Table of Contents

            Introduction               

            The Economic Dimension of Decision-Making

            Analysis: Cost Benefit Analysis

            Conclusion

 

Business Decision-Making Process: Cost Benefit Analysis

Introduction

            Companies are constantly subject to the dynamics of the market which may lead to some unpredictable factors that may threaten the business.  Although the source of the decision-making processes may vary, ranging from the strategy-creation processes to the risk management initiatives, decision-making is a critical business activity as one decision may mean that the company has created a path that will lead to a particular result.

            This explains why decision-making tools have integrated a number of analytical elements in order to have the company gather sufficient information that will lead to the creation of a sound decision.  Decisions eventually lead to the identification of the courses of action, and as much as possible, the whole purpose of these decisions is to minimise the risk that the company may find itself in. 

            Essentially, whether the company needs to make decisions for the purpose of formulating a strategy or to respond to a certain event, there is the acknowledged presence of a problem which needs certain solutions.  These problems may range in various degrees and functions such as problems in the human resources or problems in the implementation of a project.  Another kind of problem that companies face are more long-term in nature such as challenges in expansion and the potential threats of the competition and new market entries.  In any case, these decisions also make it clear for the company to determine its mode of survival and at the same time, create a set of sound strategies that ensure the company’s continuous functions despite these challenges.

The Economic Dimension of Decision-Making

            As previously mentioned, when a company makes a decision, it means that the business somehow rejects other options.  Since there are cases which a business may be faced with only a few courses of action and that the means to address these problems can be only supported by a limited amount of resources, the tendency is that the company, through its managers or decision-makers, should make a decision which acknowledges the economic nature not just of the process but the effect of the decision as well.  As Henderson and Schlaifer explain (1963, p. 32):

The general nature of all these problems is the same. A group of limited resources must be shared among a number of competing demands, and all decisions are "interlocking" because they all have to be made under the common set of fixed limits. In part, the limits are set by machine-tool capacity, plant capacity, raw materials, storage space, working capital, or any of the innumerable hard facts which prevent management from doing exactly as it pleases. In part, they are set by policies established by management itself.

            Hence, these limiting factors already establish a representation of the presence of the principles of the supply and demand; this means that a business problem, which is seen to make an economic impact, is also addressed within a similar economic framework.  The utilisation of resources, for example, is expected to bring a certain result.  Hence, if a company makes a decision to expand, and the expansion initiative is to cost the company a significant of investments, these investments which will result to this expansion is expected to generate a greater amount of profit or an increase in the company’s productivity, which will also ultimately result to greater profits.  This is why even the smallest decisions such as whether the company should cut down on operational expenses such as monitoring the use of paper can eventually create a significant effect to the company due to the accumulative nature of these actions.

            This economic dimension, apparently, works both ways.  This is because when a company exists there are already the economic factors at work as running a business already causes the company money, hence, these expenses are expected to bring the company an expected set of benefits.  At the same time, a company may also consider the economic factors of its decisions.  Since the company exists within a greater environment which is determined by various market forces and dynamics, the tendency is that the mode of survival alone has already turned up the business’ expenses.  In order to assure the returns, certain decisions have to be made, and this can be seen in a number of tools that are used by managers in order to determine the potential opportunities of the company which it will use for its own advantage.

            A number of decision-making tools are being used by businesses, ranging from tools which allow the company to analyse its various environments to decision-making support tools such as strategic planning, which generally integrates a number of analytical processes such as the SWOT and the PESTEL analyses.  Some decision-making tools approach this process more on the economic perspective in which the analysis is defined and determined by quantitative methods that will result to data that can indicate the more feasible course of action.

  Analysis: Cost Benefit Analysis

            Since that decisions have to be made in order to give the company an intelligent conclusion as to the best actions to take with regards to a specific situation, these decisions also constantly consider the economic and financial effects of the whole situation.  Cost benefit analysis is a decision-making tool used by managers or decision-makers in which the process highly emphasises on the financial costs and financial benefits of the aspects that surround the decision. 

            Adler and Posner (1999) cite Dasgupta and Pearce as to the first stage development of the cost benefit analysis.  According to the authors, this practice was initially used by the American government when the Congress ordered various agencies to conduct a cost and benefits assessment of the government’s flood control projects.  At this point it is already evident that even for a government project, officials also had to consider the potential impact of the investment since the government had to budget its resources.  Eventually, the popularity of this process would increase among other administrative agencies, especially since this tool has allowed managers to make sound decisions when it comes to projects and funds allocation.

            The second development, according to Adler and Posner (1999), was through the rise of Progressivism by the end of the nineteenth century.  Progressivism proposes that the government should approach governance as based on scientific principles as opposed to the expected values-based politics.  The third development furthers this view through the adaptation of modern welfare economics in which governance is approached from a more rational perspective, and that this can be attained through the utilisation of economic principles (Adler & Posner, 1999).

            As a process, cost benefit analysis establishes a means for the decision-maker to determine the best possible solution to a problem by determining the costs of the potential solution or a call to change minus the relevant economic benefits (‘Cost Benefit Analysis’, 2007).  However, this is just a simple application of the tool.  In a number of more complex situations, cost benefit analysis requires a series of valuation processes depending on the concerned factors that surround the decision.      

            For example, the company decides to put up a nature spa in a wooded area; when the company decides to conceptualise and design this facility, cost benefit analysis usually looks at the financial elements involved with the project.  Hence, based on this analysis, the company’s decision-making knowledge base will have to be based on the economic factors of the project.  This is to say that the cost benefit analysis will result to decisions as based on the strategic selection of the right contractor, the right designers, the right project managers and other participating proponents all within the framework of the financial and economic factors of the project.  Therefore, the decision is based on what can be deemed efficient according to the funds allocation of the project instead of addressing other factors such as the effect of the project to the stakeholders, most especially the environment.

            In a way, a number of decision-making issues in the contemporary context can be observed to have been creating serious ethical issues, most especially those that concern the environment.  One of the main issues today is the debate on global warming which has been cited to be caused by the governments’ and the corporations’ priorities to constantly have the competitive advantage, especially in the growing competition in the global economy today; a good example is the effect of industrialisation which ultimately produces all kinds of pollution.  Hence, the resolutions that these decision-makers have been making have been mostly focused on the financial and economic benefits, and that the element of costs have overlooked the effect of the decision on ethical issues such as the environment and the greater part of the society who does not benefit from these strategies.

            As Adler and Posner point out (1999), this explains why cost benefit analysis has had its criticisms, and this is because this decision-making tool “sometimes produces morally unjustified outcomes” (p. 165).  Although it can be argued that cost benefit analysis is tool and “not a moral standard” (Adler & Posner, 1999, p. 165), decision makers use this process as a justifiable means to make decisions according to the quantified expectations of the initiative.  Hence, going back to the example on the nature spa construction and instances in which these decisions have caused harm to the environment and the society, given that economic benefits typically outweighs the other issues, cost benefit analysis does create a framework of effect to the decision-makers since that the results of this analysis are more definitive because of its quantitative nature.  This is why between idealistic concepts proposed by social responsibility initiatives and the solutions proposed by cost benefit analysis, the data gathered from the latter is immediately seen through monetary values such as the millions of dollars that are going to be spent versus the millions of dollars that are going to be generated out of this investment.

            However, since that there is the reality of the placement of value in the “progressive” world today, even the social responsibility measures have also engaged in the utilisation of cost benefit analysis.  This is to say that although this methodology is initially intended for financial purposes, social initiatives such as the environmental advocacies have also taken cost benefit analysis as a “subjective science” (Schmidt, 2003).  This has been done by means of including intangible items in the overall valuation although assigning values for these intangibles have to be estimated accordingly otherwise the whole scientific methodology of cost benefit analysis will be defied (‘Cost Benefit Analysis’, 2007).

Conclusion

            Decision-making processes in the modern business world require that companies have to constantly consider its main function to generate profits for its business within the expected strategic framework.  Hence, since businesses have been long fuelled by economic and financial factors, decision-making tools have constantly integrated the financial aspects of every decision that has to be made.  Cost benefit analysis is one of the decision-making tools which demonstrate the economic dimension of decision-making as this analysis utilises valuation procedures in order to determine the soundest decision for a particular issue.  However, since cost benefit analysis emphasises the financial and economic values of the factors that surround the decision, the tendency is that the ethical, social, moral and environmental impacts of the decision are overlooked. 

            As a procedure, it can be considered that cost benefit analysis does have its strengths, but the tool can be only criticised as to how this procedure is used by the decision-makers.  Hence, cost benefit analysis is actually a very helpful tool although if the decision-maker mostly focuses on the economic and financial benefits, cost benefit analysis can potentially take away the attention on other equally important issues.

 

References

Adler, M. & Posner, E.  1999.  ‘Rethinking Cost-Benefit Analysis’.  Yale Law Journal,           vol. 109, no. 2, pp. 165.

‘Cost Benefit Analysis’.  2007.  Mind Tools.  [Online] Available at:        http://www.mindtools.com/pages/article/newTED_08.htm

Henderson, A. & Schlaifer, R.  1963.  ‘Mathematical Programming’, New Decision-  Making Tools for Managers: Mathematical Programming as an Aid in the Solving of             Business Problems, E. Bursk & J. Chapman (Eds.)  Harvard University Press,          Cambridge, MA.

Schmidt, C.  2003.  ‘Subjective Science: Environmental Cost-Benefit Analysis’.         Environmental Health Perspectives, vol. 111, no. 10, pp. 530+.