1. Easy to Use Financial Tools for Effective Decision Making
Paul M. Dooley
President
Optimal Connections, LLC
P: (949) E: W:
Welcome the audience
Mention the title of the presentation (for the recorder)
Introduce yourself

2. Typical Decision Challenges You May be Facing
Should I remain with the status quo, or implement a new Service Management System (SMS)?
If I implement a new SMS, which one should I choose?
Is it worthwhile for me to implement a Knowledge Management System?
Should I invest in Remote Access Tool A, B ..or C?
Is it wise for me to consolidate our multiple help desks to a centralized Service Desk, or should we remain decentralized?
Say examples of DECISIONS I typically need to make
Optimal Connections, LLC

3. Agenda Decision Making Challenges How to Use Financial Tools to Help:
Cost/Benefit Analysis (CBA)
Return on Investment (ROI)
Total Cost of Ownership (TCO)
7 Steps in Applying the Tools
Valuable Resources
Summary
Review the Agenda – what we going to cover
Decision Making Challenges
How to Use Financial Tools to Help:
Cost/Benefit Analysis (CBA)
Return on Investment (ROI)
Total Cost of Ownership (TCO)
7 Steps in Applying the Tools
Valuable Resources
Summary
Optimal Connections, LLC

4. Someone Once Said …
“Success in life often depends on the choices we make.”
How do you make the right choice?
Say:
Doesn’t success in life typically DEPEND on the wisdom of the choices we make?
Wise choices = faster, less cost, greater benefits, success
Poor choices = slower, higher costs, few if any benefits, little success or failure
Take advantage of best practices and available financial tools that can help you make better quality decisions
Optimal Connections, LLC

5. How Do I Know Which Course of Action to Take?
Let’s see, I could …
Guess
Pick one, based on the ‘good old boy’ network
Focus on the ‘coolest’ technology
Pick the one that’s cheapest (up front)
Choose the one that’s got the most ‘features’
Base my decision on what my management thinks (what – consider the users?)
Guess
this is like shooting in the dark – little chance of hitting the mark
Pick one, based on the ‘god old boy’ network
Choose because your friends advise you
But they may know nothing of the issues involved!
Focus on the ‘coolest’ technology
Coolest is not necessarily the “best” choice.
May be TOO expensive for the return delivered. May involve too much RISK.
Pick the one that’s cheapest (up front)
Least expensive initially is not necessarily the cheapest over the long run!
Choose the one that’s got the most features (many of which may not match ours)
Features are great, but what features are most important to your organizations, and potential users?
Base my decision on what my management thinks (what – there are users?)
Base your requirements on the needs of the key stakeholders
Yes, management is a party – but not the only one! Consider the needs of all key stakeholders when defining your requirements
Optimal Connections, LLC

6. Why Not A More Business Like Course of Action
Follow a best-practice selection process
Use a combination of financial tools to improve the quality of your decision
Do the benefits really justify the cost?
How long will it take to recover our investment?
It the investment really worth it?
What is the true total cost over the life of the asset?
These tools are not new – they have been used for decades by organizations of all kinds
Applying them to IT Services is simply good business practice
Follow a best-practice selection process
Use a combination of financial tools to help answer the following questions and improve the quality of your decision
Do the benefits really justify the cost?
How long will it take to recover our investment?
It the investment really worth it?
What is the true total cost over the life of the asset?
These tools are not new – they have been used for decades by businesses of all kinds, and are considered good business practice!
Optimal Connections, LLC

7. What’s In It For You? Demonstrate a ‘business approach’
Minimize risk and costs through informed, higher quality decisions
Increased credibility with management
Build stronger Business Cases for proposals
A more strategic approach, aligning with business goals
Help ensure successful business outcomes for customers, through improved service provisioning
Be a good steward of investments in IT services
Demonstrate a ‘business approach’ to decision making
Because you are speaking the language of business management
Minimize risk and costs through informed, higher quality decision making
Taking a systematic approach to selection technology will ensure the needs of all key stakeholders are considered, increasing your chances for success
Applying financial tools like CBA, TCO and ROI will help ensure that your recommendation will have the best cost/benefit ratio, lowest total cost of ownership over the life of the investment, and best ROI
Enjoy increased credibility with management
Your management will be impressed with your business like approach, and you will likely have greater attention paid to your proposals
Build a stronger Business Case for proposals to management, increases chances for approval
Base your proposals on a sound financial footing
Gain traction with management
Increase your chances for approval on critical projects
A more strategic approach, aligning with business goals
This is a more strategic approach, in alignment with ITIL best practices
You will naturally take a look at higher level business goals and strategies, and be more consistent and supportive of the vision and mission of the enterprise
Help ensure successful business outcomes for customers, through effective and efficient service provisioning
The investments you make – systems, tools, applications – will be more effective and efficient in meeting business and customer needs, hence improving your provision of services
Be a good steward of investments in IT services
ITIL Financial Management dictates that we need to be good stewards of the $ invested IT. Using financial tools helps ensure we are such wise stewards.
Optimal Connections, LLC

8. Tools to Improve the Quality of Your Decision Making
The three tools we will focus on are:
Cost/Benefit Analysis (CBA): Weighing costs vs. benefits, and calculating payback
Return on Investment (ROI): is it worth the investment?
Total Cost of Ownership (TCO) – what is the total cost of ownership over time?
Go over the 3 key tools we are going to talk about:
Cost/Benefit Analysis (CBA): Weighing costs vs. benefits, and calculating payback
Return on Investment (ROI): is it worth the investment?
Total Cost of Ownership (TCO) – what is the total cost of ownership over time?
Using these tools in concert will help you make better quality decisions and build stronger business cases for proposals!
Optimal Connections, LLC

9. Cost/Benefit Analysis (CBA) Overview
Technique for deciding whether or not a change is worthwhile
Add up the value of the benefits of a course of action, subtracts associated costs, and come up with an advised decision
Costs: one-time, and on-going
Benefits: usually realized over time
A time factor is built by consideration of a “pay back period”
Key: assign a financial value to both tangible and intangible benefits
Placing a financial value on intangibles needs to be justifiable
Cost Benefit Analysis or cba is a relatively* simple and widely used technique for deciding whether to make a change. As its name suggests, you simply add up the value of the benefits of a course of action, and subtract the costs associated with it.
Background:
Cost-Benefit Analysis (CBA) estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worthwhile. These projects may be dams and highways or can be training programs and health care systems.
The idea of this economic accounting originated with Jules Dupuit, a French engineer whose 1848 article is still worth reading. The British economist, Alfred Marshall, formulated some of the formal concepts that are at the foundation of CBA. But the practical development of CBA came as a result of the impetus provided by the Federal Navigation Act of This act required that the U.S. Corps of Engineers carry out projects for the improvement of the waterway system when the total benefits of a project to whomsoever they accrue exceed the costs of that project. Thus, the Corps of Engineers had create systematic methods for measuring such benefits and costs. The engineers of the Corps did this without much, if any, assistance from the economics profession. It wasn't until about twenty years later in the 1950's that economists tried to provide a rigorous, consistent set of methods for measuring benefits and costs and deciding whether a project is worthwhile. Some technical issues of CBA have not been wholly resolved even now but the fundamental presented in the following are well established.
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Costs are either one-off, or may be ongoing. Benefits are most often received over time.
We build this effect of time into our analysis by calculating a payback period.
This is the time it takes for the benefits of a change to repay its costs.
Many companies look for payback on projects over a specified period of time e.g. three years.
Objective: assign a financial value to both tangible and intangible benefits
Placing a financial value on intangibles needs to be justifiable
Tangibles: easy to calculate
Reduction in labor costs (fewer headcount needed)
Higher productivity = more work with same amount of staff
Intangibles
Benefits, but not easily quantifiable
Need to make assumptions, justify benefits in $ financial terms
Example:
More satisfied employees – does this improve productivity?
Optimal Connections, LLC

10. How to Do a Cost/Benefit Analysis (CBA): Steps
Establish a common unit of valuation ($)
Identify all of the tangible costs
Hardware, software, training, documentation, maintenance support, consulting, opportunity costs
Total all of the costs
Identify all of the benefits
Tangible benefits (where it is easy to quantify the savings)
Intangible benefits (assign values based on estimates, justifiable assumptions)
Total the value of benefits in year 1 and beyond
Determine payback time: divide [costs] / [benefits]
Establish a common unit of measurement
In order to reach a conclusion as to the desirability of a project all aspects of the project, positive and negative, must be expressed in terms of a common unit; i.e., there must be a "bottom line." The most convenient common unit is money.
This means that all benefits and costs of a project should be measured in terms of their equivalent money value.
A program may provide benefits which are not directly expressed in terms of dollars but there is some amount of money the recipients of the benefits would consider just as good as the project's benefits. For example, a project may provide for the elderly in an area a free monthly visit to a doctor. The value of that benefit to an elderly recipient is the minimum amount of money that that recipient would take instead of the medical care. This could be less than the market value of the medical care provided. It is assumed that more esoteric benefits such as from preserving open space or historic sites have a finite equivalent money value to the public.
Identify all of the tangible costs
This is easy - hardware, software, training, documentation, maintenance support, consulting, other costs
Opportunity costs
Missed work while engaging in this choice
Interruptions
Cost of doing CBA!
Total all of the costs
Identify all of the benefits
Tangible benefits (where it is easy to quantify the savings)
Intangible benefits (assign values based on acceptable estimates, justifiable assumptions)
Total the value of benefits in year 1 and beyond
Determine payback time: divide [costs] / [benefits]
Optimal Connections, LLC

11. Cost/Benefit Analysis (CBA) Consider a Scenario
A support center manager is deciding whether to implement a new computer-based incident management system.
His help desk is in start up mode, with mostly new support associates.
He is aware that with a more automated incident tracking system he will be able to handle calls more effectively and efficiently, with a higher level of quality and faster delivery.
Example:
A support center manager is deciding whether to implement a new incident management system. His department has been in set-up mode, with mostly new support associates. He is aware that with a more automated incident tracking system he will be able to handle calls more effectively and efficiently, with a higherlevel of quality and faster delivery.
Benefits:
Tripling of mail shot capacity: estimate: $40,000 / year
Ability to sustain telesales campaigns: estimate: $20,000 / year
Improved efficiency and reliability of follow-up: estimate: $50,000 / year
Improved customer service and retention: estimate: $30,000 / year
Improved accuracy of customer information: estimate: $10,000 / year
More ability to manage sales effort: $30,000 / year
Total Benefit: $180,000/year Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months
Optimal Connections, LLC

12. Cost/Benefit Analysis (CBA) Estimating Costs - Scenario
New help desk computer equipment: $36,200
10 network PCs with $2,450 ea.: $24,500
1 $3,500
3 $1,200 each: $3,600
Cabling & $4,600
On-going maintenance costs after 1st yr: $3,930/yr
Software: $15,000
IMS Software, 10 user $15,000 (includes 1st year support)
On-going support (Silver): $2,700/yr
Staff training costs: $14,800
Customer Service Skills $400 each: $4,000
Incident Mgt. System - 12 people @ $900 each: $10,800
His financial cost/benefit analysis is shown below: Costs: New computer equipment:
10 network-ready PCs with supporting $2,450 each
1 $3,500
3 $1,200 each
Cabling & $4,600
Sales Support $15,000
Training costs:
Computer introduction - 8 $400 each
Keyboard skills - 8 $400 each
Sales Support System - 12 $700 each
Other costs:
Lost time: 40 man $200 / day
Lost sales through disruption: estimate: $20,000
Lost sales through inefficiency during first months: estimate: $20,000
Total cost: $57,000
Optimal Connections, LLC

13. Cost/Benefit Analysis (CBA) Estimating Costs
Other implementation costs: $48,000
Lost time: 40 man $200 / day
Lost productivity through disruption: estimate: $20,000
Lost sales through service inefficiency during first months: estimate: $20,000
Total costs (1st year): $114,000
But what are the benefits, and the value of these?
And what’s the payback time?
Other implementation costs: $48,000
Lost time: 40 man $200 / day
Internal project costs to implement the system
Lost productivity through disruption: estimate: $20,000
Due to other work deferred or delayed
Lost sales through service inefficiency during first months: estimate: $20,000
Estimate of impact to sales due to lower service level delivery
Optimal Connections, LLC

14. Cost/Benefit Analysis (CBA) Estimating Benefits
Estimate the Value of Tangible Benefits:
Handle more work with same staff – savings: $40,000/yr
Improved uptime through prevention - estimate: $20,000/yr
Improved efficiency and reliability of call handling - estimate: $50,000/yr
Improved service and retention - estimate: $30,000/yr
Improved accuracy of information - estimate: $10,000/yr
More ability to support sales effort: $30,000/yr
Do the Same with Intangible Benefits:
Higher employee morale = higher productivity
Total Benefits: $180,000/year
Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months!
Tangible Benefits:
Handle more work with same staff – savings: $40,000 / year
Improved average resolution time means more incidents with the same level of staff – can avoid paying overtime, saving $40,000/year
Improved uptime through prevention - estimate: $20,000 / year
End users experience less down time, meaning higher productivity and cost savings
Improved efficiency and reliability of call handling - estimate: $50,000 / year
Fewer lost calls, better management end-to-end
Fewer calls outstanding, lower backlog
Less time working on the backlog, higher customer productivity due to fewer longer term issues outstanding
Improved service and retention - estimate: $30,000 / year
Improved service levels means customers realizing value of services, more willing to pay, stay
Improved accuracy of information - estimate: $10,000 / year
No longer need to spend time correcting incident logs, following up on errors – time savings
More ability to support the sales effort: $30,000 / year
Customer support center can not only handle internal calls now, but more effectively support the sales effort as well
Intangible Benefits:
Higher employee morale, resulting in higher productivity
>> We are not quantifying this in this example, but one could make assumptions based on industry practices
Total Benefits: $180,000/year
Payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months
Optimal Connections, LLC

15. Cost/Benefit Analysis (CBA) Key Point: Payback Time
Payback time is often known as the break even point
Time it takes to recover the cost (sooner the better!)
Found graphically by plotting costs and income on a graph of output quantity against $.
Break even occurs at the point the two lines cross.  
Bottom line: Although the estimates of the benefits given by the new system are quite subjective, the IT Director is very likely to approve the proposal, given the short payback time.
Tip: The payback time is often known as the break even point. Sometimes this is more important than the overall benefit a project can deliver, for example because the organization has had to borrow to fund a new piece of machinery. The break even point can be found graphically by plotting costs and income on a graph of output quantity against $.
Break even occurs at the point the two lines cross.  
Inevitably the estimates of the benefit given by the new system are quite subjective.
Despite this, the Director is very likely to introduce it, given the short payback time.
Optimal Connections, LLC

16. Cost/Benefit Analysis (CBA) Key Point: Time Value of $
For longer payback times, the “time value” of money should be factored in!
A dollar 5 years from now is not worth the same as it is today!
A dollar available now can be invested and earn interest for five years and would be worth more than a dollar in five years
When the dollar value of benefits at some time in the future is multiplied by the discounted value of one dollar at that time in the future, the result is the discounted present value of that benefit of the project.
The same thing applies to costs – future costs have to be brought back to their ‘net present value’
Net Present Value: sum of the present value of the benefits less the present value of the costs
Note:
Not only do the benefits and costs of a project have to be expressed in terms of equivalent money value, but they have to be expressed in terms of dollars of a particular time. This is not just due to the differences in the value of dollars at different times because of inflation. A dollar available five years from now is not as good as a dollar available now.
This is because a dollar available now can be invested and earn interest for five years and would be worth more than a dollar in five years.
If the interest rate is r then a dollar invested for t years will grow to be (1+r)t.
Therefore the amount of money that would have to be deposited now so that it would grow to be one dollar t years in the future is (1+r)-t.
This called the discounted value or present value of a dollar available t years in the future.
When the dollar value of benefits at some time in the future is multiplied by the discounted value of one dollar at that time in the future the result is discounted present value of that benefit of the project.
The same thing applies to costs. The net benefit of the projects is just the sum of the present value of the benefits less the present value of the costs.
The choice of the appropriate interest rate to use for the discounting is a separate issue that will be treated later in this paper.
Optimal Connections, LLC

17. Cost/Benefit Analysis (CBA) Summary
Cost/Benefit Analysis is a powerful, widely used and relatively easy tool to use
Doing it well: include all the costs and all the benefits, and quantify them!
Where costs or benefits are realized over time, work out the payback period
Include time value of money
Including intangible items within the analysis requires you estimate a value for these; supply justifiable valuations for these items.
Key points:
Cost/Benefit Analysis is a powerful, widely used and relatively easy tool for deciding whether to make a change.
To use the tool, firstly work out how much the change will cost to make. Then calculate the benefit you will from it.
Where costs or benefits are paid or received over time, work out the time it will take for the benefits to repay the costs.
Cost/Benefit Analysis can be carried out using only financial costs and financial benefits. You may, however, decide to include intangible items within the analysis. As you must estimate a value for these, this inevitably brings an element of subjectivity into the process.
Optimal Connections, LLC

18. Return on Investment (ROI) Overview
Purpose: compare the costs of a project (investment), with the value of its results
Am I getting my expected return?
Evaluate one investment vs. another
ROI is expressed as a percentage
Example: a 25% annual ROI means that a $100 investment would return $25 in one year
A basic equation for calculating the ROI:
ROI = [(Payback - Investment)/Investment)]*100
Investment relates to the amount of resources put in ($, time)
Payback is the amount of money earned from your investment
Purpose: compare the costs of a project (investment), with the value of its results
To determine if the result is worth the cost
Also used to evaluate the value of one investment vs. another
ROI is expressed as a percentage
Example: a 25% annual ROI means that a $100 investment would return $25 in one year (net investment = $125)
A basic equation for calculating the ROI:
ROI = [(Payback - Investment)/Investment)]*100
Investment relates to the amount of resources put into generating the given payback (time, money, etc).
Your payback is the total amount of money earned from your investment (savings, increased revenue generating capability).
Optimal Connections, LLC

19. Return on Investment (ROI) Considerations
Managers often underestimate the amount of investment required
Hence ROI calculations can be skewed
Common mistake: not factoring in employee time required to implement
Resources includes money, as well as human resources or “time”. Don’t under value time!
Another mistake: not factoring in the “cost of capital” – a $ today is not worth the same as it will be tomorrow!
Present Value (PV) of future costs and benefits needs to be calculated, using your organizations “cost of capital”
Net Present Value (NPV) is PV of Benefits – PV of Costs
IMPROPER CALCULATIONS BY MANY SMALL BUSINESS OWNERS
The business owner often misunderstands the actual amount of investment into a business. As a result, true ROI calculations for most small businesses are skewed.
Most small business owners make their mistake in this most necessary calculation, because they do not properly value their own time. Please note that when I previously defined "investment", I stated that it relates to the "amount of resources put into generating the payback."
Indeed, "resources" includes cash money. But, it also includes "human resources" or "time".
If most small business owners would value their hours at the minimum wage, and calculate their time into the investment equation, they would soon realize that their small business is running in the red!
Some small business owners will finally run ROI calculations including the human resources, and suddenly realize that they could make more money working a job. If the small business owner has been running their business for a really long time, struggling to make ends meet, they might see this calculation and close their doors once and for all.
Optimal Connections, LLC

20. How to Calculate Return on Investment (ROI): Steps
Determine the total amount of investment required
Resources – financial, people (time), etc.
Calculate the amount of return
Savings, revenue & productivity growth
If calculating over time, calculate the Present Value of future costs and returns by your organization’s discounted cost of capital
Calculate the ROI by dividing the return by the investment, and multiply by 100 to express as a percentage
Explain discounting money by the future value of money
Optimal Connections, LLC

21. Calculating Return on Investment (ROI): Scenario
What’s the 1st yr ROI on our scenario? Givens …
Total Costs = $114,000
Total Benefits: $180,000/year
Calculating ROI for 1st year only (since rapid payback)
Applying our ROI formula for the 1st year yields:
ROI = [(Payback -Investment)/Investment)]*100
ROI = [(180,000 - $114,000) / $114,000 ] * 100
ROI = ($66,000 / $114,000) * 100
ROI = .578 * 100 = 57.8%
CBA showed payback time: $114,000 / $180,000 = 0.63 of a year = approx. 8 months
Explain ROI on our “Scenario”
57%
Optimal Connections, LLC

22. Return on Investment (ROI) Key Points
ROI can be expressed for different time periods: be sure to stipulate your time period!
Use a spreadsheet tool to automate the process, ensure accuracy, and compare alternatives
Remember – one option is always to ‘do nothing’. Ensure you calculate this ROI!
Be thorough: include all factors …
All investments required (people, time, money, etc.)
‘Opportunity costs’ – people not able to do their regular job due to being involved
All returns (savings realized, revenue enhancements, increased productivity, employee and customer satisfaction)
ROI can be expressed for different time periods: one year, one month, one week, one day. For example, if a $100 investment returns $150 after one month, then the ROI would be 50 percent monthly ($50 profit divided by $100 investment = 0.50, or 50 percent).
Calculators and computer spreadsheet programs can be very useful in calculating ROI. Refer to their instruction manuals for more information.
When comparing ROI for different investment opportunities, be sure all fees and expenses have been included to ensure a fair comparison. Some ROI quotes do not include fees and expenses and can therefore be misleading.
Use a spreadsheet tool to help automate the process, ensure accuracy, and compare alternatives
Remember – one option is always to ‘do nothing’. Ensure you calculate this ROI!
Be thorough: include all factors …
All investments required (people, time, money, etc.).
Include ‘opportunity costs’ – people not able to do their regular job due to being involved in a project
Include all returns (savings realized, revenue enhancements, increased productivity, employee and customer satisfaction)
Optimal Connections, LLC

23. Total Cost of Ownership (TCO): Overview
Definition: all costs of owning and operating an asset over its expected useful life.
TCO ensures that you account for all associated costs over a given time period when you are considering a decision, or assessing one option vs. another
Benefits:
Accounts for not only the initial investment, but all the other costs associated with further use of the asset.
Factors in ‘useful life’ of assets, usually 3, 5 or 7 years
Ensures a comprehensive analysis of long term effects and helps account for hidden costs
Enables a total cost comparison of one option vs. another
ASK: Ever puzzled about which option has the lowest overall total cost of ownership over the life of the investment”? TCO is about calculating what is the TOTAL costs of the item – one item, or a set of alternatives.
So you can identify WHICH option is the lowest cost over the life of the asset
Note: Cheapest option up front may be the most costly over the life of the investment
Optimal Connections, LLC

24. Total Cost of Ownership (TCO): Overview
Challenges:
Does NOT consider benefits of various options
Does not factor in the ROI (or value) of one option vs. another – only total costs over time
Does not provide insight into the timing of costs:
Product A, which may have a lower acquisition cost and high on-going maintenance costs, is likely to be less attractive than
Product B, which may have a higher acquisition cost, but lower ongoing maintenance costs;
Yet both may have a similar TCO over the period analyzed!
Key points:
TCO does not factor in:
Value of benefits vs. costs
ROI of the investment, or competing alternatives
The time of the costs – whether early, mid-life, or later incurred
Timing of costs may affect decision making
Optimal Connections, LLC

25. Total Cost of Ownership (TCO): Overview
Other challenges:
Only a general formula: calculate the total costs of ownership over the life of the asset
No help for how to value “intangible assets”
Does not provide any insight to relative risk of options
Companies that rely solely on TCO end up following a strategy that minimizes expenditure rather than maximizes return!
Why this tool needs to be combined with CBA and ROI for quality investment decisions!
No specific formula for all scenarios
No guidance for:
Valuing intangibles
Risk assessment of options
Adopting TCO as sole strategy amounts to minimize cost rather than maximizing return
What you want is to do BOTH – minimize cost, while maximizing benefits and return on investment
Optimal Connections, LLC

26. How to Calculate Total Cost of Ownership: Steps
Employ a spreadsheet tool that meets your needs
Gather ALL relevant costs
All types: hardware, software, installation, conversion…
Initial costs and on-going costs over the life of the asset
Note: useful life must be the same for comparisons!
Which costs should you use? Depends on what the asset is and where it will be used
Costs for most IT investments are usually broken down into ‘direct’ and ‘indirect’ costs
No single accepted formula for calculating TCO, but many spreadsheet templates available. Here we are using a sample tool from Tech Research Group
Step 1: use a tool
Step 2: Make sure you gather ALL costs
Main idea: consider ALL relevant costs when considering an investment
All types: hardware, software, installation, conversion costs, services, maintenance/support, training, documentation, supplies, utilities, updates/upgrades, disposal costs, etc.
Initial price and on-going (recurring) costs over the projected useful life of the asset
Note: useful life must be the same for comparisons!
Which costs should you use? Depends on what the asset is and where it will be used
Costs for most IT investments are usually broken down into ‘direct’ and ‘indirect’ categories
Optimal Connections, LLC

27. How to Calculate Total Cost of Ownership: Steps
Compile Direct Costs: chargeable directly to project
Hardware & Software – capital expenditures for various HW & SW
Management Support – time required, maintenance contracts, professional services or outsourcing
Technical Support - support staff time, training time and costs, travel, support contracts
Implementation – customization, integration), testing
Communication Costs – LAN, WAN, leased lines
.. And Indirect Costs: not tied directly
End user - training, informal support outside recognized IT support channels, local self-support
Downtime - lost productivity due to planned and unplanned network, system, and application unavailability
Costs for most IT investments are usually broken down into ‘direct’ and ‘indirect’ categories …
Direct Costs: those directly attributable to the asset
Hardware & Software - capital expenditures for servers, client computers, peripherals, network components, and software.
Management Support - costs associated with network, system and storage management, including labor staffing, maintenance contracts, and professional services or outsourcing fees
Support - support staff labor costs, training labor and fees, travel, support contracts and management overhead
Implementation - development costs (customization and integration), testing, training, and consulting
Communication Fees - inter-computer communication expenses for leased lines, remote access, and allocated WAN expenses
Indirect Costs:
End user - cost of formal end-user training, casual learning, informal support outside recognized IT support channels, self-development of applications, and local file maintenance
Downtime - lost productivity due to planned and unplanned network, system, and application unavailability
Indirect vs. Direct Costs
Direct costs are those for activities or services that benefit specific projects, e.g., salaries for project staff and materials required for a particular project. Because these activities are easily traced to projects, their costs are usually charged to projects on an item-by-item basis.
Indirect costs are those for activities or services that benefit more than one project. Their precise benefits to a specific project are often difficult or impossible to trace. For example, it may be difficult to determine precisely how the activities of the director of an organization benefit a specific project.
It is possible to justify the handling of almost any kind of cost as either direct or indirect. Labor costs, for example, can be indirect, as in the case of maintenance personnel and executive officers; or they can be direct, as in the case of project staff members. Similarly, materials such as miscellaneous supplies purchased in bulk -- pencils, pens, paper -- are typically handled as indirect costs, while materials required for specific projects are charged as direct costs.
Examples
Costs usually charged directly
Project staff
Consultants
Project supplies
Publications
Travel
Costs either charged directly or allocated indirectly
Telephone charges
Computer use
Project clerical personnel
Postage and printing
Miscellaneous office supplies
Costs usually allocated indirectly
Utilities
Rent
Audit and legal
Administrative staff
Equipment rental
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28. How to Calculate Total Cost of Ownership: Steps
Fill in all the data
Direct costs
Indirect costs
First year and re-curing costs over the useful life of the asset (example – 3 years).
Use the tool to calculate the Total Cost of Ownership over the useful life of the asset
Optionally, compare the TCO of this option with that of another option, and the TCO of the ‘status quo’
Determine which option has the lowest TCO
Here is what our sample nets out to (next slide)….
Step 3: fill in the data
Step 4: Calculate TCO over the life of the asset
Step 5: if comparing, all must have same useful life
Step 6: which has the lowest CO?
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29. 3 Year Life-cycle, with upfront and recurring costs
Point out 3 year lifecycle
Same tool used
Numbers
Sample Tool: TCO Calculator, from Info-Tech Research Group
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30. - costs experienced at different times
Point out:
- costs experienced at different times
- lowest TCO
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31. TCO Calculation: Applying to our Scenario
How does TCO relate to CBA and ROI?
TCO shows long term costs, not cost vs. benefits, or ROI
To arrive at a quality decision, we need apply all three tools and account for the time value of money:
Assume a 5% required rate of return
CBA payback: $114,000 / $180,000 = approx 8 months
Costs of $129,860 over 3 yrs discounted to Present Value = $123,676
Benefits of $540,000 over 3 yrs discounted to Present Value = $514,287
ROI: 57.8% for 1st year, however 3 years ROI is much greater:
NPV of 3 yr Benefits vs. Costs: $514,287 - $123,676 = $390,611
$390,611 / $123,676 = * 100 = 315% ROI over 3 yrs!
Bottom line: rapid payback of initial investment, and high ROI over the life of the asset, with acceptable TCO. GO for it!
DCF method Discounted Cash Flow DCF method
Discounted Cash Flow (DCF) is what someone is willing to pay today
in order to receive the anticipated cash flow in future years. DCF
means converting future earnings to today's money. The future cash
flows must be discounted in order to express their present values in
order to properly determine the value of a company or project under
consideration as a whole.
The DCF for an investment is calculated by estimating the cash you
will have to pay out and the cash you think you will receive back.
The times that you expect to receive the payments must also be
estimated. Each cash transaction must then be discounted by the
opportunity cost of capital over the time between now and when you
will pay or receive the cash.
For example, if inflation is 6%, the value of your money would halve
every ±12 years. If you are expecting an asset to give you an income
of $ a year in 12 years time, that income stream would be
worth $ today if inflation was 6% for the period. We have just
discounted the cash flow of $30.000: it's only worth $ to you
at this moment.
The DCF method is an approach to valuation, whereby projected future
cashflows are "discounted" at an interest rate (also called: "rate
of return"), that reflects the perceived riskiness of the cashflows.
The discount rate reflects two things:
1. the time value of money (investors would rather have cash
immediately than having to wait and must therefore be compensated by
paying for the delay)
2. a risk premium that reflects the extra return investors demand
because they want to be compensated for the risk that the cash flow
might not materialize after all.
History: Discounted cash flow was first formally articulated in John
Burr Williams' 1938 text 'The Theory of Investment Value' after the
market crash of 1929 and before auditing and pubic accounting were
mandated by the SEC. As a result of the crash, investors were wary
of relying on reported income, or indeed, any measures of value
besides cash. Throughout the 1980s and 1990s, the value of cash and
physical assets became steadily less well correlated with the total
value of the company (as determined by the stock market). By some
estimates, tangible assets dropped to less than one-fifth of
corporate value (intangible assets such as customer relationships,
patents, proprietary business models, channels, etc. comprising the
remaining four-fifths).
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32. Applying the Tools: a Best Practice Selection Process
Step 1: Form a team, project and do a needs analysis
Step 2: Prepare a Requirements Definition
Step 3: Go through a diligent selection process to evaluate proposals
Step 4: Arrive at ‘short list’ of suppliers
Step 5: Apply the financial tools we discussed to build a business case for the best decision
Step 6: Make the decision and negotiate
Step 7: Implement and track your results
WHY follow a structured selection process?
Systematic process preferred to undisciplined method
Minimize risk
Ensure chances for success
Obtain buy-in from key stakeholders
Ensure solution matches real needs – now and in the future
Ensure selection is the BEST choice
Best ROI
Best cost/benefits ration
Lowest TCO
Key Steps:
Step 1: Form a team, project and do a needs analysis
Step 2: Prepare a Requirements Definition
Step 3: Go through a diligent selection process to evaluate proposals
Step 4: Arrive at ‘short list’ of suppliers
Step 5: Apply the financial tools we discussed to build a business case for the best decision
Step 6: Make the decision and negotiate
Step 7: Implement and track your results
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33. Step 1: Form a Team and Do a Needs Analysis
Form a cross-functional team
Appoint a project lead, and develop a project plan with milestones, resources and time frames
Conduct kick off meeting to define and prioritize needs
Set expectations, and communicate!
Do a Needs Analysis: allows you to analyze the situation to see whether the technology is truly needed immediately. May include…
Surveys, interviews and observations to gather detailed input
Reviews of past metrics – performance, customer, employee
Establish a baseline (KPIs) for later comparison
Consider best practices for the area, as well as industry analysts
Step 1: Form a cross-functional team from the various areas affected
Appoint a project lead; develop a project plan with milestones, resources and target time frames
Conduct kick off meeting to define and prioritize needs
Set expectations accurately, and communicate – on-going!
Needs Analysis: allows you to analyze existing data to see whether the technology is truly needed immediately. May include
Surveys and observations to gather detailed input
Reviews of past metrics – performance, customer, employee
Interviews end-users and those affected (critical!)
Establish a baseline (KPIs) for later comparison
Consider best practices for the area, as well as industry analysts
Source: HDI SCM
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34. Step 2: Prepare a Requirements Definition
Document all requirements for the proposed system or tool
Background
Customer end-user requirements
Current support processes
Desired features and functions
Other: usability, scalability, portability, or compliance
Categorize requirements, and list priorities (must have, nice to have, optional/plus)
Weight requirements, use numbers to quantify
Factor in optional additional information:
Special requirements from key stakeholders
Available budget allowances
Anticipated volume of transactions for scalability
Number and type of support staff required
Step 2: prepare a requirements definition
Document ALL requirements
Categorize and prioritize
Weight requirements
Factor in other information
Source: HDI SCM
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35. Step 3: Conduct a Diligent Selection Process
Identify vendors/suppliers who potentially can meet your needs
Send a RFP out to target suppliers, gather responses
Use a checklist to process responses
Considerations during the process:
Investigate quality of vendor technical support
Review demonstrations by selected vendors
If you opt for a ‘trial’, for testing consider:
Conformance testing to requirements
Load testing
End-user testing
Communications – notify stakeholders in advance of changes in the works, and keep them informed!
Step 3: Conduct a diligent selection process
Identify potential vendors
Send RFP
Use a checklist to process responses
Considerations
Support
Trials
Communications – keep people apprised
Source: HDI SCM
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36. Step 4: Arrive at the Short List of Suppliers
Schedule interviews for the short list of vendors
Considerations:
Use a ‘script’ to guide the interviews
Include your team in the demonstrations
Determine if you can get trial or pilot use
Visit vendor customer sites, explore service quality, check on industry reputation
Also check the company – depending on the investment, sometimes the company you are dealing with is also an important consideration!
Based on the proposals returned in answer to your Requirements Documents, which products/service providers most closely fulfill your needs?
Step 4: arrive at a short list of vendors
Schedule interviews
Considerations:
Use a script
Include a team
Determine if trials are available
Visit vendor sites, your selected customers
Check the company
Weight in contenders
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37. Step 5: Apply the Financial Tools in Combination
Apply the Financials Tools to this short list of solutions:
Cost/Benefit Analysis (CBA)
Return on Investment (ROI)
Total Cost of Ownership (TCO)
Considerations:
Net tangible and intangibles to a common financial metric (usually $)
Account for the time value of money
Which provides the best cost to benefits ratio?
Which provides the best return for the money?
Which provides the lowest total cost of ownership over the life of the investment?
Bottom line: which is the best decision?
Step 5: Apply the financial tools in conjunction
CBA
ROI
TCO
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38. Step 6: Document the Business Case for the Decision
All three tools should be used together to help assess which action is best to take!
Document your Business Case based on the result of the selection process, and the output of the financial tools …
Include exec summary, goals & objectives, supporting evidence: CBA, ROI and TCO of alternatives, with recommendations
Review with your management and gain their support
Negotiate with preferred vendor to arrive at final feature set, with pricing and delivery terms
Step 6: Document the business case
Document your case
Employ all 3 tools
Format properly
Negotiate final terms
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39. Step 7: Implement the Decision and Track Results
Key: follow best-practice project mgt. practices
Qualified project lead
Committed, cross-functional team
Solid project plan with milestones, assigned and budgeted resources, and time frames
Communicate effectively: across the team, and to affected stakeholders
Prioritize early, easy wins!
Drive the project, accomplish the milestones, and report on the benefits
Compare the results to your baseline(s), and report results.
Celebrate success with your team!
Step 7: Implement and track results, communicate as you go!
Follow best practice project mgt.
Prioritize early, easy wins
Drive it, report progress
Communicate as you go
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40. Summary: Using the Financial Tools Together Help You…
Use a ‘business approach’ to decision making
Minimize risk and costs through informed, higher quality decision making
Increase credibility with management
Build stronger Business Cases for proposals to management, increases chances for approval
Align with business goals, and support the vision and mission of the business
Ensure successful business outcomes for customers, through effective and efficient service provisioning
Be a good steward of investments in IT services
Summarize and restate key points:
Use a ‘business approach’ to decision making
Minimize risk and costs through informed, higher quality decision making
Increase credibility with management
Build stronger Business Cases for proposals to management, increases chances for approval
Align with business goals, and support the vision and mission of the business
Ensure successful business outcomes for customers, through effective and efficient service provisioning
Be a good steward of investments in IT services
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41. Valuable Resources to Take Advantage Of!
Handout: CBA Template
Calculating Cost/Benefit
Mind Tools CBA Tool:
Calculating ROI
Guidelines:
Tips: eHow.com
Online Tutorial - ZDnet.com:
ROI Calculator:
Calculating TCO
Info-Tech Free TCO & ROI Calculator:
Review sources of info
Calculating Cost/Benefit
Mind Tools CBA Tool:
Calculating ROI
Guidelines:
Tips: eHow.com
Online Tutorial - ZDnet.com:
ROI Calculator:
Calculating TCO
Info-Tech Free TCO & ROI Calculator:
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42. .. Any questions? Happy Decision Making!
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Paul M. Dooley
President
Optimal Connections, LLC
P: (949) E: W:
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