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

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Cost Analysis

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Cost Analysis

Yale Braunstein

School of Information Management & Systems

How does this course differ from all other project-related courses at SIMS?

  • We explicitly look at alternatives.

  • We care about economic feasibility.

  • [others ?]

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 !

    • 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

  • Statistical studies

  • Engineering studies

    • Simulations

    • Bills of Materials

  • Comparables

    • Case studies

    • Previous experience (at your organization & elsewhere)

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

  • 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

    • 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

  • 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

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