Economic Justification: Measuring Return on Investment (ROI) and Cost Benefit Analysis (CBA)

Transcription

1 Advancing Statewide Spatial Data Infrastructures in Supprt f the Natinal Spatial Data Infrastructure (NSDI) Ecnmic Justificatin: Measuring Return n Investment (ROI) and Cst Benefit Analysis (CBA) Intrductin Yur business plan must have sme type f ecnmic justificatin t prvide yur executives and elected fficials with financial infrmatin. It will help them knw that they are ding the right thing by implementing the requested prgram. A ppular ecnmic calculatin fr the attractiveness f an investment is Return n Investment (ROI). ROI is a calculatin f the mst tangible financial gains r benefits that can be expected frm a prject versus the csts fr implementing the suggested prgram r slutin. Cst Benefit Analysis (CBA) is mre cmprehensive than ROI, and attempts t quantify bth tangible and intangible (r sft ) csts and benefits. The purpse f this guide is t make these measurement techniques a little mre understandable. Calculating ROI ROI is represented as a rati f the expected financial gains (benefits) f a prject divided by its ttal csts. As a frmula it appears as: then the ROI calculatin wuld appear as fllws. ROI = (25,000/50,000) The ROI in this example is 50% which represents a psitive return n the investment. It takes an ROI rati greater than zer fr a prgram t be attractive, typically. A sub-zer rati may nt autmatically kill a prject, because it may result in a required capability that desn t currently exist. Nt all gvernment functins are required t have a psitive rate f return as they are in the business wrld. Gvernment is required t prvide certain services t the public, and s is mre tlerant f lw ROI. Cmparing the ROI f varius ptins will help t ensure that yu select the mst cst effective technlgy and apprach. Yu can prvide additinal supprt fr negative (and psitive) rates f return with the qualitative benefits identified by yur planning team. Later in this guide, a discunt factr will be applied, t shw the Net Present Value (NPV) f future csts and benefits, which is an imprtant cnsideratin when cmparing alternatives. NOTE: Even a prject with an utstanding ROI may be cntrversial r dmed t failure if the investment cst is very high. Perfrming CBA ROI = (net benefits/ttal cst) In the equatin abve, net benefits equals ttal benefits minus ttal cst. It is the incremental financial gain (r lss). If a parcel mapping prject csts $50,000 t implement, and yu These calculatins are mre cmprehensive than ROI, in that they attempt t quantify bth tangible and intangible csts and benefits. Histrically, CBA has been applied t large public wrks prjects with scietal cst and benefits that are mre difficult t quantify than hard technlgy csts. demnstrate $25,000 in net benefits, USGS Cntract #: 08HQCN0024 May 2009 Page 1 f 5 Applied Gegraphics, Inc.

2 Advancing Statewide Spatial Data Infrastructures in Supprt f the Natinal Spatial Data Infrastructure (NSDI) Intangible benefits and csts are very relevant t an verall determinatin f what is a gd investment fr the public well-being. SSDI implementatin includes bth types, and is therefre a candidate fr applying CBA, if the expertise and resurces are available t supprt the effrt. There are a number f ecnmic methdlgies fr mnetizing benefits and csts that d nt have easily discvered market prices, but these can be cmplex and any estimate derived frm them may have relatively high uncertainty. Like an ROI calculatin, the result f CBA is a rati expressed as a percentage, and ecnmic attractiveness is determined the same way: abve zer is attractive, and belw zer is nt. The equatin is the same, althugh mre csts and benefits are included. That is the essential difference between the tw methds. Effect f Time n ROI and CBA Calculatins In mst cases, executives and elected fficials expect t see an ecnmic justificatin based n phased benefits and csts ver a three t five year windw. Being able t shw a psitive ROI in a ne r tw year timeframe will prbably make yur prject an instant hit, but this is an unusual circumstance. Given the time value f mney, a dllar is wrth mre tday than it will be tmrrw. T accunt fr this ecnmic fact, future csts and benefits need t be discunted in rder t calculate tday s value (a.k.a., Net Present Value, r NPV). The discunt factr, als knwn as the cst f capital, might be specified by varius state authrities, and usually reflects the interest rate the state pays t brrw mney when it issues general bligatin bnds. By cmparisn, the federal Office f Management and Budget (OMB) recmmends the fllwing nminal discunt rates fr federal prgrams, depending n the length f the prgram. Duratin 3 Yrs 5 Yrs 7 Yrs 10 Yrs Discunt 2.7% 3.3% 3.7% 4.2% Rate Surce: OMB Circular A-94 Appendix C, as f 12/12/08 In the parcel mapping calculatin f ROI, t apply a discunt factr t determine the Net Present Value (NPV) f a future stream f benefits and csts, the fllwing equatin and factrs wuld be used: B = Benefits; C = Csts; r = discunt rate; t = time perid; n = number f time perids. NPV equals the summatin frm t = 0 (the initial start-up f the prgram) t t = n (the final year f the prgram) f [(B t - C t ) / (1 + r) t ]. Fr a 3 year prgram, the equatin wuld be as fllws: NPV = [(B 0 - C 0 )] + [(B 1 C 1 ) / (1 + r)] + [(B 2 C 2 ) / (1 + r) 2 ] + [(B 3 C 3 ) / (1 + r) 3 ] In the table n the parcel mapping example, the abve equatin was applied, and the resulting NPV calculated ut t be $22,120. The lnger the prject duratin, the greater the risks due t changes in wrk prcess flw and ther external factrs that may lead t a new prject design and additinal csts. USGS Cntract #: 08HQCN0024 May 2009 Page 2 f 5 Applied Gegraphics, Inc.

3 Advancing Statewide Spatial Data Infrastructures in Supprt f the Natinal Spatial Data Infrastructure (NSDI) Initial Csts Year 1 Year 2 Year 3 Cumulative Ttal Ttal Csts $35,000 $5,000 $5,000 $5,000 $50,000 Ttal Benefits $0 $25,000 $25,000 $25,000 $75,000 Net Benefit -$35,000 $20,000 $20,000 $20,000 $25,000 Net Present Value Initial Year -$35,000 Year 1 $19,512 Year 2 $19,036 Year 3 $18,572 NPV = $22,120 Discunt Factr (2.5 %) Initial Perid Denminatr Year Year Year This table feeds ur earlier example calculatin f ROI = ($25,000/$50,000) where the ROI is calculated t be 50% fr the parcel mapping prject. By adding a discunt factr and calculating NPV (see afrementined frmula), the ecnmic attractiveness diminishes nly slightly ($22K vs. $25K), but is still psitive, and mre meaningful because it accunts fr the time value f mney. Calculating Csts Mst rganizatins have effective methds fr identifying their csts. Infrmatin n persnnel csts can be btained frm fiscal fficers, there are ften cntracts in place (r as histrical references) fr certain services, and managers can turn t their cunterparts in ther rganizatins t btain reasnable cst estimates. Physical Facilities (if additinal space is required) Cntracting Csts Yu shuld als cnsider the varius phases f a prject and accunt fr all f the csts incurred during each phase. Many peple imprperly ignre the built-in csts and nly accunt fr large cntractual expenditures. Examples f built-in csts include: Include the fllwing incremental csts when determining yur ttal cst: Labr Including Fringe Benefits Overhead (if apprpriate) Additinal Equipment Cst (nt including additinal csts fr existing equipment) Additinal Sftware Cst (nt including additinal csts fr existing sftware) USGS Cntract #: 08HQCN0024 May 2009 Page 3 f 5 Applied Gegraphics, Inc. Prject Management Cntract Management Quality Assurance and Cntrl Persnnel Training Prject Maintenance Security (if apprpriate) Calculating Benefits This is the mst difficult part f cmpleting an ecnmic justificatin.

4 Advancing Statewide Spatial Data Infrastructures in Supprt f the Natinal Spatial Data Infrastructure (NSDI) There are very few guidelines that prvide yu with average benefit factrs fr implementing applicatins, data develpment, r crdinatin activities. NASA reprted that adherence t pen standards and interperability specificatins during prject implementatin resulted in 119% ROI as a savings t investment rati. (See Items t include in yur study include internal r external csts and benefits t yur rganizatin. It is generally much easier t dcument the internal csts, because yu shuld have a gd understanding f the wrk prcess flw and where the savings will ccur. It can be extremely difficult (r nearly impssible) t identify the dwnstream benefits that are accrued by ther users and the general public. Examples f the internal benefits yu shuld measure include: Savings frm new capabilities Decreased time t perfrm repetitive tasks Decreased travel Decreased wait times Fewer mistakes Increase in billable services Increased custmer base Imprved custmer satisfactin Decreased training csts Imprved regulatry cmpliance (i.e. reductin f fines) Reduced reprting requirements Reduced telecmmunicatins charges Reduced dependency n cnsultants As already nted, accurately identifying benefits can be very difficult and time cnsuming. It helps t list all f the expected benefits and then priritize them in terms f yur hunches n the largest expected paybacks. Explain yur assumptins and knwn biases related t yur hunches when dcumenting yur apprach. After that, make yur best guess n the ease f btaining the infrmatin required t cmplete the calculatin. Use these lists t set yur pririties fr wrking n ecnmic justificatin. Examples f external and dwnstream benefits that yu might measure include: All f the abve benefits that can be quantified in ther agencies r levels f gvernment due t the prpsed initiative. Public and Private Sectr benefits that can be clearly defined (i.e. by having assessment data n-line, appraisers can perfrm assessments in their ffice and nt have t drive t cunty r state tax ffices, thereby saving them time and travel expenses) Private sectr benefits frm being gespatially enabled (i.e. a cmpany specializing in rad centerline data gets access t better rad gemetry and prvides mre added values fr ther custmers) Public benefits frm being gespatially enabled (i.e. being able t lcate a htel near a business appintment n a web based mapping system that saves time and travel expenses) These external and dwnstream benefits can be very cmplex t calculate and will prbably be beynd the scpe f yur planning effrts. Hwever, the members f yur planning team shuld think abut these benefits; and when they can be readily calculated, include them in yur business plan. USGS Cntract #: 08HQCN0024 May 2009 Page 4 f 5 Applied Gegraphics, Inc.

5 Advancing Statewide Spatial Data Infrastructures in Supprt f the Natinal Spatial Data Infrastructure (NSDI) Putting it in Perspective ROI and CBA calculatins are useful, because they allw yu t examine yur ptins and make mre infrmed chices. They are als an essential cmpnent f yur business plan, because they becme the prf that implementing a prject is a sund business decisin. ROI is useful when csts and benefits are tangible and tightly fcused n a specific prgram with bundaries. CBA is mre cmprehensive, and is useful when bth tangible and intangible csts and benefits need t be cnsidered. NOTE: This verview f ROI and CBA is a cmpanin piece t the Strategic and Business Plan Guidelines prduced under cntract t the Federal Gegraphic Data Cmmittee (FGDC) Secretariat, in supprt f the Fifty States Initiative. The Guidelines and related materials are available n bth the FGDC and NSGIC websites. Befre yu begin develpment f yur business plan, yu shuld determine what statutry r ther requirements yu have fr develping ROI r ther types f calculatins in prescribed frmats. Many states have specific guidance and frmats identified in their budget r IT plans. In additin, yu shuld determine the threshld fr prject value at which yu must perfrm these analyses. The level f effrt that yu put tward ROI/CBA shuld be cmmensurate with the cntemplated expenditure. Fr example, spending a week s wrth f yur time t gather infrmatin and crunch numbers may nt be a wise investment f time in rder t justify a prject expenditure f $10,000, but it might be if the amunt is $100,000. As already nted, examples f ROI and CBA calculatins fr gespatial prjects can be very elusive. Please share any infrmatin, tls, r new cncepts with yur peers. USGS Cntract #: 08HQCN0024 May 2009 Page 5 f 5 Applied Gegraphics, Inc.