Balancing tangible and intangible costs and benefits
Businesses and government often need to make decisions that have both economic/financial and non-economic implications. An example of this is the actions currently being taken by governments to limit the spread of COVID-19.
Economists would usually apply a cost-benefit analysis to assess the suitability of these actions. In the case of COVID-19, a standard analysis would consider economic costs (broadly and personally) against a statistical or actuarial value of human life.
A pivotal example of this type of cost-benefit analysis is the Ford Pinto problem. The Pinto motor vehicle had a design flaw that meant a rear collision would rupture the car’s gas tank, often leading to fires and death of the passengers. On the basis of their internal cost‑benefit model, Ford determined that it was more economical to settle lawsuits than to recall their vehicles and correct the design. When it became clear that the reputational damage of this decision to Ford would be significant, the company issued a recall notice to fix the defect.
The Pinto problem, and policy actions in response to COVID-19, reaffirm that there are factors to consider beyond pure monetisation when responding to business and ethical problems. One approach that ACIL Allen has used to help clients make decisions in these circumstances is Holistic Value Measurement.
Holistic Value Measurement (HVM) can be applied in two ways:
- The first is as a method for understanding all factors that drive value – a ‘ledger’ of costs and benefits. An example of some of the factors related to COVID-19 is shown below.
- The second is as a tool that can quantify and compare all types of benefits, and provide a fuller picture of the value of proposed decisions.
Defining the COVID-19 costs and benefits using Holistic Value Measurement
Our application of the HVM framework includes four different types of value or outcomes.
The first is Economic value, which is the readily quantifiable factors such as cost and revenue. Two key drivers that may be considered for COVID-19 are the impacts of interventions on economic activity, and the economic value of human lives that would be lost otherwise. More specifically, these factors can include expected net taxation/benefits, and the value of services and supports accessed by individuals whose lives will be saved by intervention.
The second relates to Intrinsic value, which is the ethical aspect of the decision to intervene (‘the right thing to do’). COVID-19 presents intrinsic arguments for and against action by policy makers. On one hand, the goals of saving lives and ensuring the welfare of vulnerable people are strong intrinsic motivators. On the other hand, the loss of livelihoods resulting from the economic contraction could be a strong reason not to act.
The third is Instrumental value, namely the future benefits or disbenefits that are enabled by action. The changes in the way we live our lives through the pandemic may accelerate several long-term trends, such as increased remote work and learning, more use of online technologies, and a proliferation of innovative digital products. The precedents set by government action here may make bold policy reform easier in the future as well. There are also potential negative impacts, such as setting a precedent for suspension of personal freedoms.
The last is Extrinsic value, namely how actions are perceived and assessed by others. In the case of COVID-19, this is evident at an international level (think of media reactions to countries that do not act or consider relaxing restrictions early). Governments are also subject to the views of their constituencies, and this can affect the communication of policy responses, as well as the response itself.
How to assess your options
The first step in being able to assess the value in your available options is to identify the key factors that will drive value, both tangible and intangible. We can then build analytical models that compare value across options by weighting and combining economic value with intrinsic, instrument, and extrinsic sources of value.
Understanding the ways that different sources of value combine or influence each other to determine their overall importance is critical to this combined weighting. For example, the value from some combinations compounds when multiple options rate highly (for example, we prefer options that save lives and jobs), while the value of other elements may combine in an additive manner (for example, increasing health service capacity is similar in effect to decreasing demand).
The application of HVM provides a framework for you to understand and optimise decisions – particularly when there is a portfolio of options available that appear to be valuable for different reasons. This means that:
- options can be compared on the full value that they generate, rather than on the basis of what is easy to measure
- the trade-off between economic and non-economic value of options can be quantified and compared.
For more information on Holistic Value Measurement, or our analytics capability more generally contact Tim Weterings on (03) 8650 6000.