Cost Justification Techniques

1. Cost Justification Techniques Richard T. Christoph INFS 780

2. Building the Business Case • Firms (and people) need to justify their actions • We want to pick the best alternative • There is usually risk and uncertainty • Costs and benefits can be hard to identify • Especially true in Information Technology

3. The Business Case • A Business Case is a method of building a reliable justification for a specific action • Look at costs, benefits, risk, and time. • The Business case pulls these together to allow accurate comparison of various projects or options

4. Project Costs-different types! • Tangible Costs (also called “Hard” costs) • These are costs we can “see, feel and touch”. • We can measure these costs accurately • Examples: Purchase cost of computer, power usage, software purchase costs, wages, etc.

5. Project Costs- different types! • Intangible Costs (also called “Soft” costs) • These are costs we cannot “see, feel and touch”. • Usually cannot measure these costs accurately • Examples: Productivity gains from computer use, Sales gains from better customer support software, etc.

6. Tangible Displaced Cost • Displaced costs are costs you pay now, but will not have to with the new project. • These are current costs that are “displaced” by the new system. • Most certain savings possible- • I can accurately measure the costs, AND, I am paying them now! • Example: If you are renting a house now and want to purchase a house, the rent you are paying is a displaced cost.

7. Tangible Avoidable Cost • Avoidable costs are costs you DO NOT pay now, but will have to if you do not go forward with the new project. • These are costs you will need to pay in the future that are “avoided” by the new system. • Less certain than the displaced costs; • I can accurately measure the costs, BUT, I am NOT paying them now! • Example: If you want a new car. Your current car will need an engine repair in the future. This potential repair cost is avoidable IF you buy the new car.

8. Intangible Displaced Cost • Displaced costs are costs you pay now, but are not easily measured. • These are current costs that are “displaced” by the new system. • Hard to measure benefits possible- • I am paying them now – but how much are they? • Example: Student registration causes frustration – new system may displace this frustration – but HOW MUCH IS IT WORTH?

9. Intangible Avoidable Cost • Costs or benefits that you DO NOT have now, but will have to if you go forward with the new project. • These are often large benefits you may gain in the future with the new system. • Often strategic in nature, uncertain; • I can not accurately measure these benefits • Example: SABRE (the on-line travel reservation system) experienced huge strategic benefits from competitive advantage. These easily were the largest benefits, but impossible to measure accurately beforehand.

10. Cost Justification-summary Low 1 Displaced, intangible function 2 Avoidable, intangible function MEASURABLE 3 Displaced, tangible function 4 Avoidable, tangible function High High Low CERTAINTY

11. Cost Justification • Easiest to measure in Quadrant 3 • Ideally, justify your project here • If justification here is hard to do, be very careful! • Probably will end up with a losing project • Biggest risk/return in Quadrant 2 • Hard to assign benefits to a specific project • Can provide competitive advantage

12. Total Cost of Ownership • TCO = the total cost of buying, using, maintaining, and dumping something • Will always be higher than purchase price – TCO for computing equipment=3 to 10 times purchase cost • Captures costs – not benefits • Build different scenarios to handle risk (best case, worst case, expected case)

13. Return on Investment • ROI = gain from project / cost of project • Can compare ROI of a new computer with a delivery truck • Makes comparisons easy, but hard to figure benefits • Be sure that all projects calculate cost the same (TCO or just purchase cost) • Consider WHEN returns come (discount future cash flows)

14. Cost/Benefit analysis • Show all costs (tangible & intangible) and benefits • Displays costs & benefits over time as they are expected to occur • Best ones use a discounted cash flow for future earnings & costs • See http://solutionmatrix.com/ for more detail on justification.

15. Mr. or Ms. – CIO: Don’t Forget • Most managers are poor listeners. • You are often the worst. They “know” the technology and tend to look down on those who do not. • Carr states IT often adds little to the bottom line • How do we add value to the firm?

16. CIO’s – We don’t Trust ‘em • CIOs have credibility problems • Projects run late and always over budget • Can you imagine if other parts of the firm did this? • Manage the today function well • If pizza parlors had the service ratings of IT shops, they would be out of business. • FINISH the small stuff quickly, Answer questions

17. How should IT Pros Justify? • Avoid credibility issues by being very complete • Do a complete Cost/Benefit analysis • Include and identify which quadrant benefits come from • Show an ROI that makes sense • Use discounted cash flow • If you can’t justify it – why do it?

18. Consider the “waves” of Information Technology • Wave 1: Reduction of cost • clerical and administrative reductions (TPS) • No advantage here • Wave 2: Leverage investment • MRP, inventory control. Based on ROI • NOTE: both 1 and 2 depend on cost reductions or displaced costs. • Little if any proprietary advantage available here • These are infrastructural issues

19. Benefits, con’t • Wave 3: Enhancing products-provide value • Customer support lines with Dbase lookup • Wave 4: Exec. Decision support • Managers seek real-time decisions • Wave 5: Reaching the consumer • Home banking, brokerage, e-commerce • These three increasingly move to the intangible section of cost justification • Note these are moving into infrastructural

20. It Functions Business Requirements Identification Added Value Information Architecture System Development Operations Cost C’tnrl IT Knowledge Business Knowledge

21. What is a mother to do? • Increasingly, traditional IT functions are being displaced • Outsourcing of operations & knowledgeable users reduce IT function • Conventional wisdom suggests that as we move up the IT functions, they become more specialized and a possible source of competitive advantage • What does Carr say?