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What Are Cost Effective Solutions?
Cost-Effective Solutions for Reverse Mortgages and Everything Else
The need for cost-effective solutions is frequently mentioned when discussing any number of problems. This term is a particular favorite in the business and finance world but is probably misunderstood by many of us when it comes to "real world" uses. In particular most individuals and small business owners would probably make much better use of the cost effective solutions concept if only they understand what it really involved. Small businesses are just getting by in many locations because of reduced sales and increased operating costs, and the successful use of cost-effective business solutions can provide a practical helping hand to improve the bottom line.
Real estate buyers and borrowers should consider cost-effectiveness when they arrange real estate financing of any kind. This includes the need for a complete understanding of future legal and financial consequences in addition to current costs and fees. Thorough due diligence is required in order to determine if a financial agreement is cost-effective (or not). For example, reverse mortgages are complicated real estate debt agreements that involve more risks than realized by average borrowers. What are these potential risks? The national press is doing an excellent job of investigative journalism, and anyone considering a reverse mortgage should read more before they do anything. Please involve your spouse and future heirs in this complex financial decision. A recent article in the New York Times ("Pitfalls of Reverse Mortgages May Pass to Borrower's Heirs") is an excellent place to start. I have included a short excerpt from this article below the cost effective collage image.
What is cost effective? I'm glad you asked, and I have included some of my observations about cost effectiveness below.
Making Smart Choices by Using Cost-Effectiveness
Evaluating Cost Effectiveness
Help for Choosing the Right Things
On the one hand, there are frequent references to "cost-effective" solutions for a wide variety of products and processes. This can be observed in advertising (a cost effective hybrid car). It is also not unusual to hear public figures include this term (cost-effective strategies to find a cure for cancer). Certainly politicians will not hesitate to use the term because it does have an intelligent ring to it (cost effective air travel).
On the other hand, it is extremely rare (except for academic articles and papers) to see the term used along with a detailed explanation of precisely how something is in fact cost-effective. The concept of cost-effectiveness seems to have been around for 50 years or so. While it can be carried to extremes in the level of detail involved, the use of cost effectiveness and cost effective solutions does not need to be complicated.
In a simple and straightforward example of what is meant by cost-effective, a hybrid car will be used to illustrate cost-effectiveness.
$30,000 to buy our hypothetical hybrid car. But what are we getting for our money?
The tangible and intangible result of an action (in this case, buying a hybrid car). These results will include both objective and subjective consequences of doing something. Possibilities for this illustration are (1) getting much better gas mileage, (2) reducing harmful environmental outcomes, (3) feeling good about a purchasing decision because it is socially responsible, and (4) having $30,000 less to do something else.
So at a minimum, if someone is seeking a cost-effective solution they should force themselves to think about the cost (which involves time and/or money) of an action in comparison to the consequences of choosing that action.
Efficiency is doing things right; effectiveness is doing the right things.— Peter Drucker
How to Find the Right Thing to Do: Cost Effectiveness
Peter Drucker is usually thought of as the most influential management thinker ever. As indicated in the Peter Drucker quote shown above, he felt very strongly that effectiveness involves doing the right things.
Both individuals and small businesses are seemingly in a constant search to find a guide for helping them to make the best decisions. In my view, the answer is already sitting over in the corner: Cost Effectiveness. I'm a dedicated fan of using this time-tested strategy to produce increased profits and wide-ranging successes.
Reverse mortgages provide an excellent example of a financial product that is not cost-effective except for the financial agent selling it. My recommendation: senior citizens should avoid all variations of a reverse mortgage.— Stephen Bush
Cost-Benefit Analysis — Different Than Cost-Effectiveness
Whenever an expensive project is under consideration by either a company or government agency, it is likely that someone will suggest that perhaps a cost-benefit study is needed. How does this differ from cost-effectiveness?
The most basic point of distinction between the two concepts is that cost-benefit studies (should) quantify the benefits of doing something so an “apples and apples” comparison can be made. In contrast, cost-effectiveness studies do not routinely assign a specific value to each element.
Please remember the illustration above of cost-effectiveness using a hybrid car as the example. If a cost benefit analysis was prepared for that situation, there would be a need to assign a dollar value to each potential consequence of buying the car. For the improved gas mileage, assumptions about future gas costs would be made in conjunction with driving habits, how long the car will be owned and accompanying maintenance costs (among other issues that would be analyzed in a thorough and fair study). Due consideration would also be given to the timing of costs and benefits ($30,000 outlay now while benefits produce gradual cost savings in the future).
A cost-benefit study can be more difficult to prepare accurately than a cost-effectiveness study precisely because of the need to quantify everything. As you can imagine, it is difficult to assign a dollar value to some benefits. What is it worth to find a cure for cancer? What is the dollar value to be allocated to buying the hybrid car in terms of environmental benefits?
The children of elderly borrowers are learning that their parents' reverse mortgages are now threatening their own inheritances.— Jessica Silver-Greenberg (New York Times, Pitfalls of Reverse Mortgages, March 2014)
Cost-Effective Strategies: Improving the Bottom Line
Making Smart Decisions
Evaluating whether an action is cost-effective or not is part of a smart decision-making process. Clearly there is more to making any decision than just looking at cost-effectiveness.
Choices and More Choices
This is not designed to be an exhaustive list but simply a starting point for small business decisions and expenditures that would benefit from adding the element of cost-effectiveness to the decision-making process.
1 — Reducing business debt
What would be the consequences of a business debt reduction instead of seeking increased working capital and other commercial loans? Who would you need to help you do this? What would that cost? If you don't do something like this, will you be able to get needed small business financing? (and who would you need to help you get additional commercial funding?)
2 — Negotiating to reduce business operating costs
The choices to be made and questions to be asked are very similar to those raised above for reducing business debt. You should also ask "Which costs can be reduced and how quickly?"
3 — Contingency planning to prepare for something going wrong (or not as expected)
A surprising number of small businesses do not engage in significant business planning. Even fewer take the time and effort to plan ahead for the possibility that something will not happen as expected. For example, what will you do if you need to refinance your commercial mortgage and the bank says no? What will you do if your credit card processor raises their fees again? At what point should you be prepared to fire your bank?
It is our choices... that show what we truly are, far more than our abilities.— J.K. Rowling
Making Smart and Cost-Effective Choices About Case Studies and Extended Articles
The best way to predict the future is to plan it.— Peter Drucker
© 2012 Stephen Bush