Easy to Use Financial Tools
for Effective Decision Making
Paul M. Dooley
President
Optimal Connections, LLC
P: (949) 305-3544
E: pmdooley@optimalconnections.com
W: www.optimalconnections.com
Typical Decision Challenges
You May be Facing
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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?
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Agenda
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Decision Making Challenges
How to Use Financial Tools to Help:
– Cost/Benefit Analysis (CBA)
– Return on Investment (ROI)
– Total Cost of Ownership (TCO)
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7 Steps in Applying the Tools
Valuable Resources
Summary
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Someone Once Said …
“Success in life often depends on the
choices we make.”
How do you make the
right choice?
Take advantage of best practices and
available financial tools that can help you
make better quality decisions
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How Do I Know Which
Course of Action to Take?
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Let’s see, I could …
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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?)
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Why Not A More Business
Like Course of Action
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Follow a best-practice selection process
Use a combination of financial tools to improve the
quality of your decision
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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
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What’s In It For You?
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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
Optimal Connections, LLC
Tools to Improve the Quality
of Your Decision Making
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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?
Using these tools in concert will help you make
better quality decisions and build stronger
business cases for proposals!
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Cost/Benefit Analysis (CBA)
Overview
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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
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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
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How to Do a Cost/Benefit
Analysis (CBA): Steps
1.
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Establish a common unit of valuation ($)
Identify all of the tangible costs
– Hardware, software, training, documentation,
maintenance support, consulting, opportunity costs
3.
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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)
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Total the value of benefits in year 1 and beyond
Determine payback time: divide [costs] /
[benefits]
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Cost/Benefit Analysis (CBA)
Consider a Scenario
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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.
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Cost/Benefit Analysis (CBA)
Estimating Costs - Scenario
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New help desk computer equipment: $36,200
– 10 network PCs with software @ $2,450 ea.: $24,500
– 1 server @ $3,500
– 3 printers @ $1,200 each: $3,600
– Cabling & Installation @ $4,600
– On-going maintenance costs
after 1st yr: $3,930/yr
Software: $15,000
– IMS Software, 10 user license @ $15,000
(includes 1st year support)
– On-going support (Silver): $2,700/yr
Staff training costs: $14,800
– Customer Service Skills - 10 people @
$400 each: $4,000
– Incident Mgt. System - 12 people
@ $900 each: $10,800
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Cost/Benefit Analysis (CBA)
Estimating Costs
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Other implementation costs: $48,000
– Lost time: 40 man days @ $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?
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Cost/Benefit Analysis (CBA)
Estimating Benefits
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Estimate the Value of Tangible Benefits:
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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
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Total Benefits: $180,000/year
Payback time: $114,000 / $180,000 = 0.63 of
a year = approx. 8 months!
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Cost/Benefit Analysis (CBA)
Key Point: Payback Time
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Payback time is often known as the break
even point
– Time it takes to recover the cost (sooner the
better!)
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Found graphically by plotting costs and
income on a graph of output quantity
against $.
– Break even occurs at the point the two lines cross.
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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.
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Cost/Benefit Analysis (CBA)
Key Point: Time Value of $
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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
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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
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Cost/Benefit Analysis (CBA)
Summary
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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.
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Return on Investment (ROI)
Overview
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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
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ROI is expressed as a percentage
– Example: a 25% annual ROI means that a
$100 investment would return $25 in one year
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A basic equation for calculating the ROI:
ROI = [(Payback - Investment)/Investment)]*100
– Investment relates to the amount of resources put in ($, time)
– Payback is the amount of money earned from your investment
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Return on Investment (ROI)
Considerations
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Managers often underestimate the amount of
investment required
– Hence ROI calculations can be skewed
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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!
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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
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How to Calculate Return on
Investment (ROI): Steps
1.
Determine the total amount of
investment required
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Calculate the amount of return
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Resources – financial, people (time), etc.
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
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Calculating Return on
Investment (ROI): Scenario
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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)
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Applying our ROI formula for the 1st year yields:
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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
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Return on Investment (ROI)
Key Points
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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)
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Total Cost of Ownership
(TCO): Overview
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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
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Total Cost of Ownership
(TCO): Overview
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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!
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Total Cost of Ownership
(TCO): Overview
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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
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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!
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How to Calculate Total Cost
of Ownership: Steps
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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
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How to Calculate Total Cost
of Ownership: Steps
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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
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.. 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
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How to Calculate Total Cost
of Ownership: Steps
3.
Fill in all the data
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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)….
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3 Year Life-cycle,
with upfront and
recurring costs
Sample Tool: TCO
Calculator, from InfoTech Research Group
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TCO Calculation: Applying to
our Scenario
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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:
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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 = 3.158 * 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!
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Applying the Tools: a Best
Practice Selection Process
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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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Step 1: Form a Team and Do
a Needs Analysis
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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
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Establish a baseline (KPIs) for later
comparison
Consider best practices for the area,
as well as industry analysts
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Source: HDI SCM
Step 2: Prepare a
Requirements Definition
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Document all requirements for the proposed
system or tool
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Background
Customer end-user requirements
Current support processes
Desired features and functions
Other: usability, scalability, portability, or compliance
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Special requirements from key stakeholders
Available budget allowances
Anticipated volume of transactions for scalability
Number and type of support staff required
Categorize requirements, and list priorities
(must have, nice to have, optional/plus)
Weight requirements, use numbers to quantify
Factor in optional additional information:
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Source: HDI SCM
Step 3: Conduct a Diligent
Selection Process
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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:
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Conformance testing to requirements
Load testing
End-user testing
Communications – notify stakeholders in advance of changes
in the works, and keep them informed!
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Source: HDI SCM
Step 4: Arrive at the Short
List of Suppliers
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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
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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?
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Step 5: Apply the Financial
Tools in Combination
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Apply the Financials Tools to this short list of solutions:
– Cost/Benefit Analysis (CBA)
– Return on Investment (ROI)
– Total Cost of Ownership (TCO)
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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?
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Step 6: Document the Business
Case for the Decision
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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
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Negotiate with preferred vendor to
arrive at final feature set, with pricing and delivery terms
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Step 7: Implement the
Decision and Track Results
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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
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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!
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Summary: Using the Financial
Tools Together Help You…
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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
Optimal Connections, LLC
Valuable Resources to Take
Advantage Of!
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Handout: CBA Template
Calculating Cost/Benefit
– Mind Tools CBA Tool: www.mindtools.com
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Calculating ROI
– Guidelines: www.silberperformance.com
– Tips: eHow.com
– Online Tutorial - ZDnet.com:
http://news.zdnet.com/2422-13569_22-153325.html
– ROI Calculator: www.solutionmatrix.com
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Calculating TCO
– Info-Tech Free TCO & ROI Calculator: www.infotech.com
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Happy Decision Making!
.. Any questions?
Thank you for attending this
session. Please fill out a session
evaluation form.
Optimal Connections, LLC
Paul M. Dooley
President
Optimal Connections, LLC
P: (949) 305-3544
E: pmdooley@optimalconnections.com
W: www.optimalconnections.com