COST-BENEFIT ANALYSIS GUIDE FOR NIH IT PROJECTS Prepared by: Office of The Deputy Chief Information Officer October, 1998 Revised May, 1999 SHOBA KRISHNAN Summer 2004

GENERAL CONCEPTS OF COST-BENEFIT ANALYSIS Definition: An evaluation of the costs and benefits of alternative approaches to a proposed activity to determine the best alternative. Purpose: The current laws relating to managing Information Technology in the Federal government support better decision-making; demonstrate that at least three alternatives were considered Guidance:OMB Circular A-94, A-76 Time Period: system life cycle Alternative:at least three alternative means of achieving program objectives:one to continue with no change. Identifying and Measuring Costs and Benefits Analysis. Benefit-Cost Analysis , Cost-Effectiveness Analysis .

OVERVIEW OF THE CBA PROCESS HOW IS THE CBA PERFORMED? Determine/Define Objectives Document Current Process Estimate Future Requirements Collect Cost Data Choose at Least Three Alternatives Document CBA Assumptions Estimate Costs Discount Costs and Benefits Evaluate Alternatives Perform Sensitivity Analysis

HOW IS THE CBA PERFORMED? Determine/Define Objectives Document Current Process Customer Services System Capabilities System Architecture System Costs Estimate Future Requirements Determine Life Cycle Time Estimate Life-Cycle Demands

Steps (Contd..) Collect Cost Data Historical Organization Data Current System costs Market Research Publications Analyst Judgment Special Studies Choose at Least Three Alternatives Document CBA Assumptions

Steps(Contd..) Estimate Costs Activities & Resources ,Cost categories,Personnel,Indirect costs,Depreciation and Annual costs Example for Tangible Asset Depreciation

Example of Annual costs-Activity Cost Matrix

CBA Process (Contd..) ESTIMATE BENEFITS Define, Identify,Establish a measurement Criteria ,Classify –Estimate Tangible Quantify Intangible Benefits Example– Shows the scores for Benefits A-G from 4 reviewers using a scale of 1 to 5

Weighted Scoring

Discount Costs and Benefits Common unit conversion P=F(1/(1+I)^ n) where P- Present value,F – future value,n –no of years and I Interest rates.1/(1+I)^ n is the discount factor Exhibit 9, Discounted Costs and Benefits

Evaluate Alternatives Evaluate with Intangible Benefits Direct compare Convert into relative Values Evaluate with Dollar value

Perform Sensitivity Analysis tests the sensitivity of input parameters and the reliability of the results obtained from the benefit-cost analysis. Input Parameters System Requirement Definition Costs System Development Costs System Operation Costs Transition Costs, Especially Software Conversion System Life Cycle Peak System Demands Dollar Values and Relative Values for Benefits

Return On Investment RROI is a percentage (TDN-TDC) ROI=Total Discounted Benefits – Total Discounted costs

A sales director is deciding whether to implement a new computer-based contact management and sales processing system. His department has only a few computers, and his salespeople are not computer literate. He is aware that computerized sales forces are able to contact more customers and give a higher quality of reliability and service to those customers. They are more able to meet commitments, and can work more efficiently with fulfillment and delivery staff.   His financial cost/benefit analysis is shown below:  Costs: New computer equipment: 10 network-ready PCs with supporting software @ $1,225 each 1 server @ $1,750 3 printers @ $600 each Cabling & Installation @ $2300 Sales Support Software @ $7500 Training costs: Computer introduction - 8 people @ $ 200 each Keyboard skills - 8 people @ $ 200 each Sales Support System - 12 people @ $350 each Other costs: Lost time: 40 man days @ $ 100 / day Lost sales through disruption: estimate: $10,000 Lost sales through inefficiency during first months: estimate: $10,000

Tripling of mail shot capacity: estimate: $20,000 / year Other costs: Lost time: 40 man days @ $ 100 / day Lost sales through disruption: estimate: $10,000 Lost sales through inefficiency during first months: estimate: $10,000 Total cost: $55,800 Benefits: Tripling of mail shot capacity: estimate: $20,000 / year Ability to sustain telesales campaigns: estimate: $10,000 / year Improved efficiency and reliability of follow-up: estimate: $25,000 / year Improved customer service and retention: estimate: $15,000 / year Improved accuracy of customer information: estimate: $5,000 / year More ability to manage sales effort: $15,000 / year Total Benefit: $90,000/year   Payback time: $55,800 / $90,000 = 0.62 of a year = approx. 8 months