Cost Justification Techniques
Richard T. Christoph
INFS 780
Building the Business Case
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Firms (and people) need to justify their
actions
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We want to pick the best alternative
There is usually risk and uncertainty
Costs and benefits can be hard to
identify
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Especially true in Information Technology
The Business Case
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A Business Case is a method of building
a reliable justification for a specific
action
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Look at costs, benefits, risk, and time.
The Business case pulls these together to
allow accurate comparison of various
projects or options
Project Costs-different types!
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Tangible Costs (also called “Hard” costs)
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These are costs we can “see, feel and
touch”.
We can measure these costs accurately
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Examples: Purchase cost of computer,
power usage, software purchase costs,
wages, etc.
Project Costs- different types!

Intangible Costs (also called “Soft”
costs)

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These are costs we cannot “see, feel and
touch”.
Usually cannot measure these costs
accurately
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Examples: Productivity gains from
computer use, Sales gains from better
customer support software, etc.
Tangible Displaced Cost
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Displaced costs are costs you pay now, but
will not have to with the new project.
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These are current costs that are “displaced” by
the new system.
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Most certain savings possibleI 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.
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.
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These are costs you will need to pay in the future that
are “avoided” by the new system.
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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.
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.
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Hard to measure benefits possibleI 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?
Intangible Avoidable Cost
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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.
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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.
Cost Justification-summary
MEASURABLE
Low
1
2
Displaced, intangible Avoidable, intangible
function
function
3
Displaced, tangible
function
4
Avoidable, tangible
function
High
High
CERTAINTY
Low
Cost Justification
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Easiest to measure in Quadrant 3
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Ideally, justify your project here
If justification here is hard to do, be
very careful!
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Probably will end up with a losing project
Biggest risk/return in Quadrant 2
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Hard to assign benefits to a specific project
Can provide competitive advantage
Total Cost of Ownership
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TCO = the total cost of buying, using,
maintaining, and dumping something
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Will always be higher than purchase price –
TCO for computing equipment=3 to 10
times purchase cost
Captures costs – not benefits
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Build different scenarios to handle risk
(best case, worst case, expected case)
Return on Investment
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ROI = gain from project / cost of project
Can compare ROI of a new computer with
a delivery truck
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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)
Cost/Benefit analysis
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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.
Mr. or Ms. – CIO: Don’t Forget
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Most managers are poor listeners.
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You are often the worst. They “know”
the technology and tend to look down
on those who do not.
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Carr states IT often adds little to
the bottom line
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How do we add value to the firm?
CIO’s – We don’t Trust ‘em
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CIOs have credibility problems
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Projects run late and always over budget
Can you imagine if other parts of the firm
did this?
Manage the today function well
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If pizza parlors had the service ratings of
IT shops, they would be out of business.
FINISH the small stuff quickly, Answer
questions
How should IT Pros Justify?
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Avoid credibility issues by being very
complete
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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?
Consider the “waves” of
Information Technology
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Wave 1: Reduction of cost
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clerical and administrative reductions (TPS)
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Wave 2: Leverage investment
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No advantage here
MRP, inventory control. Based on ROI
NOTE: both 1 and 2 depend on cost
reductions or displaced costs.
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Little if any proprietary advantage available here
These are infrastructural issues
Benefits, con’t
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Wave 3: Enhancing products-provide value
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Wave 4: Exec. Decision support
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Managers seek real-time decisions
Wave 5: Reaching the consumer
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Customer support lines with Dbase lookup
Home banking, brokerage, e-commerce
These three increasingly move to the intangible
section of cost justification
Note these are moving into infrastructural
It Functions
Added
Value
Business Requirements
Identification
Information
Architecture
System
Development
Cost
C’tnrl
Operations
IT Knowledge
Business Knowledge
What is a mother to do?
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Increasingly, traditional IT functions are
being displaced
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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?