Cost-Benefit Analysis

MIS 2000 Information Systems for Management
Instructor: Bob Travica
Economic Aspects of
Information Systems
Updated June 2015
• Costs & Benefits from IS
• Financial Assessments of Information Systems Economy
(size and timing of returns)
• Combined Assessments of Information Systems
• Software & Hardware Acquisition (develop, buy, rent)
• Summary
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Costs & Benefits from IS
• Economic aspects of IS (or IS economy) is assessed in planning of
IS as well during IS production stage.
• Cost/Benefit analysis is a necessary component in any assessment
of IS economy.
Cost-Benefit Analysis
• Tangible Costs & Benefits ($)
• Intangible Costs & Benefits (no $)
Quantitative or
qualitative figures?
Capital Budgeting Methods ($)
• Assessments of returns’ size
• Assessments of returns’ timing
Qualitative &
Mixed Methods ($ and no $)
• Portfolio Analysis (Risk control)
• Balanced Scorecard (Org. goals
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Tangible Costs
- Direct investment in software & hardware (one time)
- IS installation & employee training (one time)
- Operating costs for an IS (recurring) – expenditures on software
licences, labor costs of IS staff, IS maintenance, overhead for
facilities, expenses of communications carried out by computer
networks partaking in IS.
- Loss of money and time with new IS that does not perform as
expected (opportunity cost).
- Total Cost of Ownership sums up all the costs in a system life
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Intangible Costs
- Effort put in learning a new IS and associated process
- Employees’ loss of work motivation due to new processes/IS
- Employees’ resistance to new processes/IS
- Lower customer satisfaction due to improperly performing IS
- Limitations in decision making when a new IS cannot deliver
reports managers need to make decisions.
- Note that intangible costs may result in tangible costs.
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Tangible Benefits 1/2
- Savings on many counts:
- savings on labor expenses
- savings due to reduced process time (e.g., reducing inventory
costs in supply chain process)
- savings due to avoiding to add more employees when improved
process/IS can carry a larger volume of operations
- Organizational performance gains: new IS & process 
organizational productivity (output value/input cost) 
financial returns (profit figures).
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Tangible Benefits 2/2
- Better decision making resulting in income increase (e.g., moving
into new product and geographical markets)
- Cutting losses by improved management control (e.g., ERPS case
of detecting fraudulent purchases)
- Data error reduction eliminating waste of business time & labour
for repeated tasks.
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Intangible Benefits
- Customer value that does not translate directly into monetary gains
for a company
- Better control and decision making, which do not translate readily
into monetary gains
- Improvement in the appearance of reports and other business
documentation (better quality but no more money).
- Increased knowledge capabilities (note: these are a condition for
making more attractive products, but before this products are
made and sold no monetary gains accrue).
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Financial Assessments of IS Economy
• 1. Returns’ size focus: Various ratios of how much an IS returns
in relation to its costs (Benefit/Cost Ratio, Net Present Value,
Return on Investment):
– The higher the ratios, the more economically valuable the IS
– Present value of money used (future returns as well as costs
discounted for some rate) as finances flow over years (NPV function
in Excel)
• 2. Returns’ timing focus: Assessment of when returns will occur
(e.g., Break-Even Analysis)
- The shorter the wait period,
the more economically valuable
the IS.
Time (years)
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Mixed Methods of Assessing
IS Economy 1/2
1. Portfolio Analysis
– The focus is on controlling risks that different systems can bring
– Risks: potential known difficulties (complications, problems)
– In planning IS, different IS projects compared on risks they bear (e.g.,
completion within budget & time, technology demands, size of
organizational change required)
– Risk = Weight (impact) of problem X Probability a problem will happen
– Risk can be thought of as a special and critical cost
– Riskier projects: Expensive systems*, new technologies, and larger org.
changes (e.g., enterprise systems)
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Mixed Methods of Assessing
IS Economy 2/2
2. Balanced Scorecard
– The focus is on achieving organizational goals
– A combination of tangible and intangible benefits in select areas – finances,
customer relations, key processes, growth potential, anything else important
for a company.
– IS contribution to these performance indicators is assessed periodically.
Balanced Scorecard
Tangibles &
- Process focus!
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Software and Hardware Acquisition
• Three options: Make, Buy, Rent
1. In-house Development (company's IS Department does
programming, hardware acquisition, and IS installation)
2. Buy:
– Off-the-shelf software (e.g., Microsoft Office, SAP)
– Buy custom-built software (a software vendor writes software
according to the client company’s requirements).
– Note: If there is a system development capability in the IS
Department, the buy options are called “outsourcing” (sourcing
outside of own company)
• For pros & cons (benefits & costs) see the chapter.
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• 3. Rent:
– Annual licencing of software or hardware
– Rent via the Cloud (partial or total IS services).
• Cloud Advantages:
– Reduce costs: pay-per-use, avoiding development & maintenance
– Client benefits from new IT as vendor keeps updating it to remain
competitive  gains in client’s business processes.
• Cloud Disadvantages:
– Synchronizing business processes between client and vendor
– Risk of compromising confidentiality of business data
– Vendor lock-in (it is hard to get out of Cloud as a company relies
more on a cloud vendor)
– Unexpected changes in pricing services.
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Costs of IS can be tangible (expressed in monetary terms) & intangible
(all other forms). Examples of tangible costs are investment in
computer software and hardware, and system’s operating costs.
Benefits of Information Systems can be tangible & intangible. Examples
of tangible benefits are cost reduction and income gains.
Financial Assessments of IS economy focus on the size of returns (e.g.,
NPV) and on timing of returns (e.g., payback period).
Mixed Assessments of IS economy cover tangible and intangible C/B
(portfolio analysis, and balanced scorecard).
Software can be developed by the company’s IS department,
purchased, or rented; hardware is usually purchased or rented. Each
option has pros and cons.
Cloud (cloud computing) is the trendy rental option with significant pros
& cons.
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