How to Conduct a Cost-Benefit Analysis Overview F = N [(E x M) – C] When people begin to talk about cost-benefit analysis, cost-effectiveness analysis, and return-on-investment, they often envision eye-glazing mathematical gobbledygook. Even when the letters in equations like the one above are explained, people may have difficulty applying real-life situations to the neatly abbreviated variables. Yet, determining whether training is a viable solution to a performance problem or which of several available training courses would be most cost effective are important aspects of a trainer’s job. These management techniques are mandatory in today’s business environment, where pressures on the bottom line often require “solid” financial results. Training should not—cannot—be relegated to the “first cut” position in any company. It can be difficult, however, to find the financial justification necessary to prove the importance of training. This Info-line will present a highly simplified model for cost-benefit analyses, with easy-to-follow instructions for conducting cost-benefit analyses and sample worksheets, and will attempt to demystify the business solutions embodied in the formula above. Cost-benefit analysis and cost-effectiveness analysis are often (wrongly) used interchangeably. Although they are similar in nature, they are subtly different. A cost-benefit analysis is simply a comparison of the cost of a thing, in this case a training program or course, and the benefits—increased productivity, fewer mistakes, less absenteeism—that result from the training course. Cost-benefit analysis is a data collection process. The trainer needs to set goals, impose constraints, and determine the types of data required for the analysis. For example, the trainer may decide that the analysis will demonstrate that a course is the most effective means of solving a performance problem. Cost-benefit analysis consists of three steps: Calculate costs, calculate benefits, and compare the results. A cost-benefit analysis enables trainers to make these types of training decisions: Is training a viable solution to the problem? What are the priorities of the training programs? Do the benefits of the program outweigh costs? Is the program beneficial to the organization? In short, cost-benefit analysis helps trainers and managers decide what to do. Once the decision has been made that training is the most effective method of “treating” the problem, a cost-effectiveness analysis determines the most cost-efficient intervention and is basically a comparison of several cost-benefit ratios. A cost-effectiveness analysis suggests how to: choose among several alternatives assess the most cost-efficient delivery method determine whether to continue a project compare all alternatives assess the consequences of doing nothing Where the cost-benefit analysis shows trainers what to do, cost-effectiveness analysis helps train- ers determine how to do it. Another difference between cost-benefit analysis and cost-
effectiveness analysis is that a cost-benefit analysis requires quantification and costeffectiveness analysis includes intangible benefits that cannot be quantified. Quantification is the most difficult aspect of any type of analysis and will be covered in greater detail later in this issue of Info-line.
Costs
The most difficult part of conducting a cost-benefit or cost-effectiveness analysis is to determine what the costs and benefits of a training program are and to place a dollar value on them.
Valuing Costs Once a decision is made about what to include as the costs of designing, developing, and delivering a training program, valuing those costs is relatively simple. The first step is to decide what costs to include. Several models have been developed to help trainers decide what training costs to incorporate in the analysis. Most models include: Personnel costs These include all salaries, consulting fees, and wages, including lost production, involved in the design, development, and delivery of a training course. Training materials These include development and delivery of expendable training materials such as handouts, workbooks, and flip charts; and nonexpendable training materials such as reusable slides, instructor manuals, and permanent transparencies. Delivery costs These include the wages and salaries of both the trainer and the trainees, travel costs, equipment and facility rentals, meals, and site tour fees. Once the trainer determines the costs to be included in the cost-benefit analysis, he or she needs to estimate the cost of a prospective program. Most estimates are based on the expected time involvement of key personnel and resources. All costs should be rounded to the nearest dollar. A simple way of making the estimates is to check costs involved in the development and delivery of a similar, recent training program. This “historical data” can be used as a guide to determine time frames, personnel costs, development costs, and implementation costs. A rule of thumb when estimating training development costs of classroom training is 60 to one; that is, 60 hours of development time for one hour of training. Self-paced or interactive training requires about 200 hours for one hour of training.
Four Steps to Calculating Costs
To determine the costs of a training project, a trainer needs to calculate: all personnel costs all materials costs all delivery costs total expenditures Each of these steps has substeps. Although numerous, they are relatively simple.
Step 1: Personnel Costs Personnel costs are figured by determining wages and salaries for the personnel involved. Wages and salaries can be calculated in two ways: Direct labor costs Simply salary or wages divided by the number of days or hours worked. The U.S. average for number of days worked is 230. Full labor costs Salary or wages plus fringe benefits (vacation and sick leave, holidays, health and life insurance, and pensions) plus overhead (facilities costs, support staff salaries, and equipment) divided by the number of days for which an
individual is paid. The U.S. average for days paid is 260; 35 percent of salary is paid in fringes; and overhead is 125 percent of salary plus fringes. As a rule, full labor costs are approximately three times direct labor costs. To calculate the personnel costs involved in the design and development of a training course, the trainer needs to: 1. Identify the steps involved in the training program (design, development, writing, editing, production, and so forth). 2. Assign an approximate time of completion for each step. 3. Determine the contributors to each step (writers, instructional designers, trainers, artists, subject-matter experts, word processors, administration, and so forth). 4. Estimate the amount of time (in hours or days) required of each contributor. 5. Calculate the salary (in hours or days) of each contributor. If the trainer cannot get the exact salary figure for the contributor, ask personnel for a salary range for the position and use the average. 6. Multiply the hourly/daily salary of each player by the amount of time each player will devote to the project. 7. Add resulting salary figures to determine total personnel costs.
A Case Study A national charity wants to develop a course on fundraising. The new course needs to cover the basic fundraising principles and steps, as well as customer service and public relations. The 16-hour (two-day) course will include exercises and provide trainees with a take-home reference manual. Development is expected to take two years and involve several field trials. Contributors will include active fundraisers as subject matter experts, a course designer who doubles as the project manager, a writer, an artist, and a support staff of word processors and administrative help. (NOTE: All supplies, support, labor, and materials costs are for use in the example only. They are not real costs.) After meeting with the staff of experts, the writer will present a first draft of both the instructor’s and participants’ manuals. After approval of the draft, the writer will work with a single subject matter expert to produce a field test version of the document. The writer and project manager will continue to work together to debug the course before it goes into final production for implementation. Using the ratios mentioned in the text, the project manager determines that development of the course will take 60 x 16 or 960 hours to develop to implementation and involve at least five people: the project manager, two subject matter experts, an artist, and the writer. The salary calculations would look like this: Project Manager Salary is $35,000 per year. Time involved on project = 200 hours. Costs will be calculated at full labor rate. Multiply salary by three according to the formula. Divide result ($105,000) by the number of days paid (260). Divide result ($404) by number of hours in a day (eight). Multiply result ($50) by number of hours allocated to project (200). Personnel costs for project manager are $10,000. Writer Salary is $40 per hour. Time on project is 400 hours.
Personnel costs are calculated at the direct wage rate. Multiply hourly rate ($40) by estimated hours (400). Personnel costs for writer are $16,000. Subject Matter Experts (Two) Salaries are $40,000 per year each. Time on project is estimated at 50 hours each. Personnel costs are calculated at the full-wage rate. Multiply salary by three according to the formula. Divide the result ($120,000) by number of days paid (260). Divide the result ($462) by the number of hours per day (eight). Multiply the result ($58) by the number of hours on the project (50). Personnel costs for the subject matter experts will be $5,800 ($2,900 for each expert). Artist Salary is $27,000 per year. Time on project is estimated at 60 hours. Personnel costs are calculated at the direct wage rate. Divide salary ($27,000) by the number of days worked (230). Divide result ($117) by the number of hours in a day (eight). Multiply the result ($15) by number of hours on the project (60). Personnel costs for the artist are $900. Total Personnel Costs Total personnel costs are $32,700 ($10,000 + $16,000 + $5,800 + $900). The chart on the next page shows these calculations graphically.
Personnel Cost Worksheet †
Contributor
Direct Rate*
Full Rate
Hours
Total
Project Manager
$35,000/yr
$105,000 4 260 = $404 4 8 = $50
200
$10,000
Writer
$40/hr
------------------
400
$16,000
Subject Matter ‡ Experts
$40,000/yr
$120,000 4 260 = $462 4 8 = $58/hr
50
$2,900
Step 2: Materials Costs Materials costs cover three basic items: Audiovisual aids. These costs include all expenses incurred for the rental, purchase, or production of audiovisuals. Expenses for artwork created by an artist, however, may appear under personnel costs for freelancers. Audiovisual aids include: videotapes/videodiscs, movies, and filmstrips slides and transparencies audiocassettes equipment or mock-ups Production costs. Any costs incurred in the production of course materials should be recorded under production costs. Examples of production costs include: word processing of field-test materials photocopying of field-test materials typesetting of final manuscript printing of all course materials collating and binding of course materials printing and calligraphy, if any, on certificates inventory maintenance To calculate the production costs of a training program, the trainer needs to: Identify all materials needed for the project. Determine the number of field tests and the projected number of participants at each test. Determine the number required for inventory after course introduction. Determine each type of material. Identify any “add-on” costs (use of color, for example) that affect the price of specific materials. Estimate price per unit for each specific item. Calculate total materials costs. If the production services are provided by in-house staff, an estimate needs to be made for this support. Calculating support costs consists of four steps: Identify all in-house services required for the development of the program. Estimate the amount of time required by in- house support services to perform those services. Estimate the number of revisions required. Estimate unit and total costs.
Step 3: Delivery Costs Delivery-of-training costs usually are less than design and development costs. Some trainers include the cost of expendable course materials under the delivery cost center. If the cost of reproduction is included in the materials costs, including the cost under delivery costs will result in a double charge. Delivery costs include: salaries of instructors and trainees travel expenses of instructors and trainees (air- fare, taxi, meals, hotel charges) conference room rentals tour fees refreshments
stationery Stationery includes all expenses relating to a program’s specific nonprinted supplies. If these items are provided by the conference center or hotel, their expense is listed under delivery costs. Examples of stationery items provided in training programs are: notebooks, spiral or paper bindings flipcharts lined pads pencils, pens, templates materials for games, mock-ups, or other activities paper clips, glue, tape, push pins purchased books, reprinted articles, or other bought handouts Calculating delivery costs requires that trainers: Identify the instructor who will deliver the course. Identify students who will attend the sessions. Determine refreshment costs. Estimate rental fees or equipment purchase costs. Determine miscellaneous costs. Estimate the stationery costs.
Step 4: Total Expenditures Now that all of the costs associated with the design, development, and delivery of the training course have been identified and written down, figuring the total costs associated with the course is easy. Simply add them all up.
Benefits
The most difficult part of doing a cost-benefit analysis is quantifying the benefits of a training program. Quantifying benefits is difficult because many of the benefits of training—improved attitudes, increased knowledge—are intangible and therefore hard to attach dollar values to.
Tangible Benefits A tangible benefit is any gain directly resulting from training. A gain is either increased revenues or decreased costs. Tangible benefits occur in these areas: Time Time savings are perhaps the most common benefit from training programs. For example, if training can eliminate one one-hour meeting a week for five engineers to share new innovations they’ve read about, the company saves one hour of nonproductive time for each engineer. In this case, the time saved increases productivity rather than reduces costs.
A Case Study, Part II In the case of the fundraising course, the project manager decided to use two videos, 75 transparencies, a participant’s workbook provided in a three-ring binder, an instructor’s manual, and certificates of completion. Text was provided for pre-made flipcharts. To save time and money, the two videos were borrowed from the public relations department and copied. Lined paper and pencils would be provided during the course. The project manager then scheduled three field tests with 25 participants in each. She also estimated that the course would be given 10 times a year, using five different
instructors, with 30 participants in each class. (NOTE: All supplies, support, labor, and materials costs are for use in the example only. They are not real costs.) In the calculation of production costs, course materials are identified. A required amount for each type of course material is assigned and an estimate of the cost is determined, either through historical data or by contacting vendors for estimates. The specific items are then added to provide a total by type. The totals by type are then added together to give the total materials costs for the course. The chart on pages 7 and 8 shows these calculations graphically. Audiovisual Aids Total cost = $3,850 Videos Copying costs only. Fourteen copies are required, one of each for each trainer, plus two backups. Cost per copy = $50 Total = $700 ($50 x 14) Transparencies Copying costs only. Fourteen copies of each set of 75. Cost per copy = $3 Cost per set = $3 x 75 = $225 Total cost = 14 (sets) x $225 (cost per set) = $3,150 Production Costs Total cost = $24,355 Participant’s Workbook Total cost = $20,375 During the development phase, manuscript production will handled in-house. The final manuscript will be typeset and printed by a vendor. The workbook is 150 pages long. A vendor will charge $70 per hour and take 20 hours to process a disk the project manager provides. Printing will cost $15 per book. Word processing charges $45 per hour for typing originals and making revisions. The original 150-page document will take 40 hours to process; revisions will require another 40 hours. Cost of word processing = $45 x 80 = $3,600 Photocopying 75 copies of the manuscript for field tests will cost $25 each. Total cost = $25 x 75 = $1,875 Typesetting = $70 x 20 = $1,400 Printing = $15 x 750 = $11,250 Binders = $3 x 750 = $2,250 Instructor’s manual Total cost = $1,700 Word processing for typing originals and revisions. The 75-page manual will require 20 hours and revisions will require another 12 hours. Cost of word processing = $45 x 32 = $1,440
Photocopying 20 copies of the manual (six for field tests; 14 for inventory) at $13 each = $260 Certificates Total cost = $2,280 A certificate of completion will be given to each participant at the end of the course. Typesetting = $30 x 1 page = $30 Printing = $3 each x 750 = $2,250 Adding the totals for the production of the instructor’s manual, participant workbook, and completion certificates yields a total of $28,205.
Materials Worksheet Audiovisual Aids Slides Photographer
$
/hour
x
hours
=
$
Graphics
$
/hour
x
hours
=
$
Film
$
/roll
x
rolls
=
$
Processing
$
/roll
x
rolls
=
$
Writer
$
/hour
x
hours
=
$
Audio Production
$
/hour
x
hours
=
$
Synchronization
$
/hour
x
hours
=
$
Subtotal
$
Transparencies Production
$
/hour
x
hours
=
$
Reproduction
$3
/copy
x
1,050 copies
=
$3,150
Subtotal
$3,150
Videos Writer
$
/hour
x
hours
=
$
Director
$
/hours
x
hours
=
$
Camera person
$
/hour
x
hours
=
$
Sound person
$
/hour
x
hours
=
$
Editing
$
/hour
x
hours
=
$
Reproduction
$50
/tape
x
14 tapes
=
$700
Studio Time
$
/hour
x
hours
=
$
Location Time
$
/hour
x
hours
=
$
Subtotal
$700
Audios Writer
$
/hour
x
hours
=
$
Director
$
/hour
x
hours
=
$
Sound person
$
/hour
x
hours
=
$
Editing
$
/hour
x
hours
=
$
Reproduction
$
/tape
x
tapes
=
$
Studio Time
$
/hour
x
hours
=
$
Subtotal
$
Computer Designer
$
/hour
x
hours
=
$
Programmer
$
/hour
x
hours
=
$
Disks
$
/disk
x
disks
=
$
Software
$
/pkg
x
pkgs
=
$
Subtotal
$
Subtotal Audiovisual Costs
$3,850
Print Instructor’s Manual Word Processing
$45
/hour
x
32 hours
=
$1,440
Photocopying
$13
/each
x
20 copies
=
$260
Subtotal
$1,700
Participant’s Manual Word Processing
$45
/hour
x
80 hours
=
$3,600
Photocopying
$25
/hour
x
75 copies
=
$1,875
Typesetting
$70
/hour
x
20 hours
=
$1,400
Printing
$15
/book
x
750 books
=
$11,250
Binders
$3
/each
x
750
=
$2,250
binders Subtotal
$20,375
Certificates Typesetting
$30
/page
x
1 page
=
$30
Printing
$3
/each
x
750 certificate s
=
$2,250
Subtotal
$2,280
Subtotal Materials Costs
$28,205
To calculate this cost, multiply the time saved by the full cost of the engineer involved. If the engineers earn $65 an hour, multiply that by five. The total savings per week is $325 or $16,250 per year. Materials Materials costs can be reduced by improving quality control, inventory procedures, and materials handling procedures. For example, stock levels recorded by an inefficient inventory system can trigger unnecessary restocking or lost sales. If the item being misreported costs $10 and 500 are “lost” each month, the monthly savings incurred through an improved inventory system would be $5,000 a month or $60,000 a year. Equipment Cost avoidance by eliminating equipment down- time or increased revenues through improved productivity can result from better use of equipment. The first step is to determine the value of the equipment. To calculate equipment value, divide the cost of the equipment by the number of hours it will be used. A $20,000 car, for example, is used two hours each weekday. The equipment cost would be $20,000; time used will be 10 hours a week for 50 weeks (500) for 3 years = 1,500. Equipment value is $20,000 1,500 hours or $13 an hour. To calculate improved productivity, multiply the hours of increased usage by the equipment value. If the $20,000 car in the above example is driven one more hour a day, the increased productivity would be about $10,000 (15 hours x 50 weeks x 3 years = 2,250_1,500 [current usage] = 750 x $13 equipment value = $9,750). The calculation for downtime is the same as that for improved productivity. If the car in the example is unusable for a week, the cost in lost productivity is the weekly use rate (10 hours) times the equipment value ($13) or $130—in addition to costs incurred in repair or maintenance and replacement of the unusable equipment. Personnel turnover Replacing employees who retire, quit, or are fired is expensive. The cost of recruiting and training new people is about the same as the salary of the departing worker. Training that reduces turnover can claim the salary of each person “saved” as a direct benefit. Multiply the turnover rate by the number of people in a given job category. For example, the word processing unit has a turnover rate of 30 percent a year and a staff of 20 people. Their average salary is $18,000 a year. The turnover is costing the company $108,000 a year [(30 percent x 20) x $18,000 = $108,000].
The new figure is determined by subtracting the value of the new turnover rate from the old turnover rate. If training reduces turnover to 10 percent a year, the savings would be $72,000 (10 percent x 20 = 2 x $18,000 = $36,000; $108,000_$36,000 = $72,000).
Other Personnel Problems Attaching a dollar value to avoiding “people problems” is the most challenging aspect of quantifying benefits. “People problems” are events such as accidents, strikes, or grievances. The calculation for this benefit is a four-step process: 1. Identify the event. 2. Identify people involved in the event. 3. Calculate the full cost of each employee by day or hour (see discussion in personnel costs in the cost section). 4. Determine the total personnel cost lost to the event by multiplying the number of personnel involved by their cost per day or hour, and then by the number of days or hours involved. For example, a worker falls and injures his back. He is out of work for 10 days and makes $18.00 an hour. The cost in lost time of this accident, which may have been prevented by proper training, is $1,440 ($18 x 8 hours per day x 10 days).
A Case Study, Part III The project manager ran the “inaugural” course herself, which required that she travel to the Midwest from California. Her 25 participants would be drawn from four states. Five of the participants would live in the area and so not require airfare or lodging. The costs would be as follows: Instructor Total cost = $2,087 Airfare = $500 Lodging/food = $125/day for 3 days = $375 Salary = $404/day for 3 days = $1,212 Trainees Total cost = $30,750 Airfare = $300 average for 20 trainees = $6,000 Lodging = $300 x 20 = $6,000 Food = $75 x 20 = $1,500 Salary = average salary $230/day x 3 days = $690 x 25 participants = $17,250 Miscellaneous Expenses Total cost = $3,872 Telephone charges = $10 x 25 trainees and 1 instructor = $260 Local transportation = $50 per participant x 26 = $1,300 Cost of room = $2,000 Refreshments = $10 per participant x 26 = $260 Stationery costs = $52 Total delivery costs = $36,709
The chart on page 10 shows these calculations graphically.
Intangible Benefits An intangible benefit cannot be described by a dollar amount or other measurement. Since intangible benefits cannot be measured, they can’t be included in a cost- benefit analysis, but they can be used to supplement it. Even though intangible benefits are extremely difficult to quantify, they shouldn’t be ignored. Among the intangible benefits that can accrue from training programs are: Improved Productivity customer satisfaction employee motivation and achievement employee recognition increased employee responsibility career development potential value of the worker payback to profession or society Decreased Costs turnover tardiness alcoholism, drug abuse
The Analysis Overview
Once all the costs and benefits have been valued, it’s time to do the cost-benefit analysis. The analysis consists of two simple steps: 1. Compare costs to benefits. 2. Value the problem, the solution, and the result. The resulting analysis report should interpret the results of the comparison and provide recommendations about solutions. Comparing costs to benefits means determining which items are larger than others. Comparisons should be made of the totals and any similar line items. If the costs outweigh the benefits, the trainer can do several things: Decide not to go forward with the project. Change the course to make it less costly or to accrue more benefits. Emphasize that some benefits are more vital than the large costs or are long-term.
Delivery Costs Instructor Airfare
$500
Lodging/food
$125
/day
x
3 days
=
$375
Salary
$404
/day
for
3 days
=
$1,212
Subtotal
$2,087
Trainees (25 total) Airfare (average)
$300
x
20 participants
=
$6000
Lodging
$100
/day
x
20 participants
=
$6000
Food
$20
/day
x
3 days x 25 participants
=
$1,500
Salary (average)
$230
/day
x
3 days x 25 participants
=
$17,250
Subtotal
$30,750
Miscellaneous Telephone charges
$10
/participant
x
26 participants
=
$260
Local transportation
$50
/participant
x
26 participants
=
$1,300
Refreshments
$10
/participant
x
26 participants
=
$260
Cost of the Hall
$2000
Stationary supplies/other
$52 Subtotal Total Delivery Costs Per Session
$3,872 $36,709
Preparing the Cost-Benefit Analysis Report The cost-benefit analysis report should lead the decision maker to make the decision the report writer wants. It should include the cost and benefit worksheets, as well as the summary worksheet and narrative recommendations. The report should discuss the following items: 1. Existing problem. Management may not be aware that a problem situation exists that could be helped by training. The trainer should determine the dollar value of the problem by determining the lost revenue or costs resulting from the problem. 2. Training solution. The trainer needs to show that training will help reduce the impact of the problem on the company. By using the cost- benefit analysis, the trainer can show that the benefits of the training outweigh the costs. 3. Result. After the training is completed, the trainer can demonstrate the actual value derived from the program. Follow up and evaluate the results of the program and then state in dollar terms the actual savings that resulted.
A Case Study, Part IV The project manager lists all of the costs he or she assumes will accrue during the design, development, and delivery of this training course. The worksheet looks like this: Cost Summary COSTS Personnel
$32,550
Materials
$28,205
Delivery
$36,709
Total costs
$97,464
BENEFITS* Increased revenue
$250,000
*Estimated increase attributable to course in first year.
Equation Explained Does investing in training add enough value to our human resources asset to make it a priority investment?” Michael Godkewitsch asks in Training magazine. Godkewitsch presents an equation for determining whether the gain resulting from the training is worth its cost. The equation is F = N[(E x M) – C], where F = Financial utility N = Number of people affected E = Effect of the training M = Monetary value of the effect C = Cost of the training per person The first step in solving the equation is to determine the value of C—the cost of training per person. In the case study, the cost of training per person is $1,468. Assume that the effect of the training (E) was .44 of the standard deviation of the “before-and-aftertraining” change (established by management). The average salary of the trainees is $230 a day or $59,800, and monetary value of the standard deviation of job performance management decides is 40 percent of yearly salary or $23,920. Plugging these figures into the equation allows the trainer to solve it.
F = N[(E x M) – C] F = 25[(.44 x 23,920) – $1,468] F = 25[10,525 – $1,468] F = 25 x 8965 F = $224,125 This equation can be used for both new courses and yearly training activities.
