Better Business Cases. Guide to Developing the Detailed Business Case

Transcription

1 Better Business Cases Guide to Developing the Detailed Business Case 28 February 2014

2 Acknowledgements This document was created using material provided by Her Majesty s (HM) Treasury in the United Kingdom, the Welsh Government (Llywodraeth Cymru) and the State of Victoria Department of Treasury and Finance. Accordingly, ownership of any copyright in the information contained in this document belongs to the original copyright owners. Other than as provided by the applicable copyright laws in each jurisdiction, permission to copy, distribute, adapt or otherwise use the information contained in this document, must be sought from the original copyright owner. The New Zealand Treasury wishes to acknowledge that the following documents were used and adapted for the purpose of creating this guidance: The Five Case Model is the best practice standard recommended by the HM Treasury for the preparation of business cases. Refer to Making Sense of Public Sector investments (2001) by Courtney A Smith and Joe Flanagan, the Green Book at and Delivering Public Value from Spending Proposals: Green Book Guidance on Public Sector Business Cases using the Five Case Model at wales.gov.uk/funding/wiipindex/5cmodel/?lang=en. The State of Victoria Department of Treasury and Finance Investment Management Standard provides a set of tools, including the Investment Logic Map (ILM) adopted in this guidance. Refer to This material is reproduced with permission and that copyright belongs to the State of Victoria. The State of Victoria is released from any liability associated with the subsequent use of the intellectual property associated with the material. The New Zealand Treasury also wishes to acknowledge the assistance of the following agencies who contributed to the preparation of this guidance material: Internal Affairs, Department of Labour, Housing New Zealand Corporation, Inland Revenue, Ministry of Economic Development, Ministry of Education, Ministry of Health, New Zealand Defence Force, State Services Commission and the Tertiary Education Commission. Crown Copyright This work is licensed under the Creative Commons Attribution 3.0 New Zealand licence. In essence, you are free to copy, distribute and adapt the work, as long as you attribute the work to the Crown and abide by the other licence terms. To view a copy of this licence, visit Please note that no departmental or governmental emblem, logo or Coat of Arms may be used in any way which infringes any provision of the Flags, Emblems, and Names Protection Act Attribution to the Crown should be in written form and not by reproduction of any such emblem, logo or Coat of Arms. ISBN (Online) The URL for this document on the Treasury s National Infrastructure Unit website at February 2014 is The Persistent URL for this document is

3 Contents About this Guidance... 2 What this Guidance is not... 2 Questions and Feedback... 2 Further information... 2 The Detailed Business Case... 3 When should a Detailed Business Case be Prepared?... 3 Revisiting the Strategic and Economic Cases... 7 Action 9: Revisit the Indicative Business Case and Confirm the Short List... 7 Economic Case Determining Potential Value for Money... 8 Action 10: Economic Assessment of the Short-Listed Options... 8 Action 11: Non-monetary Benefits and Costs Action 12: Risk and Uncertainty Action 13: The Preferred Option and Sensitivity Analysis Commercial Case Preparing for the Potential Deal Action 14: The Procurement Strategy Action 15: Specify Requirements Action 16: Risk Allocation Action 17: Payment Mechanisms Action 18: Contractual and Other Issues Financial Case Ascertaining Affordability and Funding Requirements Action 19: The Financial Costing Model Management Case Planning for Successful Delivery Action 20: Project Management Planning Action 21: Change Management Planning Action 22: Benefits Management Planning Action 23: Risk Management Planning Action 24: Post Project Evaluation Planning References Annex One: Reviewer Questions Annex Two: Sample Risk Register Better Business Cases: Guide to Developing the Detailed Business Case 1

4 About this Guidance This guidance is intended to assist developers and reviewers to build better business cases using the Five Case Model, the New Zealand Government s accepted good practice standard. This guidance document is intended to assist investors, senior responsible owners, workshop facilitators and business case developers to prepare the Detailed Business Case. This document has been written as part of the suite of Better Business Case guidance. It is part of a comprehensive and structured tool-kit of guides and templates to assist you at every stage of the business case development. This guidance can assist you whether you are considering an investment in change at the portfolio, programme or project level in either the wider Public or the private sectors. This guidance also provides a useful reference for business managers, project or programme managers, and other stakeholders who can either influence investment decisions or have an interest in the successful delivery of change. The guidance outlined in this document applies until this document is updated or replaced. What this Guidance is not This guidance is not intended to comprehensively cover all the related aspects of business case development. These may include regulatory impact, economic assessment, procurement, risk management, Public Private Partnership (PPP), Treaty, programme/project management or assurance processes. You should refer to any relevant policies, rules, expectations and practices that apply to your specific organisation or sector. Questions and Feedback General enquiries about the information contained in this guidance, not addressed in this guidance, can be directed to betterbusinesscases@treasury.govt.nz. For Government agencies, any agency-specific questions should be addressed to your Treasury Vote team. Any comments as to how we could improve this guidance can be directed to guidance@treasury.govt.nz. Further information This document is part of the Better Business Cases suite of guidance available at the Treasury National Infrastructure Unit website Better Business Cases: Guide to Developing the Detailed Business Case 2

5 The Detailed Business Case The Detailed Business Case recommends a preferred option that optimises value for money and seeks approval from decision-makers to finalise the arrangements for successful implementation. The decision to develop the Detailed Business Case typically follows from the previous Indicative Business Case recommendation to proceed with the preferred way forward. The Detailed Business Case: revisits and confirms the strategic case developed in the Indicative Business Case identifies the preferred option which optimises value for money, by undertaking a more detailed analysis of the costs, benefits and risks of the short-listed options prepares the proposal for procurement plans the necessary funding and management arrangements for the successful delivery of the project, and informs a proposal to decision-makers to seek agreement to approach the market and finalise the arrangements for implementation of the project. Apart from proposals that are likely to result in a non-traditional procurement 1, a Request for Proposal (RFP) may be issued once approval is granted. When should a Detailed Business Case be Prepared? The Detailed Business Case is a significant deliverable of the Better Business Cases process. The Better Business Cases process develops five cases that provide assurance that an investment proposal: is supported by a compelling case for change, the strategic case optimises value for money, the economic case is commercially viable, the commercial case is financially affordable, the financial case, and is achievable, the management case. The Better Business Cases process is designed to ensure that there are no surprises and that the analytical effort is fit for purpose. These two goals are achieved by adopting a staged approval process with appropriate business case deliverables that support the decisions sought. This ensures early engagement with decision-makers and means development effort is not wasted on options that can be ruled out early. 1 Refer to the PPP guidance maintained by the National Infrastructure Unit of the Treasury and available from Better Business Cases: Guide to Developing the Detailed Business Case 3

6 The Detailed Business Case is a key deliverable of a staged approval process for a project, as outlined in figure 1 below. Figure 1: Overview of a two-stage Better Business Cases process (for a sample project, either stand alone or as a consequence of a Programme Business Case decision). Initiate proposal (Project) Strategic Assessment Decision to proceed Indicative Business Case Decision to assess short list Detailed Business Case Decision to invest Implementation Business Case Decision to sign contract Risk Profile Assessment Stakeholder assessment Scoping Document Outline fit with strategy and need to invest Assurance requirements Scoping Document Make case for change Explore the preferred way forward and short list options Assurance requirements Scoping Document Determine preferred solution Plan for delivery Assurance requirements Scoping Document Confirm best value for money supplier offer Prepare for delivery Assurance requirements Prior to commencing work on the development of the Detailed Business Case, the process to be followed and the amount of analytical effort needed to meet the expectations of decisionmakers should be agreed. Typically this requires a discussion with the appropriate monitoring agency or review team and is documented in the relevant Scoping Document. 2 Senior responsible owners of significant proposals in the State sector should ensure the relevant Treasury vote team (or monitoring agency) officials are fully engaged in developing and agreeing the Scoping Document. Single stage process A simpler, fit-for-purpose single stage approval process may be used for investment proposals that are assessed as lower risk and small scale. For a single stage approval process, the Indicative and Detailed business case content requirements are combined into a Single Stage Business Case, with a lower level of analytical effort required to meet decisionmaker expectations The Scoping Document facilitates discussion and agreement between the senior responsible owner and the reviewer on how the Better Business Cases process is applied. The aim is to align the expectations of both parties to be fit for purpose for the risk and scale of the proposal. The Scoping Document templates for each of the business case deliverables are available at Refer to the relevant Better Business Cases Guide to Developing the Single Stage Business Case available at Better Business Cases: Guide to Developing the Detailed Business Case 4

7 Figure 2: Overview of a single stage Better Business Cases process (for a sample project, either stand alone or as a consequence of a Programme Business Case decision). Initiate proposal (Project) Strategic Assessment Decision To proceed Single Stage Business Case Decision to invest Implementation Business Case Decision to sign contract Risk Profile Assessment Stakeholder assessment Scoping Document Outline fit with strategy and need to invest Assurance requirements Scoping Document make case for change Determine preferred solution Plan for delivery Assurance requirements Scoping Document Confirm best value for money supplier offer Prepare for delivery Assurance requirements Agreement on the process to be applied should be negotiated with the monitoring agency or review team and documented in the relevant Scoping Document. Functional Leadership implications Functional leadership is a key pillar of the Better Public Services change programme. It aims to improve the effectiveness and reduce the overall costs to government of common business functions. Functional leadership roles have been given to three chief executives to drive performance across the state services in ICT, procurement and property respectively. Government agencies need to have regard to, and engage with the appropriate functional lead agencies when planning and progressing certain types of activities. The Functional Leaders are the chief executives of the: Department of Internal Affairs (the Chief Government Information Officer), responsible for the ICT Strategy and Action plan Ministry of Business, Innovation and Employment, responsible for Government procurement reform, and Ministry of Social Development, responsible for the Property Management Centre of Expertise and the Government National Property strategy. They retain their departmental roles but wear an additional functional leader 'hat' to achieve benefits for government overall. Where the Detailed Business Case is likely to consider options within the mandate of any of the three functional leads, the implications for the business case development process need to be considered as part of finalising the Scoping Document. Better Business Cases: Guide to Developing the Detailed Business Case 5

8 Gateway review Gateway is an assurance methodology for major investments. It is a review process that examines programmes and projects at key decision points in their lifecycle to provide assurance that they can progress successfully to the next stage. Gateway is Cabinet mandated for high risk capital projects in government departments and Crown Agents, irrespective of scale or funding source. Agencies determine if their projects are high-risk by completing the Risk Profile Assessment. The Gateway Unit determines whether a project or programme is high risk, based on its assessment of the initial Risk Profile Assessment provided by the agency, and other factors. 4 If the capital proposal is subject to Gateway review, the draft Detailed Business Case will assist to inform the Gate 2 (Detailed Business Case) review. Feedback from the review is incorporated into the document prior to final sign-off. 4 For guidance material, the Risk Profile Assessment spread-sheet and contact details, refer to the Gateway Review website at Better Business Cases: Guide to Developing the Detailed Business Case 6

9 Revisiting the Strategic and Economic Cases As business case development can be protracted, a considerable amount of time may have passed since the initial analysis. The political, economic and policy environment may have significantly changed. The previous analysis and conclusions as part of the Indicative Business Case should be revisited and updated, where needed. The intent is to inform the investment story, not to replicate previous analysis and content. Action 9: Revisit the Indicative Business Case and Confirm the Short List The purpose of this action is to revisit, and either confirm or update, both the case for change and the short-listed options recommended for further consideration in this Detailed Business Case. Revisiting the strategic case The case for change should be reviewed and revised to reflect any changes due to: any conditions made as part the earlier approval of the Indicative Business Case decision-makers influencing the direction of the investment proposal as part of the early engagement on the indicative Business Case, and/or the time that has elapsed between approval and commencing work on the Detailed Business Case. Reviewing the economic case Review and refine earlier work on the long-list and the preferred way forward. The recommended short-list contained in the Indicative Business Case should be re-tested. If there have been any changes in the underlying assumptions since the initial options assessment, are any of the short-list options now: likely to deliver the investment objectives and critical success factors? unlikely to deliver sufficient benefits, noting the aim to improve value for money? clearly impractical or unfeasible, for example if the assumed technology or land is no longer available? clearly inferior to another option, due to significantly greater costs or lower benefits? likely to violate any of the constraints, for example by now being clearly unaffordable? sufficiently similar to allow detailed analysis of a single representative option? clearly too risky? The rationale for any significant changes or revisions should be clearly documented. The intent is not to repeat the previous work already included in the Indicative Business Case, but to confirm that this analysis is still relevant and robust. Better Business Cases: Guide to Developing the Detailed Business Case 7

10 Economic Case Determining Potential Value for Money The purpose of this part of the economic case is to undertake a more detailed analysis of the costs, benefits and risks of the short-listed options. This should provide a clear understanding of the value for money likely to be provided by the preferred option in delivering the required services. This includes: cost benefit analysis of the short-listed options assessment of any intangible benefits and costs, and assessment of risk and uncertainty. Action 10: Economic Assessment of the Short-Listed Options An economic assessment seeks to capture all benefits and costs regardless of to whom they accrue. Economic assessments also take into account costs and benefits that may not be reflected in monetary transactions. An economic benefit is considered to be any gain in the welfare of society arising from the investment proposal. It can include the time savings from reduced travelling times on a new motorway or the increase in quality of life years remaining as a result of a new pharmaceutical treatment. Different stakeholder groups derive different benefits (and dis-benefits) from an investment proposal and will have different perspectives on the value added. For State sector investment proposals, Treasury s expectation is that the assessment of the investment proposal will be undertaken from a national, economic perspective rather than a narrower all-of-government, agency, programme or project perspective. A national economy perspective is preferred because the actions of an organisation can impose costs or benefits on individuals or the nation as a whole (for example increasing the size of a programme operated by a particular Government department may require a large increase in income tax on individuals). The New Zealand Treasury higher living standards framework provides a useful basis for thinking about and assessing the economic impacts of State sector investment proposals on the overall living standards of New Zealanders, as well as the distributional effects across the population. 5 Economic Cost Benefit Analysis is the preferred assessment method There are various forms of economic assessment tools that can be used for ranking competing investment options, with differing levels of complexity. The expectation is that cost benefit analysis (CBA) will be used, wherever possible, and undertaken from a national perspective rather than a narrower all-of-government, agency, programme or project perspective. This is termed economic cost benefit analysis. 5 Refer to Working Towards Higher Living Standards for New Zealanders (May 2011) available from Better Business Cases: Guide to Developing the Detailed Business Case 8

11 Economic cost benefit analysis is flexible and can generally be applied to assess most proposals. It is the recommended, first-best, approach. By identifying and quantifying costs and benefits in monetary terms, it is possible to demonstrate that the expected benefits of a given option exceed the expected costs. That is, to determine if there is a net benefit. Discounting should be applied to determine the net benefits in today s dollars, termed the net present value (NPV). The discounted net benefits can then be used to quantitatively rank between a given option and the base case, or between competing options. Decision-makers and stakeholders can be provided with a consistent basis for assessing the trade-offs and relative value for money of competing options, and can be better informed about the implications of using economic resources. Cost benefit analysis has some limitations that mean it is not suitable for assessing every type of proposal. It can be difficult to assign monetary values to all costs and benefits. Where nominal monetary values cannot be assigned, it may be possible to estimate a range of monetary values for assessment purposes. A range-based approach for selected costs and benefits will generally provide a better basis for assessment than not assigning monetary values at all. If there is not a sufficient base from which to conduct a full economic cost benefit analysis, a combination approach may be used. This would apply cost benefit analysis for those costs and benefits that can reasonably be assigned monetary values. Some benefits and costs may not be reliably quantified in monetary values and may need to be assessed separately using multi-criteria analysis techniques 6. This approach is detailed in action 11 below. The assessment process Undertaking economic assessment of the short-list options involves eight steps: a. Establish the assumptions and scope underlying the analysis. Should a national economic or agency-specific analysis be applied? Determine what additional economic analysis is required to produce suitable monetary estimates. b. Decide an appropriate period for the analysis. This appraisal period typically matches the economic life of any proposed asset. In some cases it may be determined by the contractual term of the services. Where options have differing economic lives, a single common appraisal period is required. Either residual values can be assumed for the longer term options or reinvestment of shorter term options. c. Identify all significant benefits and costs. The monetary and non-monetary benefits in action five can be revisited and updated. All material direct and indirect, monetary and non-monetary costs should be included. Indirect costs as a result of the outcomes of the proposal may be incurred by the organisation, other agencies, users and other affected stakeholders. 6 Refer to the Treasury Cost Benefit Analysis Primer available at Better Business Cases: Guide to Developing the Detailed Business Case 9

12 d. Assign monetary values to the benefits and costs, wherever possible. Document all assumptions made about the scale, timing and growth of benefits or costs over the appraisal period. All monetary estimates should be expressed in current dollar terms as allowance for general inflation is factored into the discount rate. GST, depreciation, capital charges and financing costs are also typically excluded. e. Discount the benefits and costs to present values using the Public Sector Discount Rates specified from time to time by the Treasury. 7 Where a different discount rate is proposed, this should be tested as part of the Scoping Document discussion. f. Consider the effect of any benefits or costs that cannot be reasonably and reliably assigned monetary values. Refer to action 11 for further guidance on the assessment and presentation of non-monetary benefits and costs. g. Assess risk and uncertainty where it can result in variations to benefit and cost estimates, and consequently on the options assessment. Refer to action 12 below. h. Identify the preferred option and undertake sensitivity analysis to test its robustness. Refer to action 13 below. For further guidance on undertaking a cost-benefit analysis, refer to the Treasury Cost Benefit Analysis Primer. 8 Action 11: Non-monetary Benefits and Costs All benefits and costs that can be quantified in monetary terms should be included in the economic assessment and subject to economic cost benefit analysis. However, some benefits and costs may not be reliably or reasonably quantified in monetary values. These are termed non-monetary benefits or costs. If they are significant, these non-monetary benefits and costs will influence the choice of the preferred option. Significant non-monetary benefits and costs should be explicitly highlighted and explained in the analysis so that decision-makers are aware of the value judgements and trade-offs involved in pursuing a particular option. This explanation can be quantitative, qualitative, descriptive, or a combination of these. One approach is to use decision modelling tools to weight and score the non-monetary benefits and costs for each option. The preferred form of qualitative analysis for comparing unvalued benefits and costs is multi-criteria decision analysis (MCDA). Multi-criteria decision analysis is a tool for assessing and ranking alternative options against a given set of investment criteria. The alternative options can be assessed and scored (typically by a representative panel of stakeholders) against the criteria. The weighted overall scores provide a ranking of alternative options. 7 8 Refer to the Public Sector discount rates published on the Treasury website at In addition to the Treasury guidance, a useful cost-benefit analysis spread-sheet templatel can be downloaded from the Tertiary Education Commission website at Sector/Crown-Interest/Business-Cases/Step-Two--Business-Case-Development/ Better Business Cases: Guide to Developing the Detailed Business Case 10

13 Multi-criteria decision analysis can be less rigorous than cost benefit analysis, but is relatively easy to implement and can be used to assess and compare options that involve both monetary and non-monetary impacts. It can aid decision-making by complementing the quantitative economic cost benefit analysis above. The process and the reasoning behind the scores and weightings must be documented clearly to demonstrate that a robust analysis has been carried out. Again, it is important to recognise that the assigned weights and the scores given to options are value judgements. In order to assign weights and scores, negotiation and compromise needs to take place. It is the number of people involved in the panel process and their expertise that lends credibility to these value judgements. It is, therefore, worth spending some time choosing a representative benefits team which should include stakeholders, customers (users), and business and technical representatives. The people involved should be named as part of the process. The extent or depth of the analysis should be tailored to the relative size, impacts, and risks of the proposal. A more robust assessment can be attained by using expert facilitators. Proprietary multi-criteria decision analysis tools are available and can be used to help ensure that the weighting and scoring processes are objective. However not all proposals will justify or require a full multi-criteria decision analysis. If two comparable options have similar benefits and it is demonstrated that a multi-criteria analysis would not add further value to the analysis of intangibles, a cost-effectiveness analysis may provide an adequate and fit for purpose alternative. Prior to commencing development work, negotiate the process to be followed, the amount of analytical effort and the decisions needed with the monitoring agency (or internal unit). These agreements should be documented in the relevant Scoping Document. Action 12: Risk and Uncertainty All benefits, costs and timeframes estimated in the economic assessment are subject to risk and uncertainty. Risk can influence the choice of the preferred option. Given the choice between two competing short-listed options with similar estimated costs and benefits, a riskaverse decision-maker will likely prefer the option that provides greater certainty of costs, benefits and timings of key deliverables. For this reason, decision-makers can typically prefer options that offer shorter term realisation of benefits. The aim of this section of the guide is to consider all significant risks that might create, enhance, prevent, degrade, accelerate or delay the achievement of the objectives associated with the investment proposal. Its purpose is to support better decision-making through understanding the risks inherent in each of the short-listed options and their likely impact. Over the business case development, risks need to be analysed and managed. Risk analysis encompasses identification, estimation and evaluation. It is recommended that all significant risks should be measured and quantified (in monetary terms) as early as possible. The risks initially identified by stakeholders in action five should be revisited and re-evaluated. Better Business Cases: Guide to Developing the Detailed Business Case 11

14 Optimism bias The simplest form of quantification of risk is by applying optimism bias loadings to costs or timeframes to reflect the systematic tendency for business case developers to be overoptimistic about key parameters. The adjustments can be based on past empirical experience of similar projects and should be reduced at different stages of the business case development as progressively better estimates are made 9. While simple, the disadvantages are that it reflects downside risks only and is unlikely to be fit for purpose for this stage of the analysis. Single-point probability analysis An expected value can be calculated for each significant risk by multiplying the likelihood of the risk occurring (probability) by the size of the consequence. This risk premium is expressed in monetary terms and provides an estimate of the cost of accepting all the risk. It is best used when both the likelihood and consequence of the risk event can be estimated reasonably well. The disadvantage is that it provides no information about the underlying variability in outcomes or consequences, particularly at the extremes when decision-makers may prefer not to accept the risk of the event occurring. Quantitative risk analysis (QRA) For any risk, a range of possible outcomes (and consequences) is more likely. An output probability distribution provides a more complete picture of the possible outcomes and recognises that some of these outcomes are more likely to occur than others. Quantitative risk analysis (QRA) is a modelling technique that makes risks, and the financial impact of those risks, more explicit to decision-makers when considering the business case. This recognises that using single point estimates for comparing options can provide relatively limited information about the underlying trade-offs. QRA of costs is mandatory as part of the development of a Detailed Business Case (DBC) for high risk major projects or programmes monitored by the Treasury. The State Services Commission maintains a panel of accredited quantitative risk analysis experts for use by Government agencies. 10 Quantitative risk analysis can provide a better understanding of the sources of risk to project outcomes and more accurate estimates of the likely costs or benefits. Generally a quantitative risk analysis approach is considered to be superior to an approach that solely relies on optimism bias or contingencies. Quantitative risk analysis should be used as the first-best basis and is required for high risk, large scale investment proposals. Quantitative risk analysis conducts detailed sensitivity analysis and analysis of the likely effect of these scenarios on project outcomes. This involves assessing each probability and consequence and modelling project outcomes based on simulations of each risk. The final probability distribution describes the range of outcomes and their relative likelihood. 9 Refer to the HM Treasury Green Book supplementary guide at 10 Refer to the State Services Commission website at Better Business Cases: Guide to Developing the Detailed Business Case 12

15 The risk modelling process involves: a. building the models b. including distributions for uncertain inputs c. simulating outcome distributions d. generating outcome graphs and tables, and e. reviewing and revision as necessary. Impacts, other than financial, must also be considered and documented. Monte Carlo analysis Monte Carlo analysis is a specific risk modelling technique that uses statistical sampling and probability distributions to simulate the effects of uncertain variables on model outcomes. The approach provides a systematic assessment of the combined effects of multiple sources of risk in key variables and can also allow for known correlations between these variables. Using Monte Carlo can require expert advice to develop the model and interpret the results. The Monte Carlo approach is more suited to proposals where there are several key variables with significant and/or correlated uncertainties, and when simpler sensitivity analysis approaches are unable to adequately describe the resulting variation in net benefits between competing options. Scalability of analysis effort The extent or depth of the analysis should be tailored to the relative size, impacts, and risks of the proposal. Not all proposals will require a full economic cost benefit analysis of all costs and benefits, a full multi-criteria analysis or quantitative risk analysis. An alternative to the national economy approach is to limit the scope of the analysis of costs and benefits to financial impacts on a single organisation. Examples may include the impacts of a new accounting package or a lease versus buy decision for property. This simpler form of financial analysis may be appropriate for proposals that are organisation-specific and have minimal impacts on either other organisations, individuals or the wider economy. The standard of analysis specified in the scalability matrix 11 varies from a full economic cost benefit analysis to light financial analysis, depending on the scale and level of risk of the proposal. This is detailed in the table overleaf. Prior to commencing development work, negotiate the process to be followed, the amount of analytical effort and the decisions needed with the monitoring agency (or internal unit). These agreements should be documented in the relevant Scoping Document Refer to the Better Business Cases Overview booklet at available at 12 State sector senior responsible owners should ensure that the relevant Treasury officials are fully engaged as part of the Scoping Document agreements. Better Business Cases: Guide to Developing the Detailed Business Case 13

16 Table 1: Scalability of analysis effort Full Analysis Light Analysis Scope of economic analysis National economy Organisation and selected sectors All significant resource flows, including non-monetary costs and benefits Organisation All significant resource flows that can be expressed in monetary terms Non-monetary benefits and costs Multi-criteria decision analysis using expert facilitation and proprietary tools Multi-criteria decision analysis Ranking of nonmonetary benefits and costs Uncertainty Quantitative risk analysis Quantify risks and probabilities 13 Single point adjustments of costs and benefits Action 13: The Preferred Option and Sensitivity Analysis The purpose of this action is to identify the preferred option and test its robustness using sensitivity analysis. The overall objective is to determine which of the short-listed options is likely to provide the best value for money (the optimal mix of benefits, costs and risks). Selecting the preferred option The rationale for recommending the preferred option must be clear and defensible. Sufficient evidence for the selection should be provided along with a clear audit trail for decisionmakers to check the assumptions, evidence and calculations leading up to the selection. Stakeholders and decision-makers should have assurance that the analysis and the selection processes are robust. If a full cost benefit analysis has been undertaken, to the extent that all costs, benefits and risks have been quantified and valued robustly, the best option is likely to be the one with the highest, risk adjusted, net present value. Using the net present value method is the preferred approach. Using alternative techniques, such as internal rate of return, equivalent annual cost, benefitcost ratio and pay-back period methods may be desirable in certain cases. Refer to the Treasury Cost Benefit Analysis Primer and contact your monitoring agency for further guidance. However non-monetary benefits and costs cannot easily be included in the cost benefit analysis and hence are not reflected in the net present value. If they are significant, these non-monetary benefits and costs can potentially out-weigh the net present values and influence the choice of the preferred option. Decision-makers need to be provided with a basis to inform trade-offs between competing short-listed options with different mixes of monetary and non-monetary benefits and costs. This trade-off is demonstrated in the following example. 13 Consider risk modelling techniques that are less resource intensive than full quantitative risk analysis. For example, by using multi-point probability or decision-tree analysis to estimate the impacts of different outcomes on mid-point risk estimates. Better Business Cases: Guide to Developing the Detailed Business Case 14

17 Table 2: An example of how to present a combined cost benefit analysis/ multi-criteria decision analysis with three intangible benefit criteria and prior to sensitivity testing. In this example the stakeholders need to consider the potential for the higher non-monetary benefits of option three to out-weigh the extra monetary net benefits of option four. Option 1:Do Nothing Option 2: Do Minimum Option 3: Less Ambitious Option 4: Preferred Way Forward Option 5: More Ambitious Analysis Period (years) Capital Costs ($m) $0.0 $22.5 $23.9 $31.6 $45.7 Whole of Life Costs ($m) $14.4 $34.2 $49.7 $70.7 $90.9 Cost-Benefit Analysis of monetary costs and benefits at the Public Sector Discount Rate 14 Present Value of Benefits ($m) Present Value of Costs ($m) $2 $25 $75 $115 $126 $7 $23 $40 $52 $73 Benefit Cost Ratio 0.3:1 1.1:1 1.9:1 2.2:1 1.7:1 Net Present Value (NPV, $m) ($5) $2 $35 $63 $53 NPV Rank (out of 5) Multi-Criteria Decision Analysis of non-monetary benefits and costs (score out of 10) Improved management information (20% weight) Greater inter-agency collaboration (40% weight) More competitive marketplace (40% weight) MCDA Rank (out of 5) = 3= Fully involving stakeholders is very important in making judgements between monetary and non-monetary factors. A facilitated workshop process should be used to ensure that key stakeholders are engaged early and have the ability to challenge the analysis. Often a choice will remain between high cost/high benefit options and low cost/low benefit options. In these circumstances, decision-makers must be sufficiently well-informed to enable them to decide how to make these trade-offs. 14 Refer to the Treasury Cost Benefit Analysis Primer available at Better Business Cases: Guide to Developing the Detailed Business Case 15

18 Sensitivity analysis testing the robustness of the preferred option Sensitivity analysis is a form of quantitative analysis that examines how net present values, benefits, costs or other outcomes vary as individual assumptions or variables are changed. This approach can be used to test the robustness of the analysis. Sensitivity analysis can help draw attention to those factors that require especially careful assessment or management. This analysis can address two key questions. Would the preferred option still be worthwhile pursuing if some of the key assumptions do not eventuate? What actions can be taken to reduce the risks before accepting a particular option? The sensitivity analysis needs to be well designed and clearly presented. The analysis should give a realistic picture of the extent to which the preferred option is still worthwhile pursuing even if there are significant changes in key variables. The decision about which form of sensitivity analysis to undertake and the effort to invest should be made on a case-by-case basis, depending on the scale of the proposal, the degree of future uncertainty around key costs or benefits, and the risk tolerance of stakeholders. In itself, sensitivity analysis may not change the preferred option. However, if small changes in the assumptions alter the ranking, it is an indication that the investment process should proceed cautiously, because it has non-robust elements in it. This means that a more detailed analysis and testing of the costs, benefits and risks of some of the options should be considered. Sensitivity analysis should be undertaken using two approaches: i scenario analysis, and ii switching values. Scenario analysis testing what if Scenarios are useful in considering how options may be affected by future uncertainty. Scenarios should be chosen to draw attention to the major uncertainties on which the success of the proposal depends. Are there any variables (such as exchange rates, salary costs, demand drivers, timing or assumptions) that materially influence the net benefits? These key variables should be identified using the risk assessment process above. The scenario analysis should then focus on asking what if questions and recalculating the expected Net Present Value for several scenarios. For example, what if one or more sensitive/key variables were changed by ±10%, or ±50%, or whatever is a realistic and possible variation. What if related Government policy altered or critical legislation is not passed? If these events occur, should the proposal proceed? Under what circumstances does the preferred option change? Better Business Cases: Guide to Developing the Detailed Business Case 16

19 A common approach is to test three scenarios: i pessimistic or conservative scenario ii most probable or base scenario, and iii optimistic scenario. Switching values This is a what if scenario test that highlights how much a given variable (eg an uncertain cost, benefit or key assumption) would have to change to alter the choice of the preferred option. Judgements may be necessary to model how the change would alter the choice of the preferred option. Examples of variables that are likely to impact on the robustness of the choice of the preferred option may include growth of real wages, forecast revenues, demand, prices, and/or assumptions about the transfer of risk. An understanding of how costs fall into fixed, step, variable and semi-variable categories can also help in understanding the sensitivity of the costs of given options. Table 3: Example of an off-shore procurement of capital assets valued at $US23.9 million at an exchange rate of $NZ0.80 (based on option 3 in Table 2 above) and with different exchange rate and price discount scenarios Sensitivity Testing of Option 3 Conservative Scenario Base Scenario Optimistic Scenario Exchange Rate ($NZ per US$) $0.69 $0.80 $0.88 Negotiated purchase price discount Resultant Net Present Value (NPV) of the preferred option 3 ($ million) 10% 15% 25% $29 $35 $40 Various what if scenarios can be constructed by varying the two factors, exchange rate and price discount. The resulting impacts on the overall options analysis and the robustness of the preferred option can then be considered. In the example above and keeping the purchase price discount constant at 15%, the analyst also determines that a worsening in the exchange rate from $0.80 to $0.70 is sufficient to change the choice of the preferred option from option 3 to option 4. The exchange rate of $0.70 is then a switching value. Switching value analysis is an important input to the decision on whether or not a proposal should proceed. These risks need to be clearly highlighted to decision-makers to enable them to accurately assess the degree of robustness of the preferred option. Presenting the preferred option and analysis The rationale for recommending the preferred option should be clear and defensible. Decision-makers and stakeholders should have assurance that the analysis and the selection processes are robust. Better Business Cases: Guide to Developing the Detailed Business Case 17

20 Sufficient evidence should be provided to explain: all major assumptions, including the scope of the analysis why certain costs and benefits have been included or excluded the valuation methodologies employed to estimate costs and benefits. The discount rate employed (typically the Public Sector Discount Rate specified from time to time by the Treasury 15 ) : any sensitivity analysis undertaken and any significant qualitative or non-monetary impacts identified (including externalities, deadweight losses and behavioural effects) the justification for the decision criteria employed the final recommendation in a way that its implications and qualifications are easily understood by decision makers, and the biases, limitations and deficiencies of the analysis. 15 Refer to the Treasury Cost Benefit Analysis Primer available at Better Business Cases: Guide to Developing the Detailed Business Case 18

21 Commercial Case Preparing for the Potential Deal This part of the commercial case plans early for the commercially viable procurement arrangements needed to implement the preferred solution, prior to issuing requests for proposals. Good outcomes depend on good procurement. Properly planned and effectively executed procurement is essential for all agencies. The term procurement covers all aspects of the acquisition and delivery of goods services and works. It spans the whole contract life cycle from the identification of needs to the end of the service contract, or the end of the useful life and subsequent disposal of an asset. Action 14: The Procurement Strategy Achieving strategic procurement outcomes in the business case context involves setting strategic priorities and direction. The implementation links strategic planning with operational planning and financial planning and management. Adopting a structured approach to procurement planning results in robust, objective analysis that informs the best methodology to approach the market and achieve optimal procurement outcomes across the range of procurement activities undertaken by the agency. For agencies, strategic procurement can be identified at two levels. Firstly involving highlevel strategic thinking and business planning and secondly, at an operational level when dealing with individual acquisitions. The New Zealand Government procurement framework While New Zealand does not have any legislation or regulations governing public sector procurement, there is a framework based on the Principles of Government Procurement, Government Rules of Sourcing and other procurement guidance that collectively set out expectations and constraints. The responsibility for procurement procedures and decisions is devolved to the individual departments or agencies. 16 New Zealand s Government Rules of Sourcing, along with Office of the Auditor-General s Procurement Guidance for Public Entities and the Principles of Government Procurement provides the framework that promotes responsible spending when purchasing goods and services. The five principles of Government procurement are: 1. plan and manage for great results 2. be fair to all suppliers 3. get the right supplier 4. get the best deal for everyone, and 5. play by the rules. 16 Refer to the Ministry of Business, Innovation and Employment website at Better Business Cases: Guide to Developing the Detailed Business Case 19

22 The six principles that govern all public spending are: 17 i accountability ii openness iii value for money iv lawfulness v fairness, and vi integrity. Government departments, New Zealand Police and New Zealand Defence Force are required by Cabinet to follow the Government Rules of Sourcing published by the Ministry of Business, Innovation and Employment in These Rules set out Government s standards of good practice for the sourcing stages of the procurement lifecycle. The rules reflect and reinforce New Zealand s established policy of openness and transparency in government procurement. Other State Services agencies are expected to apply the Rules and agencies in the wider State Sector and Public Sector are encouraged to apply these rules in their own procurements. Relevant good practice guidance includes: Procurement Guidance for Public Entities, published by the Office of the Controller and Auditor General (2008) 18. This good practice guide contains principles, considerations, and processes to assist public entities when procuring goods or services. Mastering Procurement: A Structured Approach to Strategic Procurement (2011), published by the Ministry of Economic Development. This guide has been developed for Government agencies. It supports good practice and introduces the eight step procurement lifecycle. It takes a structured approach to strategic procurement. 19 Government departments and agencies are encouraged to take a strategic approach to managing public funds. This means developing an understanding of the importance of procurement to achieving its overall public policy outcomes and business objectives and developing a procurement strategy. The agency can then clearly identify the most effective and efficient ways to source and secure goods and services. Identifying how important the goods, services or works are to your agency will help inform the approach you take to the market. The Supply Positioning matrix overleaf helps this analysis. 17 Available from the Office of the Controller and Auditor General (OAG) website at 18 Available from the Office of the Controller and Auditor General (OAG) website at 19 Refer to the Ministry of Business, Innovation and Employment website at Better Business Cases: Guide to Developing the Detailed Business Case 20