1. Yale Braunstein School of Information Management & Systems
Cost Analysis
Yale Braunstein
School of Information Management & Systems

2. Why do we want to know costs?
We need to measure and understand costs
To help the organization
Operate efficiently & effectively
Allocate scarce resources
Choose between competing projects
To meet legal & organizational requirements

3. General introduction to our approach
Identify opportunities & alternatives for meeting them
Agree on selection/evaluation criteria
Apply the criteria
Make choices/decisions and monitor results
A nine-step, more detailed approach is on the web and in the handout. A complete manual is available in the computer lab.

4. Special problems with new technologies
New technologies, in general, and IT, in particular, often cause problems
Exact costs are unknown/unknowable
Only some benefits are quantifiable
New technology projects can change the organization, its outputs, etc.

5. Costing terms
Costs are misleadingly concrete. It is important to understand:
Allocated vs. out-of-pocket costs
Sunk costs
Opportunity costs
Fixed, variable & total costs
Joint costs
Marginal or incremental costs
Consistency is VERY important

6. Costs depend on your perspective
Department costs vs. project costs
Current costs vs. future costs; upfront costs vs. continuing costs; etc.
(More on this later)
For public projects: CTA, CTG, CTN

7. Costs vs. Prices We need to distinguish between costs and prices
Energy in California !
“Fully distributed costs” or “allocated costs” are very popular and can easily mislead
The leased-line anecdote…a true story of faulty economic logic in a major university

8. Additional considerations
We do a sensitivity analysis to identify those factors that have the major impacts on costs
Try to understand the issues relating to economies of scale and scope.
Computer automation in publishing example

9. Cost-benefit analysis
We distinguish between cost-benefit analysis and cost-effectiveness analysis
In CBA, both costs and benefits are measured in dollars
In CEA, only the costs are measured in dollars; we use non-monetary measures for the benefits
Examples: increased reliability, reduced lag times

10. Time value of money General rules:
Dollars spent at different times have different costs to the organization
Dollars received at different times have different values to the organization
Therefore, we need to explicitly account for timing of cash flows (in & out)
We “discount” future flows to the present to obtain their “present value”

11. Calculating PVs Logic:
Take each year’s cash flow and “discount” it back to the present using the “discount rate”
See spreadsheet with examples

12. Three ways to compare projects
Payback period – NEVER use this
Internal rate of return – very common, but has problems
Net present value – the preferred approach

13. Review: General principles
Focus on total costs OR incremental costs, whichever is appropriate
Are we introducing something entirely new or a change in an existing system?
Comparability of data is important
Timing matters
Have similar start & end points
Know what is in and what is out

14. Using the principles Sunk costs are sunk – ignore them
You need to know the purpose of the analysis
Planning for the future vs. benchmarking current operations
Forecasting & Projections
Know what is changing