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Government and ministries

Focus on lifecycle benefits instead of minimum price

26.5.2020 8.25
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For those purchasing equipment, lowest price is rarely the decisive factor; instead, lifecycle calculation is used to determine the best solution in terms of overall costs. Public administration organisations would also be well advised to adopt this approach of focusing on the total lifecycle instead of the lowest production or performance-based price.

Petri Hillin kuva

While equipment buyers look for the lowest total lifecycle cost, organisations striving to promote wellbeing seek the highest lifecycle benefit. This expected benefit is then measured against the costs of the investment. But this is where it gets tricky. How do you compare the outcomes and benefits different service providers promise to deliver? One provider promises to lower the school dropout rate by 30% and the other one by 40%, but how do you assess the credibility of these promises?  How do we solve this problem? By introducing an outcomes-based procurement model, in which a performance bonus is tied to the outcomes achieved, and the service provider is either fully or partially responsible for achieving the promised results, depending on the risk-sharing arrangement agreed on.

Evaluating the lifecycle benefits of activities that improve wellbeing is not as straightforward as the traditional lifecycle cost analysis. It is very difficult to predict the course of life of an individual person, but it is possible to produce statistical estimates for a larger group of people based on probabilities. Data for this analysis is readily available. We know how the lack of an upper secondary qualification increases exclusion from working life, how weight loss and a healthy lifestyle reduce the need for medical care and increase productivity, and so on. We can identify the lifecycle benefits of educational qualifications, weight loss and other similar indicators, although the real-life benefit may vary significantly between individuals. However, when we look at a sufficiently large number of people, we will see improvement in outcomes. These may include an increase in tax revenue following an increase in employment rate, or cost savings resulting from a decrease in morbidity.

Calculation of lifecycle benefits highlights the fact that benefits are distributed between players in multiple sectors. If we use a simple approach and place the dividing line between the state and municipalities, we may face profitability problems, especially in areas such as risk group wellbeing. Employment is, undeniably, profitable if employing a person with low employment potential creates a benefit of EUR 10,000 while the costs of employment amount to EUR 5,500. However, if the benefit of EUR 10,000 is divided equally between the municipality (tax revenue) and the state (decrease in unemployment benefits), some type of a sharing scheme between those who pay for the activities and those who benefit from it is necessary to permit the payment of EUR 5,500 as a reward for employment.

It is a rule rather than an exception in today’s public sector financial administration systems that benefits are distributed between multiple sectors of public administration. This arrangement prevents certain investments that would make sense for taxpayers, further widening the public sector’s sustainability gap. Therefore, it would be advisable to change the allocation of tax revenue such that the right players would be able to engage in activities that are financially healthy from the taxpayer perspective, regardless of whether the future benefits will flow to another municipality, a ministry or perhaps to an earnings-related pension scheme. In the end, the impact in euros on the taxpayer’s wallet is the same regardless of the benefit.

In an economic recession, against the backdrop of falling tax revenue, public administration is under pressure to cut expenditure even though stimulus measures such as increased investment would be crucial in an economic downturn.  Making investments now that are sensible from the lifecycle benefits perspective will promote economic activity and employment immediately. Moreover, this will also automatically cut future costs and the taxes needed to finance them without painful cuts to other activities.

Petri Hilli

 

Petri works for the Centre of Expertise for Impact Investing where he has the key responsibility for the economic calculations involved in the modelling of social benefits.

 

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