Estimating costs

5.16 The costs of using assets and resources are defined by the value which reflects the best alternative use a good or service could be put to - its opportunity cost. Market prices are usually the starting point for estimating opportunity costs. Where market prices are not suitable or available non-market valuation techniques can be used.

5.17 Sunk costs refer to expenditure or payments already incurred and should be excluded from the appraisal of social value. What matters are costs and benefits affected by decisions still to be made. The costs of continuing to use resources that are already paid for (e.g. assets or buildings) are relevant and should be included as opportunity costs.

5.18 Private sector costs (including capital and revenue for spending proposals) should be valued on an opportunity cost basis and included in the appraisal. This is particularly important for regulatory options where the costs of regulation would fall largely on private companies.8 Relevant prices and costs for public and private sector options should be done on a comparable basis.

5.19 Cost and benefit estimation will normally involve input from accountants, economists or other specialists. Consultation with stakeholders, particularly those who will potentially incur costs, is an important part of this.

5.20 Distinguishing between fixed, variable and other costs can be helpful to aid sensitivity analysis (see Box 8). A step change in the cost of one input factor may not apply to others. Costs and cost drivers need to be fully understood and each cost requires its own relevant set of governing assumptions.

Box 8. Definitions of Costs

Costs can be defined as:

fixed costs or overheads remain constant over wide ranges of activity for a specified time period (e.g. a building)

variable costs vary according to the volume of activity (e.g. external training costs vary with the number of trainees)

semi-variable costs include both a fixed and variable component (e.g. maintenance where there is usually a planned programme and a responsive regime such as call-outs, where costs vary with activity)

semi-fixed, or step costs, are fixed for a given level of activity and eventually increase at a critical point (e.g. after telephone call volumes reach a certain level, a new call centre may be required)

5.21 Other ways of categorising costs may be relevant to support full consideration of opportunity costs and sensitivity analysis:

capital and resource costs should be accounted for separately, and built up from their fixed, variable, semi-variable and stepped elements

direct values relate to the originating public sector organisation, while indirect values fall to the wider public sector

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8 Such additional costs should be recorded at the point they will be incurred and should be discounted by the Social Time Preference rate (STPR).