Cost Benefit Analysis

Description

• A quantitative assessment that evaluates design opportunities by linking benefit streams to associated investment costs.   Based upon the results, the opportunities are either undertaken or rejected by client senior management.

When to Use

• The Cost/Benefit Analysis may be completed at several points along the BPI initiative. The points when the analysis should be completed correspond with client decisions on whether to proceed with the initiative (given the financial implications).  Commonly, estimates of +/- 50%, +/- 30% and +/- 10% can be made at the end of the Focus Phase, the end of Design High-Level Phase and the end of Design Details. The criteria for deciding when it is appropriate to create a cost/benefit summary are: the size of the investment, the need for buy-in to the benefits, the accessibility of data and information from the client, and the needs of the client for financial analysis.

Approach

• Cost/Benefit Analysis can be approached from a very rigorous quantitative analysis to a more qualitative analysis.  Various methods include: Cost/Benefit Descriptions, Return on Investment, Internal Rate of Return, etc.  Depending on the needs of the client, it may be necessary to complete all or none of the above.
• The following steps are repeated for each iteration of the financial analysis required by the project (e.g. at varying levels of detail).

1. Determine costs and benefits for identified design opportunities
1. Identify costs and benefits.
1. Be aware that while benefits of the design generally come from either reductions in cost or increases in revenue, other types of benefits also exist including
1. Reduced rework, and associated material and people costs
2. Faster billing and collections, and improved cash flow–This may be taken as a one-time benefit or as an ongoing reduction in interest expense
3. Improved customer retention–Studies have shown that the cost to attract new customers (advertising, sales, etc.) is high, therefore retaining current customers can be a significant benefit
4. Reduced forms and materials – These savings should be relatively easy to substantiate
5. Reduced staffing – These savings are typically the most controversial and will require the most extensive analysis.  Severance costs may be significant
6. Improved utilisation of equipment or other assets–In some industries, improved uti­lisa­tion of fixed and movable equipment and facilities due to improved scheduling or other changes may have a significant impact.  Benefits can be expressed in reduced replace­ment cost, or reduced capital and maintenance requirements  
2. Costs may be segregated into one-time and ongoing expenses.  Consider the following areas of costs.
1. Technology costs:
1. Hardware purchase, installation and maintenance (including duplicate capacity to support phased migration of systems to new platforms or technologies)
2. Ongoing technical support
3. Voice and data network upgrades
4. Software development and support
5. Software purchase and maintenance charges
2. New telephone systems
3. Changes in job classification and related compensation
1. Recruiting and hiring costs
2. Training expenses
3. Performance incentives
4. Cost of severance pay or retraining
4. Other:
1. Changes in physical facility and fixtures
2. New equipment
3. Identify the year in which the costs will be incurred.
4. Categorise costs and benefits as tangible and intangible or quantifiable.
1. Always include assumptions and sources for cost data as a part of the Cost/Benefit Analysis.
2. Quantify the benefits.
1. For tangible benefits, quantify them where possible in dollar terms, and assign them to the year they will be realised
2. Assign a probability for the realisation of each benefit.
3. Create scenarios
1. Develop various scenarios based on assumptions, risks and alternative decisions.  This may be based on a best-case, expected-case and worst-case scenario.
2. Identify key project decisions influencing a cost/benefit realisation.
1. Some decisions include:
1. Funding- self funding, available funds
2. Tax, asset, capital versus expense issues
3. Desired profit and loss impacts
4. Business drivers- critical gaps or needs i.e. “technology pill”
5. Dependencies
3. Identify assumptions and risks
4. Costing (e.g. revenue, recurring costs, CPU, processing costs, bank interest rates, inflation, technology depreciating periods, number of users, external labour assumed rates per hour, equipment pricing and communication)
5. Benefits (e.g. number of people, margins, dollar value of productivity, utilisation, and “Value” inventory turns)
4. Evaluate scenarios
1. Based upon the scenarios identified, compare and contrast their performance on all desired performance indicators such as present value cash flow, internal rate of return, return on investment or other techniques required by the client for project approval.  Determine the quarterly impact on the profit and loss, and cash flow.
2. Develop a financial analysis framework (Dupont Pyramid Analysis).
3. Project costs and benefits over time.
4. Identify break-even points, payback periods, other.
5. Select viable scenarios.

Guidelines

Problems/Solutions

• In some cases, use outside research to complete a Cost/Benefit Analysis.  For example, outside assistance may be needed to ascertain current market share and overall market growth, which could be needed as a basis for estimating growth in share and resulting revenues.
• Be aggressive in looking for tangible benefits, but ensure that the team understands and is confident about the final result.  Since team members may be inclined to be conservative, become the driving force behind identifying benefits and assessing their potential contribution. The team must be creative in identifying benefits and realistic in assigning dollar amounts.
• Identify all costs associated with the project, even if they are not obvious (e.g. maintenance costs when purchasing new equipment, training costs when hiring new employees, etc.).

Tactics/Helpful Hints

• It is important to recognise the distinction between costs that are relevant (i.e. directly-tied) to any change decision versus non-relevant costs that will remain regardless of the decision (allocations of overhead costs).
• It is important to understand distinction between cost “elimination” and cost “avoidance”.  Cost elimination results in a reduction of cash expenditures from an organisation, while cost avoidance refers to anticipated future expenditures that will not have to be incurred.
• When completing a cost/benefit analysis, specify the cost components of workflow, organisation, technology and other changes.  For example, the $200,000 cost for a new system to manage cus­tomer orders might be broken into the cost of 15 personal computers, networking software, licenses, communication lines, outside developer cost, charges for in-house MIS development support, and ongoing MIS maintenance and support.
• Have the team present the cost/benefit information in a format that the organisation typi­cally uses, such as a profit-and-loss impact statement, or a graphical representation of cumulative costs and benefits.  Get agreement on the practices for calculating various inflation rates.  Inflation or growth factors can impact payroll costs, benefits, materials and product/service prices.  Find out the organisation's tradi­tional hurdle rate and payback period for assessing investments.  If this project cannot meet those standards, the team and sponsor may need to work together and with the relevant executives to package the redesign in a way that will still be economically justifiable.
• Carefully document the estimate of each cost, including any assumptions made.  Some resources may be important to recognise, but may not be included as costs.  These typically include internal staff time to participate in implementation activities (although many orga­nisations elect to cost out this time) and use of equipment or facilities that may be in demand.  Recognising and documenting these resources may be important to ensure that they are available, when implementation starts.  Use extended team members for these activities.

Resources/Timing

• Consider using extended teams to develop detailed costs and benefits.  The information systems department can assist in estimating hardware, soft­ware development and support costs.  The human resources department should have data on training development and delivery costs, both from inside providers and contractors.  Similarly, human resources department involvement is crucial to assessing the financial impact of job changes, recruiting, hiring, layoffs, etc.  Other depart­ments, such as purchasing, maintenance, quality assurance and various operational units may also provide needed information.

• Which processes currently provide the most value?
• Which processes should we prioritise for improvement?
• What are the high-impact, low-maturity processes?
• Who should be responsible for establishing and maintaining value-driven BPM?
• What are we doing to further develop a lasting BPM capability?
• Which processes should be locally governed, and which should be centrally administered?
• What is the business case for each proposed process improvement?
• Which BPM capabilities do I have in place, and which new ones do I have to build?

• Which processes add the most value to my business?
• Which processes are most important to focus on?
• How do I know which processes most need improvement?
• How do I assess a particular effort’s improvement potential?
• In what ways might process-improvement efforts interrelate?

Core Competency, Product and Market Analysis

Description

• 
  Identification of the “core of uniqueness” of a company and their combinations in areas such as products and services, markets and market segments and activities and competencies. It also serves as the basis for a rethinking of the strategic orientation and will help to define and embody in those activities a unique competitive position.
• A Competency and Product/Market combination is the use of a core product in a market, providing end products for specific customers. A core product is an application of one or more core competencies and is a link between a core competency and end products or services.
• A core competence will provide potential access to a wider variety of markets and a high entry barrier for potential competitors. It has to make a significant contribution to the perceived benefits of the end product and is difficult to imitate by competitors.

When To Use

• Most likely within the first three phases (Arouse, Envisage and Focus) of the project to generate the need for change within the senior management and to orient and assist with a strategic thinking exercises about the core of uniqueness of an organisation (Business Position, (Confirmed) Business Vision)

Approach

1. Identify products or services
1. How can grow in products?
2. What is the required product mix?
2. Characterise/specify the activities that constitute the product or service, for example, engineering, production control, material management, consultancy, etc. (create a 1 to 4 page description for each activity)
3. Identify the required competencies for each Product and  Services Combinations e.g.: total aircraft engineering concept, technological knowledge & access to external resources, airline experience, modern facilities, skilled & motivated workforce partnership capability, customer oriented attitude, etc.(provide a 1 to 4 page description and possibly some figures)
4. For all Product and Service Combinations together
1. Group customers in sub-market
2. Group product/services in main product groups
3. Group required competencies in core competencies
5. Spot and keep aware of inter-dependencies

6. Choose Product/Market/Competency combinations to serve as basis for strategic decisions or focus sessions.

The following generic examples show how a company can structure itself to align Core Competencies and Products to Customers and Markets through the use of Business Units.

Change History Diagnosis

Description

Structured method for assessing the degree to which an organisation is ready to change. The process draws on the perceptions of employees regarding how effectively the organisation has managed change in the past, and generates practical insights into how the organisation should manage change in the future. To succeed, they also must have an intimate understanding of the human side of change management by aligning the company’s culture, values, people, and behaviors to encourage the desired results. These insights are then integrated into a strategy for the involvement of  employees during the BPI initiative, which will ensure that there is broad employee commitment both to the content of the change and the way it will be implemented.

When to Use

The Change History Diagnosis can be used in two main ways.

• To structure the development of a Readiness for Change Assessment
• Because the diagnosis is based on objectively accepted factors that contribute to the effective buy-in of employees, it assists the joint client/project team to think in a very practical way about how to manage change in the future. At the early stage of the BPI initiative, conduct a relatively focused assessment, using a small, carefully selected sample of employees who represent the key areas within the organisation.  Then, conduct further assessments, on a just-in-time basis, at each of the other key stages in the process.
• To facilitate project management
• At every stage of the BPI project there are decisions made concerning how employees will be involved in the next stage of the initiative.  Use the Change History Diagnosis to highlight the importance of employee involvement in achieving lasting change in all aspects of the organisation.  Integrated with project management, it will provide each layer of sponsors and change agents with a valuable opportunity to hear from employees about what matters to them, and to demonstrate that the organization is genuinely interested in their views.

Approach

The use of a Change History Diagnosis needs to be carefully framed in the context of the overall BPI initiative Supplement the diagnostic with other data-collection processes such as interviews, and an analysis of reports and surveys relating to change initiatives conducted within the organisation over the previous two to five years. Once this context is clearly established, there are typical steps for using a Change History Diagnosis.

1. Ensure that the organisation is comfortable about the method of diagnostic. If they have used a diagnostic in the past that has worked well, it may be worthwhile using it again. It is best to check, however, if employees were comfortable with the process and whether the diagnostic has low credibility, because it was either poorly conducted in the past or there was no follow up.
2. Introduce the project team and the project sponsors to the diagnostic method , explaining its conceptual underpinning and language, and how it will assist the overall change initiative.
3. Select a representative sample of employees for surveying purposes.
4. Conduct the survey using focus groups.
5. Develop a report on the findings.
6. Feedback the results to relevant sponsors.

Ensure that employees who participated in the focus groups are provided with a clearly written summary of the results of the diagnostic, and the opportunity to respond to any of the subsequent findings.

Guidelines

Problems/Solutions

• Some people may be resistant to the diagnostic method , and may dismiss it as an impractical questionnaire. This is often demonstrated by lengthy debate about its validity. These people can sometimes be hard to convince, and time spent trying to do so can be wasted. Thus, encourage participants to complete the diagnostic first, and then facilitate discussion about the issues that emerged from completing it afterwards. In most cases, people become supportive of the diagnostic. This is because it allows them to talk about issues such as management support, adequate resources, training and communication, which they may feel management has not handled well in the past.

Tactics/Helpful Hints

• Have the leadership team and the internal change agents complete the diagnosis first. In most cases, they identify many of the same issues as are later identified by employees. This often leads to useful discussion about their past disappointments with how change has been managed, and sensitises them to the often deep-seated concerns that employees have about such a major change as BPI.
• Some organisations become very attracted to the diagnostics and want to conduct large-scale surveys using them. These can be costly, slow to generate results and logistically complex.  In addition, such surveys lack the interactive qualities of the approach outlined above.  If the organisation is committed about going ahead with such an approach, ensure that there are mechanisms in place to manage communications, to manage the project within tight time and budget parameters, and to keep key opinion leaders on side.
• Make all responses confidential, if necessary, and establish a ground rule about confidentiality, whenever there is an expectation that people talk frankly about the findings of the diagnosis.

A Framework for Understanding an Organization's Success

Compelling case - “Why Should we Change?”

• Establishing the reasons for change
• Identifying the cost/benefit
• Articulating the articulating the argument persuasively
• Communicating it to all

Vision - “What will we change to?”

• Creating the overall vision of the enterprise
• Identifying the immediate objectives and goals
• Relating the immediate project to the overall vision
• Maintaining clarity

Values - “Which behaviours do we value?”

• Articulating the preferred values and implementing them
• Identifying the values that the organisation’s reward and other systems support
• Establishing norms
• Ensuring consistency

Strategy - “How do we realise our vision?”

• Identifying the enterprise-wide strategy
• Ensuring that the chosen strategy is correct, appropriate and sustainable
• Project goals and how they relate to that strategy
• Implementation plans
• Benchmarking

Information - “How well are we doing?”

• Adequacy of information systems
• Knowledge management
• Process efficiencies
• Performance benchmark
• Key performance indicators

Communication - “Who needs to know what?”

• Content
• Constituencies
• Tools and techniques
• Managing the information flow
• Testing for effectiveness

Leadership - “Who is keeping us on track?”

• Establishing ‘followership’
• Effective leadership styles
• Modelling new behaviours
• Taking risks, demonstrating courage

Resources - “What do we need to get there, and how do we get it?”

• Resource management
• Identification of necessary and/or missing resources
• Retention of the right quality/quantity
• Contingency planning

Capability - “Do we have the right mix of abilities?”

• Change management skills
• Acquiring and instilling the necessary skills
• Overcoming organisational barriers
• Developing maximum potential

Motivation - “How can we get all our people to work with us?”

• Leadership and people management
• Recognition and reward
• Tools, techniques and programmes
• Performance management