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What Are Cost Effective Solutions?

Updated on November 20, 2017
bushaex profile image

Stephen Bush is a consulting and career training expert. He is the CEO and Founder of AEX Commercial Financing Group.

What Is Cost-Effective?
What Is Cost-Effective?

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.

Cost =

$30,000 to buy our hypothetical hybrid car. But what are we getting for our money?

Effectiveness =

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.

Cost Effective Solutions
Cost Effective Solutions

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

And now, your thoughts on the subject...

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    • profile image

      gene-0 lm 4 years ago

      I always hat the sayig "you get what you pay for" because sometimes you don't -- great lens

    • profile image

      anonymous 4 years ago

      I guess the government doesn't know about the concept of cost effectiveness, someone should call them! I like how you explain things so the rest of us can understand. FB liked this excellence. :)

    • profile image

      Aunt-Mollie 4 years ago

      This is a superb article!

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      SteveKaye 4 years ago

      There is cost effective and there is Cost Effective. Too much planning is based on a model that exploits something - resources, environment, or people. While some ventures can be cost effective in the short term, they can prove to be negative ventures when others have to pay the real, long term costs. -- Great thought provoking article about an important topic.

    • VspaBotanicals profile image

      VspaBotanicals 4 years ago

      I really needed this information. Thank you so much!

    • emilysmaids profile image

      emilysmaids 4 years ago

      I loved the fact that you took on the kind of x factor benefits that are not quantifiable, I think there is a lot of "if we can't put a number on it let's just not take it into account at all" and so the end picture gets very blurry. This was beautifully done, cheers to you!

    • LouisaDembul profile image

      LouisaDembul 4 years ago

      I am really impressed with your way of putting things in an understandable way. Like the difference between efficient and effective.

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      aquarian_insight 4 years ago

      You've conveyed important but not always easily understood information in a very clear and concise manner. This was a really interesting read - thank you! *blessed*

    • DeborahDian profile image

      Deborah Carr 4 years ago from Orange County, California

      Extremely helpful information in your business lenses. This should be helpful to many small business people.

    • profile image

      anonymous 4 years ago

      What an amazing page full of information. Thank you.

    • squidoopets profile image

      Darcie French 4 years ago from Abbotsford, BC

      @bushaex: Many thanks for the kind response. There was a shift in direction recently when I finally did something I'd been procrastinating for a year about getting done. Now that it's done, the drive that fueled the procrastination has evaporated. Something new is on the horizon. This period between letting go of the old and not yet knowing what that new thing is feels like inactivity, even stagnancy, however I am learning about the practical side of surrender (patience) as I go. Faith in a higher power directing the scene does help. Thanks for being someone I could talk with.

    • aesta1 profile image

      Mary Norton 4 years ago from Ontario, Canada

      Like your take on cost-effectiveness.

    • bushaex profile image

      Stephen Bush 4 years ago from Ohio

      @squidoopets: This is a struggle that many of us have (including me), and I think it primarily involves deciding how to "get the right things done" which Peter Drucker wrote about so effectively in "The Effective Executive". I personally see Squidoo as part of a larger picture, but there is still an ongoing challenge of reassessing priorities in any venture. There are always risks and mistakes in anything worthwhile.

    • squidoopets profile image

      Darcie French 4 years ago from Abbotsford, BC

      I'm at a cross roads with my squidoo business in terms of cost effectiveness. The question is, do I continue putting so much time and energy into the program or do I branch out and try some new things. It may be more worth it monetarily to put Squidoo on auto run and invest my time (which is my greatest resource) in a new project. Ideally, the new project would enhance what's already been created on squidoo. I guess that's the risk part :D

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      anonymous 4 years ago

      Your lenses are so well organized and informative. Thank you for the information you share. I may not be a small business owner, but the information serves me well as a manager, and of course as the CEO of a rather large family. Blessed.

    • strategylab profile image

      Jeph Maystruck 4 years ago from Regina, SK

      Great explanation mate!

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      Doc_Holliday 4 years ago

      It's a pity that some politician's have their own interpretation of what effectiveness means ;-)

    • profile image

      anonymous 4 years ago

      Thanks for the information.

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      ratetea 5 years ago

      I like how you start by questioning what it means to be "cost effective". I also like your hybrid car analogy, showing how there are different ways of interpreting benefits. I think a useful concept to illuminate costs is to look at short-term costs vs. long-term costs. Many decisions optimize one at the expense of the other. I find that one of the keys to being successful in business is ways to get enough flexibility so that you're able to eat a loss in the short-term in order to stay in it for the long-term gain. A major trap though is risk--the long-term often is more uncertain, and carries greater risk. Factoring risk in and balancing it appropriately is also key in being cost-effective in a holistic way. I also like how you blend discussion of risk into your presentation here too, as this is a key point that is often treated separately, when I think it is best integrated into the discussion the whole time.

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      reasonablerobby 5 years ago

      A really important topic. I think the corollary has to be value judgement and that whilst costs are certain value is often hard to determine in advance.

    • victoriahaneveer profile image

      victoriahaneveer 5 years ago

      Good solid information, it's amazing how many businesses don't understand cost-effectiveness, or don't use it the best they could.

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      JoshK47 5 years ago

      Wonderful work putting together this lens! Blessed by a SquidAngel!

    • Melissa Miotke profile image

      Melissa Miotke 5 years ago from Arizona

      Very important information to consider when making a business decision.

    • ajgodinho profile image

      Anthony Godinho 5 years ago from Ontario, Canada

      Very informative and useful lens on the importance and benefits of determining cost effectiveness and how it compares to cost benefit analysis.

    • themoneymakerMCA profile image

      themoneymakerMCA 5 years ago

      Very good information! Thanks

    • profile image

      oclthree 5 years ago

      Lots of good info here! I will refer back to it often. Thank you

    • aesta1 profile image

      Mary Norton 5 years ago from Ontario, Canada

      Solid info here.

    • sukkran trichy profile image

      sukkran trichy 5 years ago from Trichy/Tamil Nadu

      very interesting and informative read. learned new things from you. thanks.

    • Brandi Bush profile image

      Brandi 5 years ago from Maryland

      Your lenses are very well done and very informative! Thanks for sharing your expertise. SquidAngel Blessed! :)