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 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. Business Requirements
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?