Triple bottom line and costbenefit analysis

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Triple bottom line and cost-benefit analysis

• Presented by Dr Daniel Terrill
• Senior Consultant, ACIL Tasman

February 2005
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What is an economic evaluation?

• Different to other types of valuations
• The comparative analysis of alternative courses
  of action in terms of both their costs and
  benefits
• Most useful to consider when making choices that
  involve tradeoffs in allocating resources.

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Cost-benefit

• Cost benefit analysis (CBA) refers to the tools
  and procedures needed to establish whether a
  proposed project or policy is worthwhile -
  designed to answer the basic question of how do
  costs and benefits compare?

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Triple bottom line

• Triple bottom line (TBL) accounting refers
  literally to the accounting of an entities
  Economic, Social and Environmental performance -
  depends upon the idea that the overall
  performance should be measured based on
  combined contribution to economic prosperity,
  environmental quality and social capital.
  (Source European Commission, 2001)

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What we are seeking

• Economic evaluations seek to maximize the public
  good
• But what does that mean?
• the national interest, the public interest,
  national welfare
• However, who is the public, and what is their
  good?

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Public goods and the public good

• Two very different concepts that are commonly
  confused
• A public good
• A good or service that has to be provided
  publicly
• The public good
• A social outcome that, by some stated criterion,
  is better than all other outcomes

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The standard for judgment

• How do we assess what decision is in the public
  interest?
• By what standard can such an assessment be made?
• The Hicks-Kaldor compensation criterion
• If gainers from a project or a policy change
  could compensate the losers and still come out
  ahead, then the project or policy is in the
  public interest

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Comparison of CBL and TBL Similarities

• CBL and TBL are forms of impact assessments, both
  evaluations
• incorporate externalities
• An extension of impact beyond the immediate
  interests of the organization performing the
  analysis
• consider a range of economic, social and
  environmental impacts.
• require quantification of impacts

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Comparison of CBA AND TBLMain differences
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Triple Bottom Line Accounting

• An emerging philosophy placing emphasis on
  economic, environmental and social goals, rather
  than solely the (financial) bottom line.

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Example of TBL methodology

• Identify the unit of interest (firm, project)
• Identify the impacts
• Choose indicators to quantify impacts
• Flagship template Global Reporting Initiative,
  2002 (http//www.globalreporting.org)
• Online corporate example, http//www.geodynamics.c
  om.au

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Typical TBL impacts
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Use of Indicators

• Indicators quantify the impacts.
• Example of use of Indicators
• Water quality impacts
• Chemical analysis of water
• Biota index
• Salinity levels
• Coliform density
• Number of algal blooms

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Examples of TBL applications

• Reporting on organisation's social performance
• allows for green consumerism
• Monitoring projects or policy over time
• Project or policy evaluation
• when used in this role, the distinction between
  TBL and CBA can become very blurred
• Highlighting trade offs and linkages between
  economics, society and the environment

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Current Thinking on TBL

• An increasingly popular reporting tool
• Some criticism
• lacking rigor
• open to misuse
• conceptually misleading.
• Best thought of as a conceptual means to approach
  impact assessment, through a logical
  categorization of impacts that is not burdened
  with the same methodological constraints as CBA.

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Current Thinking on TBL

• Some hope that, in the future, there will be
  eventual integration of indicators into something
  more like a bottom line, and then of all three
  forms of company performance a single bottom
  line
• Most applications do not represent a true
  economic evaluation

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TBL References

• Elkington, John, 1997. Cannibals with Forks, the
  Triple Bottom Line of 21st Century Business,
  Capstone Publishing, Oxford
• (First to use the term)
• The Institute of Social and Ethical
  Accountability, 1999. AccountAbility 1000
  Framework, Exposure Draft, The Institute of
  Social and Ethical Accountability, London.
• Business Ethics Quarterly http//www.businessethic
  s.ca/3bl/triple-bottom-line.pdf
• Ryan P, 2002 Corporate social responsibility
  Economic Research Institute http//www.marubeni.co
  .jp/research/eindex/0211a

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Uses of cost benefit analysis

• Accepting or rejecting a single project or policy
• Choosing between alternative projects
• Choosing the scope of one or many projects.

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Cost Benefit analysis procedure

• Outline of project to be analyzed
• Identification of alternatives
• Determine impacts (both benefits and costs)
• Values (usually ) assigned to those impacts
• The net value (total benefit minus total cost) is
  calculated)
• Decision is made

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The Concept of Net Value

• Decision on once off use of scarce land cattle
  or sheep which is more valuable?

• Analysis does not allow for timing of impacts

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The treatment of time Discounting

• All things being equal, people prefer benefits
  now and costs to be later
• people discount their future
• Discount rate
• The rate at which people discount the future
• enables us to bring future benefits and costs
  back to the present so that they can be compared
  against costs and benefits of today.
• Estimating the discount rate and using it to
  determine net present value

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Use of the discount rate
Assuming a discount rate of 10
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Extending the analysisexternalities

• CBA considers costs and benefits accrue to the
  wider society
• What we have performed thus far is more properly
  considered a financial evaluation from the
  perspective of the farmer alone
• Externalities that may come from trees include
• improved downstream water quality
• pleasant views for neighbors
• flood mitigation
• cleaner air
• biodiversity

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Extending the analysisexternalities

• Considering these positive externalities of
  trees, the trees option may now be more desirable
  than the cattle option from an economic
  perspective,
• But to know this we need to place values on those
  externalities a most difficult task

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The challenge of attaching values

• The main challenge of CBA is not the mathematics
  involved in subtracting the costs and benefits
  accrue to the organization making the decision,
  but of attaching values to those benefits and
  costs

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The challenge of attaching values - Where
market values are available

• Actual market value
• E.g. the value of cattle or timber
• Hedonic pricing - Property value technique
• e.g. the value of nice views
• Preventative expenditure technique
• e.g. the value of clean water
• Travel cost technique
• e.g. the value of a lake for recreation

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The challenge of attaching values where
markets are not available

• Benefit transfer method
• Willingness-to-pay - contingent valuation
• Contingent choice
• A highly imprecise science

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Another category of costs Opportunity costs

• the value of lost opportunities
• an important cost to consider in CBA
• It is the cost of the most valuable alternative
• It is an economic concept, rather than an
  accounting one
• Example
• if the farmer chooses to do nothing with the
  land, an opportunity cost accrue to that choice
  is the lost income that could have been earned
  through cattle or trees, or whatever else was
  most valuable.

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Beneficial uses of cost benefit analysis

• Typically, projects with large up front costs and
  long term benefits
• heavy plant, eg power stations
• infrastructure, eg roads, rail lines, pipelines,
  electricity transmission lines, water
  reticulation, port upgrades
• Less useful where benefits are hard to measure
• eg parks

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Exercise Step-by-step CBA

• Outline project to be analyzed
• Identify alternatives
• Determine impacts (both benefits and costs)
• Assign values to those impacts
• Calculate the net benefit and make decision

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Some abuses of cost benefit analysis

• Failure to identify all costs
• Claiming of benefits that would occur anyway
• Double counting
• Mixing inflated and real (deflated) values
• Unrealistic projections of growth rates
• Failure to identify and consider all alternatives
• Assumption that resources (e.g. labour) have no
  alternative use

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Treatment of uncertainty

• Options
• Increase the discount rate
• Causes a bias against longer term projects
• Put in ranges of values for the costs or benefits
  that are uncertain (e.g. the discount rate used),
  and test sensitivity of findings.

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Some other types of economic evaluations

• Cost-minimisation - Comparing the costs of
  alternative programs with the same expected
  outcomes
• Cost-effectiveness comparing the ratio of costs
  to benefits that are not in commensurate units
  (e.g dollars per life saved)

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References

• For basics on discounted cash flows, cost benefit
  and real options analysis Principles of
  Corporate Finance, Brearley Myers
• Applications and abuses Facts and furphies in
  benefit cost analysis transport, Bureau of
  Transport Economics Drummond MF., O'Brien B.,
• Stoddart GL., Torrance GW (2000). Methods for
  the Economic Evaluation of Health Care
  Programmes. (2nd ed.) Oxford Oxford University
  Press.