Share with OthersEconomics is a social science that studies the making of choices under constraints. Every day, economic decisions are made by project, program, or portfolio managers. We strive to maximize value delivery within the constraints of time and cost, quality, risk, resource availability, and risk.
Economics can help project managers make better decisions. It gives project managers a framework to evaluate different options and make objective decisions. Economics doesn’t have to be complicated. It is possible to make better decisions by understanding the tools available and how to use them. This article will provide an overview of the most common frameworks.
Data Creation
Finding “good” data can often be the biggest challenge. We are trying to predict future events’ impact. It is easy to calculate and analyze the output once we have the data.
John Maynard Keynes, a British economist, said that it was better to be “approximally right” than “exactly wrong”. Our analyses don’t have to be exact. They should provide more information and insight that we currently have.
How to Measure Anything outlines frameworks and tools that can be used to estimate things that may seem difficult at first. It can be difficult to estimate the dollar costs and benefits of a decision or project. However, we can use proxy measures to compare the relative sizes and impact of different items.
To create high-level estimates, T-shirt and bucket sizing are often used. We divide items into relative sizes, such as small, medium, large, extra-large. To drive our analysis, we can use numeric values (e.g. 1, 3, 5, 8, 13, 13) to convert the sizes into quantitative data.
Cost-Benefit Analysis
A common tool is the cost-benefit ratio, also known as benefit-cost ratio. It is the ratio between the expected benefits and the cost. This is a quick and easy measure to calculate. It should not be used for short-term decisions as it does not include the time value money.
This analysis can be used for determining whether a project has a net negative (most likely not pursue) or positive (proceed) impact. It can also be used for comparing different projects. The highest ratio projects will likely provide the greatest value.
Calculating the ratio is simple when the dollar values of the benefits and costs are available. It is often easier to estimate costs than benefits. Benefits can often be projected of future performance or intangibles like risk reduction. When quantitative data is unavailable, relative-size estimates can be used.
Present Value and Net Present Valu
To evaluate projects that have a multi-year stream with expected benefits and costs, present value (PV), and net present value(NPV) are used.
The sum of future benefits (revenue) discounted together is called the present value. The discounted costs are subtracted from the net present value. These measures adjust for time value of money. Both measures are a better choice.
Discounting recognizes that it is better to have one dollar today than one year from now. A dollar is worth $0.91 in a year, and $0.39 in 10 years with a 10% discount rate. It is better to make money sooner than to pay expenses later.
Imagine that you are looking at two apartment buildings. Both buildings have a 30-year expected life span. The total cost includes the purchase price, ongoing operating maintenance costs, and development costs. Rents are the revenue stream.
Assume that both properties have the same lifetime revenue and costs. This means they have identical cost/benefit ratios. The timing of these revenues or expenses can have a significant impact on net present value.
Let’s say that the first building is an existing structure, with a lower price but higher maintenance cost. The second building is brand new, but has higher construction costs and lower operating costs. The older building could be a good bet.