What is cost–benefit analysis?
Cost-benefit analysis (CBA) is the primary appraisal tool at the options assessment and initiative prioritisation stages of the appraisal process. It is a rigorous, transparent, quantitative method that measures the degree to which individual initiatives generate net benefits (benefits minus costs) across Australia and allows comparison and ranking of options and initiatives.
CBA is a standard technique used all over the world and can be applied to a wide range of initiatives in a defensible, comprehensive, transparent and rigorous way. The CBA methodology set out in the ATAP Guidelines is tailored to suit transport initiatives in a multi-modal context and where a wide range of options are being explored.
CBA aims to identify and express, in monetary terms, all the gains and losses (benefits and costs) created by an initiative to all members of society and to combine the gains and losses into a single measure of net benefit (benefits minus costs). If the result, expressed as a net present value, is positive — that is, total benefits exceed total costs — implementation of the initiative will be an economically efficient use of resources: Australia, as a whole, will be better off. The words ‘as a whole’ are emphasised because there will be losers as well as gainers. A positive result from a CBA means that the total gains exceed the total losses.
CBA is a well-established methodology that is widely employed by government departments and consultants in a range of areas. It permits initiatives to be compared, not only in respect of different transport modes, but also between the transport sector and other sectors of the economy. It can also be applied to non-infrastructure solutions such as the introduction of new technology or changed management practices.
CBA aims to summarise, in a single number, the combined benefits and costs to all members of society. Non-monetised benefits and costs are considered and presented alongside the monetised results.
In contrast, financial analysis aims to summarise, in a single number, the combined benefits and costs to a single entity: the owner or operator (if leased) of the initiative. Financial analysis considers the monetary costs and revenues to the owner or operator contemplating the investment: in this analysis, benefits are replaced with revenues from sales minus operating expenses. Identifying and measuring benefits and costs are usually simpler for a financial analysis than for a CBA because in financial analysis, the analyst needs to focus only on cash flows. Financial analysis becomes more complicated when taxation and financing costs are also included in the analysis.
While analysts have considerable leeway in making assumptions, the rules about which benefits and costs to include in a CBA and ways of valuing them are, for the most part, straightforward. If correctly followed, a CBA can result in comprehensive coverage of benefits and costs, without double-counting.
Structure of CBA guidance
This Part of the ATAP Guidelines sets out general guidance for undertaking CBAs in a series of steps.
- Step 1: Specify the initiative and analyse options
- Step 2: Identify the benefits and costs
- Step 3: Estimate investment costs
- Step 4: Make demand forecasts
- Step 5: Estimate infrastructure operating costs
- Step 6: Estimate user benefits
- Step 7: Estimate cross-modal and network effects
- Step 8: Estimate safety benefits
- Step 9: Estimate externality benefits and costs
- Step 10: Discount benefits and costs, calculate summary results
- Step 11: Assess risk and uncertainty.
More detailed discussion of each step is provided in NGTSM 2006 Volume 5. For ease of use, the CBA category has the same chapter and section headings as the steps.
Category M of the Guidelines establishes related guidance on the application of CBA to specific transport modes and specific types of initiatives. The present coverage includes roads, public transport, rail transport, active travel, travel behaviour change, maintenance and flood mitigation. Future editions of the Guidelines will introduce other aspects such as climate change adaptation, regulatory change and other non-infrastructure initiatives.
The PV category of the Guidelines provides parameter values for public transport, road, rail and active travel and for environmental externalities.
The last chapter of this part of the Guidelines covers the adjusted CBA technique, which is a hybrid of CBA and multi-criteria analysis. Using the CBA as the starting point and retaining the monetary measuring rod of CBA, adjusted CBA avoids some of the deficiencies of score and weight systems of multi-criteria analysis (see Box 1 in F3). Productivity metrics (see Part T4) is a form of adjusted CBA, with the emphasis placed on impacts on national productivity.
Rapid and detailed appraisal
Part F3 of the Guidelines introduces rapid and detailed appraisal as the second and third stages of options assessment. This split of appraisal reflects the fact that the appraisal of initiatives is not costless. To limit the cost of assessing a large number of options in the early stages of identifying and sifting potential initiatives and options, a simpler 'rapid' assessment process is required. This also applies to smaller initiatives where the consequences of a wrong decision are small.
Rapid appraisal is a cost-effective way of gauging whether an initiative is likely to pass a detailed appraisal. The resources required for a detailed appraisal can then be expended only on initiatives that have a good chance of succeeding.
A rapid appraisal should consider as many benefits and costs as necessary to establish whether an initiative is worth developing further. Rapid appraisal assists with considering or rejecting options by assessing their net benefit, indicating their net economic worth.
It is appropriate to undertake a rapid appraisal as the only form of CBA for small-scale initiatives where the costs of a wrong decision are small. Jurisdictions will have their own views about what constitutes a small-scale initiative. The ATAP Guidelines suggest an upper limit of investment costs of about $15 million for small-scale initiatives. This figure may need to be adjusted over time.
Most small-scale initiatives will probably be for road and active travel, but small initiatives involving rail initiatives or technology solutions should be treated the same way. Intelligent transport systems initiatives will often fall into the small-scale initiative category.
A rapid CBA allows consideration of monetised benefits and costs. In a rapid appraisal, non- monetised benefits and costs also need to be explored at an indicative level.
The methodology used for rapid CBA is the same as for the detailed CBA. However, the estimates for a rapid CBA are less precise and the benefits and costs that are small, or difficult to estimate, can be omitted altogether.
The majority of initiatives submitted for rapid appraisal are likely to be at an early stage of development, with limited planning and limited available data. An estimate of investment costs is essential. Based on the experience of Australian jurisdictions, the expected margin for error in rapid CBAs for investment costs is -20 per cent to ±40 per cent.
Where any of the following benefits (or costs) amount to more than 10 per cent of total benefits (or costs), they should be quantified if possible:
- Changes in infrastructure operating costs
- Savings in transport user costs — vehicle operating costs
- Savings in transport user costs — time for passengers and freight
- Improvements in service quality to users (e.g. reliability)
- Gains for generated traffic or traffic using a new service
- Benefits or costs from route or mode diversion
- Savings in crash costs
- Externality impacts.
Where benefits or costs can be readily estimated using default parameter values (such as externalities), an estimate should be made, even if they amount to less than 10 per cent of the total benefits or costs. Where the estimation of a benefit or cost is impossible without using resources above a level appropriate for a rapid CBA, describe the impact qualitatively, with quantitative measures in physical units where possible.
Risks associated with the initiative should be discussed in qualitative terms. Particular attention should be given to risks that could lead to construction costs being substantially higher than estimated and risks that could lead to benefits being substantially less than estimated.
In a rapid CBA, externalities can be valued using ‘default values’ if this can be done with little effort. This helps to determine the significance of each externality benefit or cost.
Significant externalities should be re-estimated at the detailed CBA stage, with site-specific data and modelling, to obtain a more detailed value of the externalities. For detailed CBAs, studies may be required to obtain initiative-specific unit values for externalities. For the most part, other parameter values are well-established; hence, the same values are used in both rapid and detailed CBA.
The detailed CBA should include a comprehensive risk assessment with adjustments made to ensure the final results are not biased by over-optimistic estimates of benefits and costs. Sensitivity testing should also be undertaken; although, if a thorough risk analysis has been undertaken, sensitivity testing may not be required.