Yale Braunstein School of Information Management & Systems Cost Analysis Yale Braunstein School of Information Management & Systems

Why do we want to know costs? We need to measure and understand costs To help the organization Operate efficiently & effectively Allocate scarce resources Choose between competing projects To meet legal & organizational requirements

General introduction to our approach Identify opportunities & alternatives for meeting them Agree on selection/evaluation criteria Apply the criteria Make choices/decisions and monitor results A nine-step, more detailed approach is on the web and in the handout. A complete manual is available in the computer lab.

Special problems with new technologies New technologies, in general, and IT, in particular, often cause problems Exact costs are unknown/unknowable Only some benefits are quantifiable New technology projects can change the organization, its outputs, etc.

Costing terms Costs are misleadingly concrete. It is important to understand: Allocated vs. out-of-pocket costs Sunk costs Opportunity costs Fixed, variable & total costs Joint costs Marginal or incremental costs Consistency is VERY important

Costs depend on your perspective Department costs vs. project costs Current costs vs. future costs; upfront costs vs. continuing costs; etc. (More on this later) For public projects: CTA, CTG, CTN

Costs vs. Prices We need to distinguish between costs and prices Energy in California ! “Fully distributed costs” or “allocated costs” are very popular and can easily mislead The leased-line anecdote…a true story of faulty economic logic in a major university

Additional considerations We do a sensitivity analysis to identify those factors that have the major impacts on costs Try to understand the issues relating to economies of scale and scope. Computer automation in publishing example

Cost-benefit analysis We distinguish between cost-benefit analysis and cost-effectiveness analysis In CBA, both costs and benefits are measured in dollars In CEA, only the costs are measured in dollars; we use non-monetary measures for the benefits Examples: increased reliability, reduced lag times

Time value of money General rules: Dollars spent at different times have different costs to the organization Dollars received at different times have different values to the organization Therefore, we need to explicitly account for timing of cash flows (in & out) We “discount” future flows to the present to obtain their “present value”

Calculating PVs Logic: Take each year’s cash flow and “discount” it back to the present using the “discount rate” See spreadsheet with examples

Three ways to compare projects Payback period – NEVER use this Internal rate of return – very common, but has problems Net present value – the preferred approach

Review: General principles Focus on total costs OR incremental costs, whichever is appropriate Are we introducing something entirely new or a change in an existing system? Comparability of data is important Timing matters Have similar start & end points Know what is in and what is out

Using the principles Sunk costs are sunk – ignore them You need to know the purpose of the analysis Planning for the future vs. benchmarking current operations Forecasting & Projections Know what is changing