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The Business Case: A Commercial Perspective Building the IT Business Case Information Resources Management College National Defense University 8-1-2011 1

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The Business Case:

A Commercial

Perspective

Building the IT Business Case

Information Resources Management College

National Defense University

8-1-20111

Objectives

Identify significant factors influencing investment

decisions in the public and private sectors.

Evaluate and compare alternative investments in

the light of strategic business objectives.

Select and justify an investment based on a variety

of financial and non-financial criteria.

Analyze a private sector business case

development model for application to the public

sector.

2

Challenges in Federal IT Acquisitions

Political Influences

Size/Complexity

Budget Cycle

Goals and Measures

Other

3

The Basic Questions

How much should we invest in IT?

How should we allocate the IT investment

budget?

How do we know whether we’ve made the

right decision?

4

The Basic Questions

How much should we invest in IT?

How should we allocate the IT investment

budget?

How do we know whether we’ve made the

right decision?

5

Determining the IT investment budget

Last year plus Inflation plus x….

% of O&M….

Zero based budgeting….

Industry Best Practices….

Other….

6

Determining the IT investment budget

Gomolski, B. How IT Spending Varies According to Company Size.

Gartner .9 May 2005. ID G00125306. 7

Determining the IT investment budget

Gomolski, B. How IT Spending Varies According to Company Size.

Gartner .9 May 2005. ID G00125306. 8

The Basic Questions

How much should we invest in IT?

How should we allocate the IT investment

budget?

How do we know whether we’ve made the

right decision?

9

Commercial Model- an example

Keep the doors open

Infrastructure

Software maintenance

Mandated

Y2K

Sarbannes-Oxley

Privacy

New Initiatives

Tactical

Strategic

10

Investment by Type by Sector

Light, M., Rosser, B. & Hayward S.

Realizing the Benefits of Project and

Portfolio Management. Gartner. 4

January, 2005. ID G00125673.

11

Federal Agency IT Investments

12

PART

Effective Moderately

Effective

Adequate Ineffective

The Environment

IT Manufacturing Marketing

…etc

Investment Portfolio

Selection

13

The Business Case Model- Purpose

Aid Management select best

value for investment dollars:

Justification

Analysis

Includes

Costs

Benefits

Risks

14

Assessment

Quantitative

Costs

Benefits

Risks

Qualitative

Costs

Benefits

Risks

Includes:

Facts

Assumptions

Constraints

15

Facts

Did we include all relevant facts bearing on

the investment?

Are they facts or are they beliefs?

Are they provable?

Are they demonstratable?

16

Assumptions

Assumption: A factor that is

considered to be true, real or

certain, without proof.. affects the

project…contains risk.

Assumptions as to benefits

External

Internal

Assumptions as to cost.

Assumptions as to schedule.

May require some testing.

Cost

Benefit

?

17

Constraints

Constraint: A factor that limits the

organization’s options.

Examples:

Cost

Schedule

Skills available

Facilities available

Legal & regulatory

Includes Exclusions

Cost

Benefit

18

Comparison of projects

19

Portfolio Selection

Cost

Benefit

Total investment budget

A

B

C

Problem: Allocation of investment dollars to maximize total benefit

Typical solution: Investment Review Panels and Multi-Function Analysis

Portfolio Selection

Cost

Benefit

Total investment budget

B

Problem: Different investments have different risk profiles

B’

Typical Solutions:

Use of risk adjusted discount rates.

Modeling and Simulation21

Portfolio Selection

Budget year

Net Benefit

Problem: Cost/Benefit profile over time must be considered

1 2 3

DE

F

Typical solution: Payback Period and NPV 22

Selection of the right projects

23

Portfolio Selection

Select in order COSTTOTAL BENEFITTOTAL

A 400 10 400 10

B 500 13 900 23

C 100 4 1000 27

D 300 6 1300 33

E 200 5 1500 38

Select by lowest cost COSTTOTAL BENEFITTOTAL

C 100 4 100 4

E 200 5 300 9

D 300 6 600 15

A 400 10 1000 25

B 500 13 1500 38

PROJECT COST BENEFIT

A 400 10

B 500 13

C 100 4

D 300 6

E 200 5

Budget = 1200

Cost: 1000

Benefit: 27

Cost: 1200

Benefit: 29

Cost: 1000

Benefit: 25

Select by highest benefit COSTTOTAL BENEFITTOTAL

B 500 13 500 13

A 400 10 900 23

D 300 6 1200 29

E 200 5 1400 34

C 100 4 1500 38

24

Portfolio Selection

PROJECT COST BENEFIT RATIO

A 400 10 0.025

B 500 13 0.026

C 100 4 0.040

D 300 6 0.020

E 200 5 0.025

Select by Benefit to Cost ratio COSTTOTAL BENEFITTOTAL

C 100 4 100 4

B 500 13 600 17

E 200 5 800 22

A 400 10 1200 32

D 300 6 1500 38

Cost: 1200

Benefit: 32

25

Graphical Comparison Based on Two

Criteria

GO

CAUTION

TERMINATE

BE

NE

FIT

Risk

Hig

hM

ediu

mLow

High Medium Low

PMBOK®

26

Multifunction Selection

27

A B C

Obj 1 2 2 3

Obj 2 3 2 2

Obj 3 1 3 2

Obj 4 1 3 2

Obj 5 3 2 2

Total 10 12 11

Weight A B C

Obj 1 5 10 10 15

Obj 2 10 30 20 20

Obj 3 5 5 15 10

Obj 4 1 1 3 2

Obj 5 5 15 10 10

Total 61 58 57

Weight A B C

Obj 1 10 20 20 30

Obj 2 5 15 10 10

Obj 3 3 3 9 6

Obj 4 5 5 15 10

Obj 5 5 15 10 10

Total 58 64 66

Weight

Obj 1 5

Obj 2 10

Obj 3 5

Obj 4 1

Obj 5 5

Total

Weight

Obj 1 10

Obj 2 5

Obj 3 3

Obj 4 5

Obj 5 5

Total

Rating from 1 (min) to 3 (max) Score = Weight times rating

Multifunction Selection

A B C D

Obj 1 10 7 1 2

Obj 2 8 3 1 2

Obj 3 7 4 2 3

Obj 4 0 3 2 2

Obj 5 4 6 0 6

Total 29 23 6 15

Cost 1000 1000 300 700

Budget: 2000

28

Multifunction Selection

A B C D Total

Obj 1 10 7 17

Obj 2 8 3 11

Obj 3 7 4 11

Obj 4 0 3 3

Obj 5 4 6 10

Total 29 23 52

Cost 1000 1000 2000

A B C D Total

Obj 1 10 1 2 13

Obj 2 8 1 2 11

Obj 3 7 2 3 12

Obj 4 0 2 2 4

Obj 5 4 0 6 10

Total 29 6 15 50

Cost 1000 300 700 2000

A B C D Total

Obj 1 7 1 2 10

Obj 2 3 1 2 6

Obj 3 4 2 3 9

Obj 4 3 2 2 7

Obj 5 6 0 6 12

Total 23 6 15 44

Cost 1000 300 700 2000 29

Multifunction Selection

Selection Criteria

10 is maximum

value for any

objective

A B C D Total

Obj 1 10 7 17 10

Obj 2 8 3 11 10

Obj 3 7 4 11 10

Obj 4 0 3 3 3

Obj 5 4 6 10 6

Total 29 23 52 39

Cost 1000 1000 2000

A B C D Total

Obj 1 10 1 2 13 10

Obj 2 8 1 2 11 10

Obj 3 7 2 3 12 10

Obj 4 0 2 2 4 4

Obj 5 4 0 6 10 10

Total 29 6 15 50 44

Cost 1000 300 700 2000

A B C D Total

Obj 1 7 1 2 10 10

Obj 2 3 1 2 6 6

Obj 3 4 2 3 9 9

Obj 4 3 2 2 7 7

Obj 5 6 0 6 12 10

Total 23 6 15 44 42

Cost 1000 300 700 200030

Multifunction Selection

Selection Criteria

10 is maximum

value

Total must score

at least 5 for

each objective

A B C D Total

Obj 1 10 7 17 10

Obj 2 8 3 11 10

Obj 3 7 4 11 10

Obj 4 0 3 3 3

Obj 5 4 6 10 6

Total 29 23 52 39

Cost 1000 1000 2000

A B C D Total

Obj 1 10 1 2 13 10

Obj 2 8 1 2 11 10

Obj 3 7 2 3 12 10

Obj 4 0 2 2 4 4

Obj 5 4 0 6 10 10

Total 29 6 15 50 44

Cost 1000 300 700 2000

A B C D Total

Obj 1 7 1 2 10 10

Obj 2 3 1 2 6 6

Obj 3 4 2 3 9 9

Obj 4 3 2 2 7 7

Obj 5 6 0 6 12 10

Total 23 6 15 44 42

Cost 1000 300 700 200031

The Basic Questions

How much should we invest in IT?

How should we allocate the IT investment

budget?

How do we know whether we’ve made the

right decision?

32

Did we get what we paid for…?

Year after

Project

Completion

Net Benefit

Planned

Actual

The key:

Know the baseline

Know how to measure performance 33

Practical Exercise

34

Practical Exercise- IRMC Electronics

Maker of Information Technology Products. The

following data represents the results of its Data

Server Division.

Note: all $ in 000,000.

2005 2006 2007 2008 2009

Revenue 190$ 220$ 260$ 260$ 270$

Profit 19$ 20$ 24$ 23$ 22$

$0

$100

$200

$300

2005 2006 2007 2008 2009

(000,0

00)

Operating Results

Revenue

Profit

35

Practical Exercise- Competition

The Data Server Division has two major

competitors, SMNS and LECANT.

Note: all $ in 000,000.

2005 2006 2007 2008 2009

IRMC-E 190$ 220$ 260$ 260$ 270$

SMNS 30$ 40$ 60$ 80$ 100$

LECANT 20$ 50$ 65$ 55$ 100$

Total 240$ 310$ 385$ 395$ 470$

$-

$100

$200

$300

$400

$500

2005 2006 2007 2008 2009

Sa

les

Market Share

LECANT

SMNS

IRMC-E

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009

Market Share

LECANT

SMNS

IRMC-E

36

Practical Exercise- Product Segment

The market for data servers is divided into three

segments: high-end, mid-range and low-end.

Note: all $ in 000,000.

2005 2006 2007 2008 2009

High End 25% 23% 25% 26% 33%

Mid Range 29% 35% 35% 34% 31%

Low End 46% 41% 40% 39% 36%

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009

Product Distribution- Total Market

Low End

Mid Range

Revenue Profit Return

High End 27$ 4$ 15%

Mid Range 90$ 11$ 12%

Low End 153$ 7$ 5%

Total 270$ 22$ 8%

2005 2006 2007 2008 2009

High End 30% 25% 20% 15% 10%

Mid Range 33% 33% 33% 33% 33%

Low End 37% 42% 47% 52% 57%

Product Distribution- IRMC-E

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009

Low End

Mid Range

High End

37

Practical Exercise- Corporate

Objectives

IRMC-E Strategic Objectives for the next

three years:

Meet or exceed the company’s internal rate of

return of 15%.

Maintain leadership in market segment

Establish a significant presence in emerging

international markets

Reduce key technical and managerial turnover

Regain reputation for technical excellence

38

Practical Exercise- the Investment

Choices

Engineering has developed a business case proposing an investment of $1,000k to develop a high-end server to be delivered in 12 months.

Manufacturing has developed a business case proposing an investment to reduce manufacturing costs. This investment would cost $500K.

Projected financial comparisons are to be developed using the standard IRMC-E cost analysis form and the data provided by Manufacturing and Engineering/Marketing.

You are the IRMC-Electronics Data Server Division Investment Review Committee (IDSDIRC). You are to recommend which of these two investments to approve.

39

Financial Comparison

40

IRMC-Electronics Cost Analysis Form

IRR: 15%

Year: 0 1 2 3 4

Option 1: Manufacturing Improvement

Investment $ 500.0

Savings $ - $ 50.0 $ 150.0 $ 150.0 $ 150.0

Net: $ (500.0) $ 50.0 $ 150.0 $ 150.0 $ 150.0

NPV =

Option 2: New product

Investment $ 1,000

Net Profit Increase: $ 50 $ 250 $ 500 $ 1,000

Net: $ (1,000) $ 50 $ 250 $ 500 $ 1,000

NPV=

Evaluation

New

Server

Improved Mfr Other

Financial analysis

Mkt Ldrshp

Emerging Mkts

HR Turnover

Tech Reputation

Score

Risk Rating

Recommended (Y/N)

Facts

Assumptions: 41

Challenge

I’m the boss: Convince me!

42

Thoughts for Consideration

What triggers the need for a new investment?

Does this affect the case study?

Is selling an IT investment any different than

selling other types of investments?

Are the risks the same for a Government

investment and a commercial investment?

43

Challenges

Do we really achieve our ROI’s?

Do we really achieve our non-financial

objectives?

Linking IT investment to Corporate objectives is

still as much an art as a science.

Focus on quarterly results can skew judgments.

44

Questions?

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