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Cost Analysis. Yale Braunstein School of Information. How does this course differ from all other project-related courses at the i-School?. We explicitly look at alternatives. We care about economic feasibility. [others ?]. Why do we want to know costs?.

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cost analysis

Cost Analysis

Yale Braunstein

School of Information

how does this course differ from all other project related courses at the i school
How does this course differ from all other project-related courses at the i-School?
  • We explicitly look at alternatives.
  • We care about economic feasibility.
  • [others ?]
why do we want to know costs
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
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
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.
making sense of costs
Making sense of costs
  • Costs vary with level of output
    • Therefore, we focus on fixed and variable costs
  • Costs vary over time
    • Therefore, we “discount” future costs back to the present
  • Costs can vary with technology and market conditions
    • Therefore, we distinguish between the short- and long-run
costing terms
Costing terms
  • Costs are misleadingly concrete. It is important to understand:
    • Fixed, variable & total costs
    • Opportunity costs (what really matters)
    • Sunk costs (what is past is past)
    • Marginal or incremental costs (the “true” cost of producing the next unit of output)
    • Joint costs (with multiple outputs)
    • Allocated vs. out-of-pocket costs (accountants & economists view costs very differently)
  • Consistency is VERY important
costs depend on your perspective
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
Costs vs. Prices
  • We need to distinguish between costs and prices
    • Proposed fees for “extra” units at UC, CSU
    • DSL (component-by-component)
  • “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
where to get cost information
Where to Get Cost Information
  • Statistical studies
  • Engineering studies
    • Simulations
    • Bills of Materials
  • Comparables
    • Case studies
    • Previous experience (at your organization & elsewhere)
additional considerations
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
    • See Morton * :
      • IT potentiallyincreases productivity by lowering transaction costs…if you reorganize work.

* Michael Scott Morton, “How Information Technologies can Transform Organizations,” in Rob Kling, Editor, Computerization and Controversy (San Diego: Academic Press 1996) 148-160.

cost benefit analysis
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
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
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
Three ways to compare projects
  • Payback period – NEVER use this
  • Internal rate of return – very common, but has problems
    • One: assumption about re-investment
    • Two: multiple solutions possible
    • Three: (most important) can lead to incorrect choices with MX projects
  • Net present value – the preferred approach
review general principles
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
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
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