonnel inform ation more quickly, accurately and efficiently. T his can m ake it feasibleto conduct cost-benefit analyses that m ight have been prohibitively costly w ithout easyaccess to data.S econd, the cost-benefit fram ework helps us understand where autom ated system scan add the m ost value by supporting business-related decisions. A utom ation cansom etim es add value by reducing the costs of processing and adm inistering inform ation.This clearly adds value w hen the inform ation m ust be processed and adm inistered to satisfyG overnm ent or other requirem ents. H ow ever, m uch of the inform ation included inautom ated system s is not gathered to satisfy G overnm ent or other requirem ents--it is

gathered because som eone inside the organization presum ably uses it. This second kind ofinform ation is "discretionary" because no one requires that it be kept or dissem inated.E xamples of this second kind of inform ation include salary surveys, attitude surveys,tu rn ov er ra te s, a nd p erfo rman ce ra tin gs.

What determ in es th e va lu e o f "d iscretio nary" in fo rmatio n?D iscretionary inform ation adds value only if it satisfies tw o requirem ents: (1) H aving theinform ation must correct future decisions; and (2) T he consequences of the correcteddecisions m ust be im portant. In sim plest term s, the num ber of corrected decisionsm ultiplied by the difference in value betw een being correct and incorrect equals the valueof the inform ation. W hile it is seldom possible to calculate this value precisely, it is oftenpossible to use these principles to diagnose areas w here the value of inform ation can beenhanced, or w here valuable inform ation exists but is not being used effectively.Once the value of the information has been identified, it m ust be com pared to the costs ofgathering, processing, dissem inating, and using that inform ation. T hese costs can below ered through autom ation, but it does little good to low er the costs of producing uselessinform ation. V alue and cost m ust be considered together.

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Q u e s t io n s a n d A n s w e r s a b o u t C o s t - B e n e f i t A na ly s is a n d E v a lu a t io n P a g e 4

C a n c o s t - b e n e f i t a n a ly s is b e u s e d to m e a s u r e t h e v a lu e o f c o m p e n s a t io n in fo rm a tio n ?C onsider an exam ple in w hich an organization is considering developm ent orpurchase of a computer application to provide job evaluation inform ation to compensationanalysts. Job evaluation inform ation includes descriptions of jobs and procedures totranslate the descriptions into pay levels that logically relate to other jobs in theorganization, and other sim ilar jobs in com peting organizations. A ssum e that theorganization's job analysts evaluate about 100 jobs per year, and about 20 evaluations areincorrect because they are based on outdated inform ation. The com puter application systemwill correct 18 of these 20 wrong evaluations each year. Thus, the quantity of correcteddecisions (Factor #1) is 18. Further, suppose that w hen a job is m is-evaluated, theorganization know s that this increases the pay of at least 10 job incum bents by $2,000 peryear, and that it takes about tw o years to discover this m istake. Each m is-evaluated job,then, costs $40,000 (that is, 10 em ployees times $2,000 times 2 years). Thus, the value ofcorrecting each decision (F actor #2 above) is $40,000. F inally, suppose that developm entof a com puter system that can actually help correct m is-evaluated jobs w ill require up-front developm ent costs of $700,000 plus $60,000 per year m aintenance and operationcosts. If we evaluate the system over a five-year period, the total cost w ill be $1 million(or, $700,000, plus 5 tim es $60,000).Does th is computer a pplica tio n p ro vid e in fo rmatio n th at impro ves jo b ev alu atio nenough to offset system costs? Is the system w orth the $1 m illion investm ent required? Toget the yearly value of the system , w e sim ply m ultiply the num ber of corrected decisionsin each year (18 decisions) by the value of each corrected decision ($40,000) to get ayearly value of $720,000. Over a five-year period, the new system w ill provide roughlyfive times this value, or $3.6 million dollars, at a cost of $1 million. This is a substantialreturn on the com puter system investm ent. In fact, the investm ent w ould still payoff evenif the system cost is substantially higher, or if the num ber of corrected decisions or thevalue of each corrected decision is sm aller. W hile this exam ple w as sim plified, and w eassum ed w e had the num bers available to m ake the necessary com putations, the principles

em bodied in the exam ple can apply to m ore com plex decisions or to decisions w here thenumbers are m ore doubtful.

A C ase Study A pplying Cost-B enefit PrinciplesA nd B reak-Even A nalysisH um an resource program s are activities designed to increase the value of one orm ore groups of em ployees. Exam ples m ight include training program s, tests or interview s,career counselling, m erit-based compensation, team building or benefit program s. T his casestudy illustrates how to im plem ent a cost-benefit approach to such decisions. It follow s aten-step process that helps to identify and organize decision inform ation, and present it in a

w ay that is system atic and com patible w ith other financial and m anagerial system s, such as"value-based strategic m anagem ent." A s you consider applying this technique, you w illrealize that you may be unable to make precise estimates for m any of these factors. Don'tbe concerned. The main purpose of these concepts is to provide a framework foro rg an izin g y ou r th in kin g. Info rmed ju dgmen ts, where n ecessary , a re p erfectly co nsisten tw ith m anagerial decisions. In fact, one advantage of this approach is its ability to provideana ly sis w ithou t p erfe ct p re cisio n.

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Cost-Benefit Ana ly sis Cas e S tu dy , Page 5

Ten Steps in Applying Cost-Benefit AnalysisT o Identify B reak-E ven R elationshipsStep One: Define the Decision Issue, Relevant Stakeholders, Target Group andObjectives.Step Two: Define the Decision OptionsStep Three: List the Potential Outcomes of Each OptionStep Four: Estimate the Total Cost of the OptionsStep Five: Calculate the Leverage (N um ber of Person-Y ears A ffected) of Each O ptionStep Six: Com pute the Total Payoff Form ula for Each O ptionS tep S even: C ompute B reak-E ven Values F or E ach Option IndividuallyStep Eight: Com pute the D ecision Rules for Choosing Among O ptionsStep Nine: Compare the List of Outcomes from Step Three to the Decision Rules and

Break -Even ValuesStep Ten: Evaluate Whether A dditional Inform ation Would P roduce Im proved D ecisions

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Cost-B ene fit A nalysiS C ase Study , P age 6Step O ne: D efine the D ecision Issue, R elevant Stakeholders, T arget G roup and O bjectives.Decis ion I ssue :First we m ust state the decision issue or strategic problem that you want to exam ine in your cost-benefitanalysis. This should be an issue that is im portant, strategic and related to com petitive advantage, butalso a specific gap between current and desired conditions. A one or two-sentence descriptions issufficient. It is often helpful to state the issue in the form of a question. For this case study we are. faced w ith the strategic goal of increasing skills, so w e express the general decision issue as:. "W hat is the best method for enhancing equipment maintenance skills among our operator work force?"Relevant Stakeholders :

Relevant stakeholders are those w ho care about, or are affected by the outcom e and effects of thehum an resource m anagem ent decision. In this case, they include the hum an resource program initiatO rs,the em ployees affected by the decision, their supervisors, others w ho w ork w ith the em ployees, andposs ib ly customers and supp lie rs .T arg et Emp loy ee G ro up :

This is the group of em ployees directly affected by the program s being considered. Thedescription should include the number of employees, their w ork description, and their organizationalposition. It should also include their average tenure or the length of time the program is expected toaffect their value to the organization. For the skill-enhancem ent issue the target group is:"T his program w ould enhance the skills of 1,000 process operators, by adding skills in m aintenance asw ell as operations. These operators m onitor and adjust various m anufacturing tools and m achines. Theyare in non-supervisory positions. T hese operations and m aintenance skills rem ain im portant to jobperform ance for five years, after w hich tim e they m ust be updated to reflect technological changes."Broad Object ives:

These are the objectives of the program (that is, the gaps, needs or problems the program isdesigned to address). K eeping in m ind the critical business needs identified earlier, plus the internal andexternal stakeholders, w e describe behaviors or results the program should affect. T he skill-enhancem entiss ue obje ctiv es m ight in clude :"(1) C ost reduction through enhanced ability to sw itch employees betw een operation and m aintenancetasks; (2) Im proved quality through m ore com plete job aw areness; (3) Shorter m achine dow n tim e."

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C os t-B en efit A na ly sis C as e S tu dy > p ag e 7

Step Tw o: D efine the D ecision O ptionsNow that w e have precisely stated your strategic decision issue, the target em ployee group, andthe general program objectives, w e identify the set of choices or "alternatives" available to you foraddressing the issue. These represent specific alternative approaches that m ight be used to address theissue described above. If possible, the description should include:

1.2.3.4.'5 .

Activ itie s req uired to de velo p th e a lte rn ativ e pro gram s.A ctivities involved in carrying out the ongoing program .N um ber of em ployees affected by the program in each future tim e period.R equired off-the-job tim e of participants (if any).O ff-site a nd on-site fa cility re qu irements.

Include any other factors that m ight be related to cost and benefit differences betw een alternatives. Tryto clearly distinguish each alternative from the others.For the skill enhancem ent decision, w e m ight identify tw o alternatives:O ption A :Use staffing to hire 200 new process operators per year over the next five years. The new hiresw ould have tw o-year degrees or equivalent experience in skills required for m aintenance (e.g.,electronics, m echanics, etc.), in addition to the previous requirem ents for process operators. T hiso ptio n wou ld in vo lv .e estab lish in g ad ditio nal screen in g req uiremen ts, some in terv iew train in g, an drecru itin g ta rg eted to d iffe ren t ed ucatio nal in stitutio ns. O rien tatio n activ ities wou ld also b eenhanced to reflect increased job scope including m aintenance as w ell as operations. Programdevelopm ent w ould require 300 hours of personnel staff. O ngoing staff requirem ents w ouldinclude an additional 10 hours per hired operator, or 2,000 additional staff hours per year.A ttracting highly-qualified employees w ould require that new hires be paid $2/hour m ore thanregular entering process operators (plus 50% in benefits). B etter-selected employees w ould beassigned to jobs w here these operations and m aintenance skills rem ain im portant to jobperform ance for five years, after w hich tim e they m ust be updated to reflect technologicalchanges . "O ption B :C ontinue to hire new process operators w ithout advanced skills, but institute a training programfor existing process operators to upgrade their skills commensurate w ith m aintenance. This w ouldinvolve having operators attend advanced technical training trough a one-year program developedw ith a local U niversity. T he program w ould involve 100 hours of developm ent activity requiringa personnel staff m em ber w orking w ith the U niversity. T hree-hundred operators per year could betrained during the first three years, and 100 in Year four, to reach the desired total of 1,000.University tuition would be $1,500 per person. Classes w ould be half off-site during work hours.Approxim ately 10 hours per w eek for 40 w eeks per person is required for the training.Candidates w ould volunteer for the program , but would also be paid an average of $2/hour m ore

than regular process operators after training. B etter-trained employees w ould be assigned to jobsw here these operations and m aintenance skills rem ain im portant to job perform ance for five years,after w hich tim e they m ust be updated to reflect technological changes."

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Cost-Benefit Ana ly sis Case S tu dy , Page 6Step Three: List the Potential O utcomes of Each Option

In this step, w e identify the potential positive and negative outcom es of each option. W e don'thave to know for sure exactly what the effect w ill be, but we want to list as many of the possibleim portant consequences as we can. W e use this step to ensure that we have thoroughly considered theram ifica tio ns o f o ur d ecisio n.For the skill enhancem ent decision, the tw o options obviously differ in the num ber of operators

. w ith enhanced m aintenance skills. In addition, how ever, it m ight be anticipated that the cam pus programw ould have a different effect from reassigning existing operators and hiring new ones to replace them .

. W e can express the outcomes in the form of a matrix as follows:Outcome Option AOperato r Reac ti onSupervisor Reac tionReduc ed h irin gIn cre ased p roduct qua lityLess m achine dow n tim eMaintain s p romo tio n from w ithinP roductio n Spe ed

Option BNegativePositive40 per year5% per year100 hou rs le ss/y ea rNo10% Imp roved

PositiveModerate60 per year7% per year100 hou rs le ss/y ea rYes7% Improv ed

Step Four: Estimate the Total Cost of the OptionsN ow, w e estim ate the cost elem ents for the alternatives identified above. For som e of these cost factors,records m ay provide fairly precise inform ation. For others, you m ay not have precise inform ation. K eepin m ind that exact cost inform ation is not usually necessary to enhance decision m aking. Therefore, w edo the best you can (even if it involves m aking educated guesses about som e factors).

A "cost" is the value of any resource you must use in order to pursue an alternative. Some costsare direct expenses w hich require out-of-pocket paym ents to em ployees or third parties. Som e costs areopponunity costs that do not require out-of-pocket expenses, but do involve using organizational resourcesthat could have been used for other purposes (such as the lost time on the job of trainees, trainers, orinterview ers). These costs are estim ated by considering the value that the resources w ould produce intheir next best alternative use.It m ay also be helpful to consider initial developm ent costs (those that occur only once at thebeginning of the program) as well as on~oin~ costs (those that occur as the program is carried out, andcontinue as long as the program continues).For the skills-enhancem ent issue m ight w rite the follow ing analysis (this is just an exam ple, thesenumbers are hypothetical, and an actual analysis w ould include more cost factors):

Cost F ac to rD evelopm ent Fees (Y ear 1 only)Staff P rogram D evelopmen t T im e (Y ear 1 o nly )Ex tr a S ta ff ing Admin is tr at ion (S-Year total )Recrui ting/Selection Materia ls (S-Year to ta l)In cre ase d Compensa tio n Costs (S -Y ea r to ta l)T rainee T im e (A ssum in g $1 0/hou r p ay lev el)T ra in ee Ma te ria ls ( S-Year to ta l)Training Tu it ion (S-Year total )

Five-Y ear T otal C ost E stim ate

O ption A Option B$20,000$1S,000$2S0,000$SO,OOO$18,720,000NoneNoneNone

$30,000$5,000NoneNone$23,712,000$4,000,000$2S,000$1,SOO,000$29,272,00019,055,000

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S tep F ive:Cost-B enefit A nalysis C ase S tu dy , P age 9

C alculate the Leverage (N um ber of Person-Years Affected) of Each O ptionThe costs and benefits of a decision depend on its scope. A decision that w ill affect productivitym any years, that affects m any employees, or that affects critical em ployee characteristics has a larger scoThe scope of a decision is the number of employees and time periods it affects the value of the wforce. It is often easiest to think of a program 's scope in terms of employees and years. Human resourcdecisions m ay affect w ork force value for decades, but it is usually feasible only to explicitly consider th

. first five or ten years for planning purposes, and then make some assum ptions about the later years. A f. year analysis will be show n in the skill-enhancem ent exam ple, but your tim e fram e m ay differ.In the skill enhancem ent exam ple, A lternative A w ould select 200 new process operators per year.A lternative B would train 300 process operators in the first three years, and 100 in Year Four. Forsim plicity, let us assum e that 10 previously-selected or trained process operators w ould leave in each futuyear. The Leverage of each decision is 2,850 total person-years for Option A, and 3,650 total person-yeafor O ption B , calculated as follow s:

O ption AYear12345TotalsOption BYear12345Totals

Step Six:

Number Add ed20 020020 020 020 01,000

Num ber Add ed30 030 0300100JL1,000

Number Leaving1010101010

Number Leaving1010101010

Total Affected in the W ork Force1903805707609502,850 person-years

Total A ffected in the W ork Force29 058 087096 09503,650 person-years

Compute the Total Payoff Formula for Each Option

Based on the above analysis, the payoff functions for the tw o alternatives m ay be w ritten as follo

Where:

Payoff APayoff B

==

[2,850[3,650

x PA]x Pa]

$19,055,000$29,272,000

PA is the unknown average increase in w ork force value produced by O ption A per person-year, andPa is the unknow n average increase in work force value produced by Option B per person-year.

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Cost -B enefit A nalysis C ase S tucty, pag e' 0Step Seven: Compute Break-Even Values For Each Option Individually

Dividing the cost by the leverage for each alternative, w e get the value of the unknown payoff perperson-year that w ould cause the option's total value to just cover its total costs. These are called theb re ak -e ve n p ayoff le ve ls:Break-Even Payoff for O ption A (PA) = $19,055,000/2,850 = $6,686 per person, per yearBreak-Even Payoff for O ption B (PB) = $29,272,000/3,650 = $8,020 per person, per yearThis suggests that as if we believe that the effects of Option A will be to increase employee quality by a. least $6,686 per person-year, and that O ption B w ill increase em ployee quality by at least $8,020 per persyear, w e w ill cover the costs of investing in one of these program s. Notice that these values are m uchlower than the cost per trainee, which is $19,055 for Option A and $29,272 for Option B.

These break-even values are inform ative, but if both program s are expected to produce benefitsexceeding their break-even values, then w e need to determ ine how much better the m ore expensive progra(O ption B ) m ust be to justify investing in that program instead of O ption A .S te p E ight: C om pute the D ecision Rules for Choosing Am ong O ptions

We need to know w hen to choose the m ore expensive option (O ption B) instead of the less expenoption (O ption A ). So, w e calculate a form ula representing the Total Payoff from O ption B m inus the TPayoff from Option A. W hen this form ula is positive, B is the better investm ent, and vice versa.Payoff B - Payoff A = (3,650 X PB) (2,850 X PA)- ($29,272,000 - $19,055,000)

= (3,650 X PB)- $10,217,000 (2,850 X PA)This difference equals zero w hen: PB = (.78 X PA) + $2,799So, Payoff B > Payoff A if: PB > (.78 X PA) + $2,799

W hen PB is greater than this, the payoff from the m ore expensive Option B justifies doing it. W hPH is less than this, it is m ore cost-effective to do Option A.The D ecision R ules are:1.2.3.

If PA is less than $6,686 per person-year, elim inate O ption A .If PH i s less than $8,020 per person-year, elim inate O ption B .If rules #1 and #2 do not elim inate either option, thenDo Option B if: PB > (.78 X PA) + $2,799Do Option A if: PB < (.78 X PA) + $2,799

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C o st-Ben e fi t An a lys is Case Study, Page 11

S tep N in e: Compare the List of Outcomes from Step Three to the Decision Rules and Break-Even ValA lthough w e can never forecast the future perfectly, w e now know more precisely w hat infonnationour outcom es must provide to justify the more expensive program. For example, if we feel that the list ooutcom es for Option A suggest a payoff of $5,000 in value per person-year am ong the new ly-hiredoperators, then the payoff from Option B must be greater than $6,699 [or (.78 X $5,(00) + $2,799] tojustify using Option B instead. As the presum ed payoff from Option A gets larger, the payoff from OptioB must also get larger, but at a decreasing rate. Thus, when the quality increase per person-year from

Option A is high (e.g., $15,000 per person-year), Option B can produce equal total payoff at a smaller pe. person quality increase (e.g., 14,500 per person-year), due to its higher leverage value. The result of this.. com parison is the business case for investing in either Option A or Option B.

In the skill-enhancem ent decision, we w ould now return to our list of outcom es in Step Three, andevaluate w heth er that list suggests an obviously superior ch oice considering the fonnulas above.

Step Ten: E valuate Whether A dditiona l Information Would P roduce Im proved D ecisions.We can now detennine whether we need to gather more infonnation to m ake the estim ates from SThree more precise. Additional infonnation will be valuable to the extent that we believe it w ill show us

something to change our m inds, and that the change will be valuable for Kodak. For example, if we wervery unsure about the reduction m achine dow n tim e using the O ption A (external hiring) rather than OptioB (internal training) w e m ight do a pilot study or confer w ith organizations that have tried both options.However, if it is clear that Option B's work force quality increase will exceed that of Option A, we mighconclude that gathering such infonnation is not w orth the effort.

C on clu sio n an d Implica tio nsT hough this decision involves large cost-benefit im plications, and a good deal of uncertainty, w e hm anaged to systematically analyze it as an investment. W e have produced a set of formulas that showexplicitly the effects of our data and assum ptions, in term s that line m anagers can easily relate to theirbottom -line consideratio ns. Moreover, this form ulation allow s us to judge w hether m ore inform ation w illhelp us m ake a better decision, and to communicate our decision m ore clearly and efficiently.

J . B ou dre au

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Cost Benifit Analysis in HRM