Measuring the Business Value of Deploying Wireless


Identifying and understanding the qualitative and quantitative benefits of investments are key prerequisites to deciding whether to proceed with those investments. This holds true independent of the investment that is being considered. Indeed, when considering investments in financial instruments such as stocks and bonds, deliberations are made about tangible benefits (quantitative benefits), such as expected returns, in addition to intangible benefits (qualitative benefits), such as familiarity with the markets for the securities, and finally the different risks (capital, market, and operational) associated with the instruments.

The same rationale is applicable for WLANs. When constructing your business case for WLANs, you need to consider three distinct dimensions:

  • Quantitative benefits These financial opportunities (that is, the possibility to monetize the benefits enabled by your WLAN) consist of direct savings through reduced capital and operational expenditures and indirect savings of opportunity costs.

  • Qualitative benefits Examples of qualitative benefits include increased comfort and productivity, improved aesthetics, and strategic aspects such as enabling upstream mobile applications.

  • Risks The risks associated with your WLAN project are related to executing the project (implementation risk), operating the WLAN infrastructure (risk of disruption), and securing the project (risk of loss and theft).

Even though ROI typically refers only to a quantitative analysis, a mutually exclusive and collectively exhaustive (MECE) approach necessitates that not only the quantitative but also the qualitative parameters and the risks of the investment are considered. A choice can then be made about the relative weights or importance attributed to each respective benefit. Indeed, you do not select a portfolio of financial instruments solely on expected returns without, for example, considering your familiarity with the underlying market for the instruments.

In the IT world, ROI typically refers to the financial assessment of an IT project. This assessment would be more correctly denominated as a cost-benefit analysis. The more appropriately named cost-benefit analysis (CBA) is a method of measuring the quantitative yield of an investment in IT assets. To avoid confusion we shall continue to use the terms ROI and cost-benefit analysis interchangeably.

When performing a cost-benefit analysis of an investment, you need to closely examine two distinct areas:

  • The numerator of the ratiothat is, the costs associated with the investment

  • The denominator, which quantifies the benefits associated with the investments

Only when both factors have been determined can a decision be made about whether the quantified benefits outweigh the quantified costs. Note the word "quantified" in the previous sentence. As we shall see, there are several costs and benefits that are either very challenging or all but impossible to quantify. An exhaustive consideration requires that these softer parameters are indeed considered in making a business decision. No information about physical location can be inferred from a user attaching to a WLAN. The user can be inside the building, or outside in the parking lot.

The following sections explore the quantitative and qualitative elements of WLANs in more detail. Finally, given the importance of financial metrics in today's business environment, we take a closer look at decision metrics.

Total Cost of Ownership

In the context of IT investment, an often-used term is the total cost of ownership (TCO) of the IT asset. This measure reflects all costs associated with the entire lifecycle of the asset.

As you learn in Chapter 3, the WLAN technology lifecycle can be modeled with the preparation, planning, design, implementation, operation, and optimization (PPDIOO) solutions lifecycle. As such, you need to identify the costs related to the PPDIOO lifecycle of your WLAN. The corresponding expenses will include the capital expenditures (CAPX), assuming the WLAN assets will be capitalized; the one-time costs of preparing, planning, designing, and implementing your WLAN and training the WLAN users; and the recurring costs of maintaining and upgrading the WLANthat is, operation and optimization.

Table 2-1 provides a breakdown of the various WLAN cost components. The table is not intended to be exhaustive and provides a nominal approximation only. The sum of these terms yields the WLAN's TCO.

Table 2-1. Total Cost of Ownership Components

Stage

Type

Item

CAPX

Hardware

Access points

LAN switches

Management consoles

WLAN NICs

Power cords

Cabling

Authentication servers

Network administration/security tools

Software

AP software licenses

LAN switch OS licenses

Management console licenses

End-user licenses

WLAN management tools

Authentication server software

Finance

Cost of capital

Preparation

Program management

WLAN program team resources

Planning

Program Management

WLAN program team resources

Site surveys

Design

Program management

WLAN program team resources

Engineering resources

Consulting services

Engineering services

Implementation

Program management

WLAN program team resources

Installation

Internal engineering resources

External engineering services

Training

Operations staff

End users

Operation

Support

WLAN management staff

Maintenance

Optimization

Support

WLAN management staff

Upgrades


Currently, the per-user TCO of a WLAN is higher than for a wired LAN. This difference is due to the operational and administrative costs of WLANs, which are typically two to three times higher than for wired LANs. As a result, WLANs should be considered mainly for their mobility and connectivity options and not for enabling savings in IT budgets. Over time, the TCO gap should narrow. Because of this current nominally higher TCO of WLANs, it is critical to identify the types and sizes of benefits that a WLAN can enable.

Value of Ownership

You need to ask two key questions when attempting to identify the benefits your organization can extract from WLANs:

  • Where in the organizational ecosystem can WLANs have a positive impact?

  • How will a WLAN positively influence the identified areas by the first question?

For the purpose of this book, we shall focus on corporate business ecosystems. The same logic can be extended to educational institutions, albeit with slight modifications to the frameworks that will be discussed in the following sections.

Question 1: Where in the Organizational Ecosystem Can WLANs Have a Positive Impact?

A framework that is highly applicable when determining where a WLAN will have a positive impact in your organizational ecosystem is the Value Chain framework developed by Michael E. Porter, university professor at the Harvard Business School, where he leads the Institute for Strategy and Competitiveness Porter describes the framework in his 1985 book Competitive Advantage: Creating and Sustaining Superior Performance. The framework depicts an organization as an interlinked set of primary and secondary activities that create and build value. Figure 2-11 illustrates Porter's Value Chain framework.

Figure 2-11. The Value Chain Framework Adapted from Michael E. Porter Competitive Advantage, 1985


Consider three different industries: manufacturing, consumer retail, and financial services. This discussion first focuses on the primary activities because this domain exhibits the greatest variability among the selected industries when it comes to the application of WLANs. Note that the distinctions are based on highly simplified views of the respective industries and only serve to illustrate the logic behind the identification of key application areas of WLANs in the respective organizations.

Primary Activities

The manufacturing industry is characterized by the necessity for excellence in inbound logistics, operations, and warehousing of finished goods. As goods move through the value chain, the physical attributes of the goods change. The information associated with these goods changes in accordance with the transformations applied. The shop floor thus becomes a prime candidate for being enabled with WLANs. WLANs can help untether logistics and warehousing applications, thus simplifying real-time production updates, wireless asset tracking, quality assessment, and inventory logging.

In the consumer retail industry, the primary focus areas are outbound logistics (warehousing, transportation, distribution, and store operations) and marketing and sales. The consumer retail industry has been a relatively early adopter of wireless solutions because mobile devices help automate the supply chain. Handheld scanners are used to receive inventory into the store, validate shelf-label pricing, perform markups and markdowns, carry out item counts, and do store transfers.

As higher bandwidth becomes available, the wireless applications move up the value chain to sales- and marketing-related functions. Customer-facing activities such as line busting, sales assist activities, and finding product information for the customer can be greatly enhanced by having specific and relevant product information available at the point of sale. Furthermore, store managers can be released from their desks and armed with real-time information to increase their interaction with customers. WLANs thus effectively enable managers to access performance data anywhere in the store at any level of detail.

The third industry that we consider is financial services. The primary activities in the financial services industry of most importance are the marketing, sales, and service activities. As such, it is clear that an area of opportunity for WLANs exists in the financial services industry. WLANs provide the opportunity to mobilize the front office.

A domain where mobility is a key benefit is the bank branch. Roaming staff can handle simple transactions from anywhere in the branch. Service delivery is enhanced through rapid access to customer information, line busting, sales assist activities, and swift accessibility to product information that ultimately enhances the customer's experience in terms of quality, accuracy, and promptness of service. Furthermore, as the capability to transfer ever-greater volumes of data to mobile devices increases, greater use can be made of multichannel web services delivery efforts.

Given the sensitivity of the information in the financial services industry, several challenges remain. These include security, integrity of data, and system reliability. As WLAN technology continues to mature, these challenges will be resolved, providing financial institutions with a robust and secure alternative to or extension of the traditional wired infrastructures.

Secondary Activities

The previous section illustrates the differences among industries when it comes to identifying opportune areas of application for WLANs. We first focused solely on the primary activities in the value chain, so it is now time to take a closer look at the secondary activities.

Porter defines the secondary activities as being all activities that support the value-creating primary activities of an organization. The details of the secondary activities are considered to be industry-specific and they include organizational functions such as general management, planning, legal, accounting, finance, human resources, research and development, and purchasing. This is exactly the environment in which the knowledge worker operates.

Given the reliance of today's knowledge worker on information, it is not surprising that business intelligence and business processes have become highly dependent on IT to increase worker productivity, collaboration, and accuracy. WLANs provide the unprecedented opportunity to inject true mobility into the information supply chain.

The benefits that WLANs offer to secondary activities are many and diverse. Some of the benefits include the following:

  • Providing mobile data connectivity, thereby enabling workers to transparently roam among different locations without being burdened with the concern of locating a free data port.

  • Facilitating collaboration by making ad-hoc meetings easier because laptop computers can freely move around the office.

  • Enabling richer and more accurate communications sessions because information is untethered from the desk (assuming the availability of mobile computing devices).

  • Provisioning connectivity to temporary locations or intermittently used spaces. Examples of temporary locations include rapidly deployed new sites or disaster recovery facilities. Meeting rooms and boardrooms are examples of sporadically used spaces.

  • Improving aesthetics of customer-facing locations or executive meeting rooms by precluding dangling wires.

As you can see, the benefits of WLANs for secondary activities are mainly related to boosting productivity and comfort of the knowledge worker by arming him or her with mobile access to rich media content. Additional benefits, albeit of lesser extent, are associated with the ability to reduce capital expenditures on communications equipment for temporary locations and occasionally used areas. Finally, intangible benefits such as improved aesthetics are also enabled by WLANs.

Keeping these benefits in mind will help you identify specific secondary activity areas of your organization where the targeted application of WLANs makes business sense. Note that the application is not limited to a WLAN-only environmentit also includes the hybrid (wired and wireless) LAN. After you have identified the primary and secondary activities of the organization that can most benefit from WLANs, you are ready to tackle the next question.

Question 2: How Will a WLAN Positively Influence the Identified Areas?

As you've learned in this chapter, the benefits that a WLAN can provide are many and diverse. The variety of benefits is related not only to the place of application in the organization's value chain but also to the type of benefits.

One potential framework for analyzing the impact of WLANs in a given application area is to consider the strategic, operational, financial, and technological dimensions. Breaking down the problem provides a framework to help define the enabling capabilities of WLANs. However, given that the goal is developing a robust WLAN business case, a different set of lenses is more conducive to structuring and presenting an exhaustive justification for WLANs.

The following sections describe three such lensesquantitative factors, qualitative factors, and risksto further analyze the WLAN benefits identified by the previous question.

Quantitative Factors

Quantitative factors are sometimes referred to as hard, tangible, or quantifiable benefits that can be translated relatively easily into a dollar value. The realization of the financial benefits occurs through direct cost reductions, indirect cost avoidance, and increased end-user productivity. Examples include these:

  • Displacement of equipment costs through replacement of switches by APs

  • Reduction in cabling expenses

  • Avoidance of circuit expenditures when utilizing inter-building WLAN bridges

  • Employee productivity benefits because network access now follows the user, as opposed to the opposite

  • Ability to connect to public WLAN infrastructure (cafes, hotels, and airports)

As mentioned earlier in the "Total Cost of Ownership" section, the TCO of WLAN-only or hybrid LANs is typically two to three times higher than the wired-only equivalent. However, in situations where connectivity needs to be provided to sporadically used spaces such as meeting rooms or executive boardrooms, temporary locations, or locations where there is a high degree of variance in the number of users requiring connectivity, the cost per end user of provisioning WLANs can be lower than connectivity solutions with more expensive traditional enterprise LAN switches.

Similarly, WLANs provide an opportunity for a reduction in cabling costs. This does not, however, hold true in all situations. Cabling infrastructure is typically depreciated over 10 years. As such, its annual cost contribution tends to be relatively low. However, when temporary sites are required, the cabling cannot be depreciated over such extended periods of time. In these cases, WLANs then provide a cost-effective solution for providing connectivity, even though the expenses associated with the operation and administration of WLANs might be higher. The same argument can be made for environments that provide challenging, and hence costly, cabling situations.

The use of directional antennas enables the construction of inter-building WLAN bridges. This solution can be used as an inexpensive means of interconnecting buildings that are separated by public infrastructure and that would otherwise require the purchase of service provider-provisioned circuits. The installation, subscription, and utilization fees associated with these circuits can thus be avoided.

Staff mobility and productivity enhancements are by far the largest benefits associated with WLANs as increased productivity equates to avoided opportunity costs. The capability to remain connected to the network, independent of one's physical location, eliminates the opportunity cost of not being able to access online applications and information. Not only does this result in incremental amounts of productive work that users can perform, but it also enables greater responsiveness and speed that these users can bring to business processes.

You can approximate an approximation of the aggregate quantified productivity benefit that is enabled by the WLAN with a two-step approach. First, you identify the total end-user base for which the benefit is applicable. You then establish the monetary benefit for each end user. Multiplying both factors yields the total productivity benefit for the organization.

You can determine the number of users who benefit from WLAN productivity enablement with the following factors:

  • Total number of employees (total employees)

  • % of employees using computing devices (percent computing)

  • % of computing devices that are mobile (mobile computing)

  • % of mobile devices that will employ WLAN (WLAN mobile)

Multiply these factors to determine the total number of WLAN-enabled users who can benefit from increased productivity:

(Total WLAN beneficiaries) = (total employees) x (percent computing) x (mobile computing) x (WLAN mobile)

Note

The number of total WLAN beneficiaries should be in accordance with the number of users who will effectively be covered by the physical footprint of your WLAN. Indeed, if your WLAN is deployed in site A, but all the potential users are in site B, no productivity benefits will be realized.


The next step is to determine the monetary value of the productivity benefits. This value is determined by considering the fully loaded cost of an average user who uses the WLAN and identifying how much time is converted from unproductive (that is, no network access) to productive (that is, with network access). This calculation, of course, assumes that the unavailability of network access is the reason for the user not being productive.

The rationale for allocating a monetary benefit is based on the following: If we assume that end users require access to online information to perform their tasks, then the time during which this information is unavailable is an entirely sunk costthat is, during this time, the end user is in effect not contributing to the value-creation process of the organization. However, the loaded cost of the employee continues to accrue and hence there is a direct ongoing expense associated with the person's time.

A prime example can be found in meetings. Meetings are a part of everyday organizational life. Individuals need to come together to resolve challenges collectively and collaboratively. Participants rarely arrive at the gathering place at the same time, or even on time. Several minutes are thus spent waiting for others before commencing the actual meeting. Even though one can argue that this waiting time is an opportune time for socializing with colleagues, more often than not, some more urgent matter needs attention. The ability to retain network connectivity can thus transform this otherwise idle time into value-creating time. The sunk cost of the organizational resource is now counterbalanced by a positive contribution. Thus, increasing employee productivity translates into reducing or altogether eliminating the sunk cost of idle time.

A similar example can be found in the healthcare industry. By providing physicians with the information that they require at the point of care, the necessity to shuttle between the patient and the information terminal is avoided. The sunk cost of the caretaker's salary expense is offset by the value creation of taking care of patients.

Ideally, it would be great if you could quantify the exact monetary benefit of the value-creation process. A very accurate picture could then be developed in terms of the net contribution. However, because this quantification is next to impossible to achieve, we approximate the productivity benefit through the conversion of downtime into time spent on the primary and secondary activities of the organization. The productivity benefit enabled by WLANs is thus represented by the total reduction in sunk cost associated with non-value-contributing activities of staff because of unavailability of network access.

You can determine the monetized productivity benefit per WLAN user with the following factors:

  • Fully loaded annual cost of WLAN user (loaded employee cost)

  • Business days per year (busday per year)

  • Hours per business day (hours per busday)

  • Minutes per hour (min per hour)

  • Minutes per day of downtime converted (min converted)

The daily sunk cost per staff member that is avoided by conversion of unproductive time into value-creating time is calculated by multiplication of the these factors:


Note

Note that the first four factorsfully loaded annual cost of WLAN user, business days per year, hours per business day, and minutes per hourare straightforward to determine. The annual loaded cost of a staff member includes salary, benefits, furniture, and equipment required by the worker, allocated expense, and so on. The Human Resources department should be able to provide an estimate of the loaded cost of a staff member.


Typical values that would be used for the number of business days in a year would be 220 or 240. The variation can be explained by the fact that the number of holidays and vacation days varies from one place to another. Similarly, a typical value for the number of business hours per day would be eight, although local variations do exist.

The number of minutes of downtime per end user that is converted into productive time by the WLAN is also the trickiest factor because it is the factor that can exhibit the highest degree of variance and hence have the biggest influence on the final outcome.

One of the options to quantify this number is to select an arbitrary, albeit conservative, number that will pass the reviewers' "sniff test." For example, few people are likely to object to a number such as 5 or 10 minutes a day of useful network connectivity. On the other hand, making the assumption that an end user will benefit from 60 minutes of increased productivity a day is likely to be rejected. If there would be no objection to 60 minutes, something else is seriously awry, and we would suggest that resolving this challenge should take priority over determining the viability of WLANs for your organization.

A second, and more accurate, option for determining the number of incremental productive minutes is through sampling. In statistics, the Law of Large Numbers states that the average of a random sample from a large population is likely to be close to the mean of the whole population. When combined with the Central Limit Theorem, which states that sampling distribution approaches the normal distribution independent of the underlying distribution of random variables, statistical sampling becomes a practical method for determining a robust estimate of the number of minutes that a member of the organization can convert into productive time because of the WLAN.

Fortunately, the Central Limit Theorem converges rather quickly, and a sample size of 30 or more results is a good estimate for the population mean. As such, a simple survey can be constructed in which users are asked for an estimated number of minutes per day they would be online (and hence assumed productive) with availability of a WLAN. Performing the survey on a population sample size of 30 or more will yield a relatively accurate organizational mean.

Note

No information about the skewness of the population distribution around the mean should be extracted from the sample.


After you have determined the number of users whose productivity can benefit from WLANs and the daily productivity benefit captured by these users, the daily organizational productivity benefit is computed by multiplying the two factors, as follows:

Daily WLAN-enabled organizational productivity benefit = (Total WLAN beneficiaries) x (Daily staff productivity benefit)

You can then calculate the annualized benefit by multiplying the daily benefit by the number of business days per annumthat is, by the factor busday per year.

Lastly, an indirect tangible effect of providing WLAN connectivity to the user is that it implicitly creates the capability to connect to public WLAN infrastructures. This can be considered a synergistic effect of deploying WLANs. Public WLANs denote those wireless networks that are made available to the general public. Today, they can be found in cafes, airports, hotels, and even WLAN-enabled airplanes.

Road warriors or staff members who travel frequently can be provided with connectivity to the intranet across this public infrastructure when armed with the necessary remote access tools. Virtual Private Networks (VPN) create the possibility to construct secure tunnels across the Internet. This enables the organization's private network to be extended in a secure and transparent fashion across public networks, thus effectively providing full access to office applications. E-mail, intranet websites, and the full suite of online applications become accessible.

Note

The IT security implications for providing such remote access are considerable. Chapter 7 covers tools and methodologies for securing such environments.


As such, a similar reasoning is applicable as the one employed for determining the benefit of providing WLANs inside the organizational boundary. Time that would otherwise be spent idle can now be converted into time spent on primary and secondary organizational activities. For example, waiting in an airport lounge can be combined with reviewing and responding to corporate e-mail. Alternatively, time spent at a coffee shop before a client meeting can be used to examine updates on the competition that have been posted to the internal website.

The same algorithm can be employed for quantifying this productivity benefit. The first step is to determine the number of users who have a roaming profile. Subsequently, the benefit per user needs to be determined. We recommend determining the monthly (versus daily) benefit and annualizing it later because it is rather difficult to determine the number of minutes a day that can be converted into productive time by using public WLANs. This difficulty results from the distributed nature of travel requirements. Identifying the number of minutes per month, however, should be easier.

As before, there are two options for determining the average monthly benefit per user. The first option is to select an arbitrary, yet conservative, number that will pass a sniff test. For example, 30 minutes per month saved is likely to be a realistic and conservative estimate. The second option is to perform a survey of 30 or more frequent travelers. The result can then readily be converted into minutes of savings per day as follows:


The formulas to be used in the computation are almost identical to those used for calculating the benefit of the nontraveling users. An additional factor is used to determine the number of WLAN users who also travelthat is, traveling WLAN user. This yields the following formula for determining the total number of traveling staff members who can benefit from increased productivity while on the road:

(Total traveling WLAN beneficiaries) = (total employees) x (percent computing) x (mobile computing) x (WLAN mobile) x (traveling WLAN user)

The monetary productivity benefit per traveling WLAN user thus becomes


Finally, the total daily organizational benefit of converted traveling idle time is

Daily WLAN-enabled traveling productivity benefit = (Total traveling WLAN beneficiarie)s x (Traveling staff productivity benefit)

After you have determined all the parameters that contribute monetary benefits, simple summation yields the aggregate annualized monetary benefit that can be extracted from the WLAN solution. The total quantifiable benefit thus becomes

Displacement of equipment costs (incl. CAPX, one-time, and recurring OPEX)

Reduction of cabling expenses

Avoidance of circuit expenditures

Office employee productivity benefits

Traveling employee productivity benefits

TOTAL BENEFIT


Qualitative Factors

Qualitative benefits are often referred to as soft or intangible benefits. Even though these benefits are typically exceedingly hard to convert into a monetary value, they are still valuable to an organization. Indeed, decisions are often made to pursue initiatives based on strategic drivers. Examples of strategic initiatives include programs that intend to increase customer satisfaction, reduce customer churn, or provide the organization with enhanced scaling capabilities to support mergers and acquisitions (M&A)-driven or organic growth.

Earlier in this chapter, we considered the example of Starbucks, which decided to provide WLAN connectivity in its coffee shops. The rationale for this project was to enhance the customer's experience and hence boost customer satisfaction. This increases customer loyalty, which results in more repeat business. In addition, because customers now have Internet access, the average stay becomes longer and potentially leads to more servings per customer.

The primary goal of the majority of strategic initiatives is to either increase revenues or reduce costs. The linkage between such programs and WLANs is often too complex and too long to permit easy quantification. In the Starbucks example, this translates into determining the effect of WLANs on the creation of repeat business and growing the number of servings per customer.

Even though this value could, in theory, be determined through market studies and surveys, this calculation is rarely done in practice. Stakeholders make a qualitative assessment and rely on sound business judgment to find the balance between risks and rewards.

That said, an exhaustive business case does demand that all dimensions are considered, and it is relatively hard to tell which of the benefits (that is, hard or soft) will have the greatest impact on the organization. Hence, we strongly recommend that the soft benefits be analyzed, documented, and included in the WLAN business case to minimize the risk of oversight and to maximize the business case's credibility and impact.

Risks

Risks are a part of everyday life. They come in all forms, shapes, and sizes. Entire industries revolve around the management, mitigation, and transfer of risk. The insurance industry is built upon the transfer of risk. The financial services industry is rife with instruments whose purpose is the management and transfer of risk.

This section intends to provide a brief overview of the risks associated with WLANs and what can be done to mitigate, reduce, or transfer them. The goal is to arm you with an awareness of the various types of risks so that you can not only proactively address them in your business case but also develop a holistic framework for dealing with them. Chapter 7 is dedicated to one type of riskthe risk of IT security in the WLAN ecosystem, and Chapter 8, "Management Strategies for Wireless LANs," covers operational risks as well as strategies and tools for managing this type of risk.

Risk is a double-edged sword. Whenever you introduce a new technology into an environment, you lower one set of risks while increasing or introducing another set of risks. In the case of WLANs, examples of risks that are reduced include the unavailability of network connectivity and incapacity to support mobile applications. Examples of risks that are introduced or increased consist of additional equipment that needs to be deployed (execution risk) and managed (operational risk) and additional IT security risk because WLANs provide a new vehicle for disruption, loss, or damage.

Awareness of a problem is the first step toward resolving it. As with any other technology, WLANs carry a diverse set of risks that span the entire lifecycle of the solution. Identification of these risks and what will be done to address them and inclusion of this information in the business justification is paramount to creating a balanced and credible basis for deciding whether to pursue the deployment of WLANs in the organization.

Figure 2-12 illustrates the organization's vector in the three-dimensional space created by the tangible benefits, the intangible benefits, and the risks. The depiction not only summarizes the relative sizes of the benefits and risks but also creates the possibility to display a sensitivity boundary. Because many of the benefits and risks are based on subjective assessments, variance needs to be included to accommodate the uncertainty surrounding the parameters. As such, the illustration forms a summarizing scorecard for how much the organization can benefit from WLANs.

Figure 2-12. Organizational Positioning in Benefit and Risk Dimensions


Upon completion of the identification and analysis of the costs, benefits, and risk components, you can tackle the next step of constructing the WLAN cost justification.

Cost-Justification Analysis

When it comes to business decision metrics, everybody is looking for the one tell-all metric. This silver bullet will not only precisely measure the value of your investment but also allow maximization thereof. However, just as there is no single metric for corporate performance or for the state of the economy, there is no single measure to assess IT investments and performance. A collection of measurements and assessments is required to form a relevant and accurate snapshot or projection of the performance of IT investments.

Before delving further into the quantitative ramifications of WLANs, you need to understand the position of WLANs in the IT value chain so that you can place the benefits of WLANs in a more appropriate context.

WLANs form an integral part of today's IT transport portfolio. These assets exist to move information from a point of origin to a point of consumption. The challenge that you face when evaluating the value of such assets is that these types of assets are located at the bottom of the IT hierarchy. You can think of this hierarchy as conceptually similar to the hierarchy of human needs developed by Abraham Maslow, one of the founders of humanistic psychology, in the 1940s. Maslow posited that human beings employ a hierarchy when it comes to fulfilling their needs. The precondition for fulfilling higher-order needs is that lower-order, more basic needs must be met first, as shown in Figure 2-13.

Figure 2-13. Maslow's Hierarchy of Human Needs


Maslow's model begins with the fulfillment of physiological needs, such as thirst, hunger, and other basic needs. After physiological needs are met, humans seek to satisfy needs involving physical safety, such as protection from bodily harm. After safety is obtained, Maslow then conjectured that humans act to fulfill their needs for belonging and affection. The next stage in the model is the need for esteem, which includes self-esteem, respect, and recognition. The final phase that humans seek to realize is the need for self-actualization. This includes such things as self-fulfillment and job satisfaction.

Fulfillment of each level is sequential in nature, suggesting an intrinsic need to satisfy the more basic needs before moving to the next level. Maslow's hierarchy of needs is a classic model in human behavior. But why is this conceptual model relevant to the IT space? Maslow's concept can readily be mapped to the corporate or institutional ecosystem. Figure 2-14 illustrates this high-level mapping.

Figure 2-14. Hierarchy of Organizational Needs


The basic needs to be fulfilled for any organization include the availability of basic infrastructure. This refers to fundamentals such as power, transportation, and water from a public infrastructure point of view; parking space and physical security from a site perspective; power, structural integrity, and air conditioning for buildings; and finally items such as rack space, fire control, and access security for data centers. Figure 2-14 refers to these components as basic infrastructure.

Only after the requirements for basic infrastructure have been met can attention be turned to identifying the necessities in terms of IT infrastructure. This includes both hardware and software. Examples of hardware include the full range of IT transport, compute, and storage assetsthat is, network devices, servers, clients, and storage arrays. Software includes middleware, operating systems, and database systems that provide the intelligence to manage the hardware and raw information. No meaning is associated with the information at this level in the hierarchy. That is the responsibility of the next level.

The next stage in the model is the need to provide meaning to the information. This is achieved through applications. As the raw information is moved, transformed, and stored, different applications enable the attribution of semantics. The information now takes on such heterogeneous forms as a phone call, a video session, an e-mail, or a purchase order.

The information presented by the various applications is in turn used by a variety of organizational processes that the organization engages in while performing the primary and secondary activities. The organizational processes provide the ecosystem intelligence that allows the organization to sense and respond to changes in its internal and external environment. Finally, armed with this ecosystem intelligence, the organization can pursue its primary goal, which is the creation of value.

This hierarchy is relevant within the context of developing an ROI or cost justification for wireless networks because of the enabling character of WLANs. That is, the majority of benefits that WLANs create is not on the same level in the organizational hierarchy. The hierarchy enables you to make this intra-level relationship between WLAN costs and organizational benefits explicit.

For some types of assets, there is a direct relationship between the costs associated with the asset and the benefits that can be extracted. Consider, for example, manufacturing equipment. The TCO of this equipment includes all costs associated with the purchase, installation, and operation of the equipment. Examples of benefits could include an increase in production velocity (such as more widgets per minute) or a decrease in cost of goods sold (COGS) as raw materials are used more efficiently. One could postulate that the costs and benefits are at the same level in the hierarchy of organizational needs. The benefits are in essence direct.

Now consider WLANs. The main benefits of WLANs can be derived from their enabling character. They enable mobility of staff and applications, which translates into increased productivity. In some cases, WLANs translate into lower cabling or equipment expenses. However, this is more the exception than the rule because the operational cost is typically higher than for wired LANs. Hence, we find that the costs are at one level of the hierarchy, while the benefits are located at a higher level. The benefits are indirect.

A good analogy can be found in electrical wiring. The cost tied to the acquisition and installation of electrical power is relatively straightforward to determine. However, the quantitative benefit is next to impossible to compute. Indeed, electrical power is an enabler. At home, it permits the use of electrical appliances such as televisions, dishwashers, and vacuum cleaners. In an organization, it allows the use of lighting and computers. As such, electricity has an enabling character because the benefits that it enables are higher up the hierarchy of needs. The same is true for WLANs.

The hierarchy of organizational needs is important for two distinct reasons in the construction of WLAN cost justifications. First, it provides a framework for defining the boundary of what must and what can be included in the analysis. You can include benefits that are higher up the hierarchy either in a quantified form as demonstrated earlier for staff-member productivity or in a qualified form as was the case for increasing customer satisfaction.

Second, the framework explains the linkage between the WLAN and its application points. As one moves higher up the hierarchy, it is implicit that the quantified benefits become more abstract. They are also characterized by an ever-greater degree of subjectivity. However, after the linkage becomes clear, a higher degree of comfort with the benefits included in the cost justification should result.

After you have defined which benefits are to be included in the organizational justification of WLANs, it is time to consolidate the cash flows of the identified costs and benefits into metrics that are meaningful to the decision makers. Because these metrics reflect absolute monetary terms, the benefits included are limited to those that have thus far been quantified.

The following are the standard metrics for evaluating cash flows associated with costs and benefits:

  • ROI The average expected cash flow over the period of the project divided by the initial investment outlay. ROI provides a satisfactory method of evaluating an investment over a short period of time. ROI does not take into account the time value of money.

  • Payback period The period required to recover the initial investment of the project. This method of evaluating an investment does not consider all cash flows and does not discount the cash flow. This method might not be appropriate for evaluating an investment over an extended period of time.

  • Net Present Value (NPV) The Present Value (PV) reflects what a future sum of money is worth today, given a particular rate of return (and inflation). NPV expresses the net value of costs and benefits in today's monetary terms that is created or destroyed by an investment. It is computed by taking the PV of the expected future cash flow of an investment and subtracting the initial investment cost. Alternatively, the NPV can be determined by subtracting the PV of all cash flows related to costs from the PV of all cash flows from benefits.

  • Internal Rate of Return (IRR) The interest rate that equates the PV of the expected future cash flow to the initial investment outlay, where the NPV is equal to zero.

The next sections take a closer look at each metric by using a numerical example. The sample cash flows shown in Table 2-2 are for illustrative purposes only and are not based on actual WLAN cases.

Table 2-2. Sample 5-Year Cash Flows of WLAN Investment
 

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

5-Year Total

Total Costs

$500

$200

$200

$200

$200

$200

$1500

Total Benefits

$0

$400

$400

$400

$400

$400

$2000

Net Benefit

($500)[*]

$200

$200

$200

$200

$200

$500


[*] Parentheses denote a negative value

Return on Investment

The ROI is a key indicator of an investment's value. It expresses the relative total gain of the project compared to the total cost. Its computation is very straightforward and is performed by dividing the cumulative expected benefit by the cumulative cost over the analysis period of the WLAN project. The ROI formula is as follows:

ROI = Total cumulative benefit / Total cumulative cost

The formula yields the expected net return on every monetary unit spent. For the cash flow example in Table 2-2, the ROI is this:

ROI = $2000 / $1500 = 133 percent

In other words, for every dollar spent, there is a net return of $1.33.

The simplicity of the ROI calculation is its strength. It generates an easy-to-comprehend ratio. However, it has two considerable drawbacks. First, ROI does not consider the time value of money. The golden rule in finance is that a dollar today is worth more than a dollar tomorrow. This is because cash can accrue interest in a risk-free fashion over time when invested in a risk-free instrument such as U.S. treasury bonds. Additionally, there is the requirement for investing the cash in a risk-free instrument because cash hidden under the mattress does not accrue interest.

Note

This reasoning assumes that the probability of default of the U.S. government is zero. Let us plainly accept that assumption.


Hence, future cash flows should be adjusted in value to reflect their true value today. These future outgoing or incoming cash flows should in effect be discounted. The later section "Net Present Value" delves deeper into this topic. Because ROI does not consider the time value of money, it tends to overestimate the return generated by the investment because the nominal future cash flows are inflated in real terms.

A second drawback is that ROI masks the relative sizes of the cumulative cash flows. An investment of $100,000 that returns $133,000 has an ROI of 133 percent. Compare this to an investment of $100,000,000 that yields a monetary benefit of $133,000,000. Yet again, we find an ROI of 133 percent. It is clear, however, that very different considerations will be made in the latter case. The absolute size of the investment will result in unlike deliberations about risks and will drive very different decision criteria.

Payback Period

Another calculation that is easy to understand is the payback period. The payback period defines the breakeven point of a project and is typically quoted in months. The timer is started at the beginning of the project, and it is stopped when the cumulative benefits exceed the cumulative costs.

For the example mentioned in Table 2-2, the payback period results are shown in Table 2-3.

Table 2-3. Payback Period Results

Payback Period

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Cumulative costs

$500

$700

$900

$1100

$1300

$1500

Cumulative benefits

$0

$400

$800

$1200

$1600

$2000


Figure 2-15 illustrates the breakeven point of costs versus benefits.

Figure 2-15. Identifying the Payback Period


Table 2-3 illustrates that the breakeven point should occur at some point after year 2. If you assume a linear distribution of costs and benefits on an annual basis, you can compute the exact point of intersection.

The line section depicting the cumulative costs between year 2 and year 3 goes through the points with coordinates of (year, cost), which in this case is (2, 900) and (3, 1100). As such, the line is represented by the equation:

(X 2) / (3 2) = (Y 900) / (1100 900)

or

Y = 200 x X + 500

Note

The function that describes a line that goes through coordinates (a1,b1) and (a2,b2) is constructed as follows:



Similarly, the line depicting the cumulative benefits that goes through the coordinates (2, 800) and (3, 1200) is represented by the equation:

(X 2) / (3 2) = (Y 800) / (1200 800)

or

Y = 400 x x

Solving both equations for X results in this:

400 x X = 200 x X + 500

or

X = 2.5 (years)

Multiplying X by 12 results in the number of months for the payback period, which is 30 months for this example.

Payback period is important because it measures the duration to the point that the investment starts generating positive cash flow. The further out in time this breakeven point is, the more risky the project should typically be considered.

Finally, payback period has its drawback in that it communicates nothing about the return size. It only measures the time to a positive return.

Net Present Value

The "Return on Investment" section introduced the time value of money concept. This concept is based on the fact that cash that is invested today will increase in value by some future date through the accrual of interest. Because of this accrual of interestand interest on interesta cash flow today is worth more than the same cash flow in the future. The idea is that you can invest the cash that you receive today and accrue interest on it. If you receive the same principal amount in the future, you have the opportunity cost of the interest that you miss out on. Hence, cash today is worth more than the same amount of cash tomorrow. The exact amount by which these cash flows differ depends on two parameters:

  • The interest rate, which shall be further discussed shortly

  • The number of compounding periods

Interest in its turn accrues interest with time, and hence there is a compounding effect.

The discounting of future cash flows to their PV enables the direct comparison of present and future cash flows. The cash flows have been normalized in time to represent today's value in monetary terms. NPV refers to the fact that the PV of all outgoing cash flowsthat is the PV of the costsis subtracted from the PV of the incoming cash flowsthat is the PV of the benefits. The result is the "net" value today.

To determine the PV of a future cash flow, identify the exact time of the cash flow so that the correct number of compounding periods can be established. Next, select the right discount rate.

One option for selecting the discount rate is to set it equal to the interest rate that could be earned elsewhere by investing the cash. Depending on risk averseness, the cash could be invested in risk-free U.S. government bonds, stocks, or complex instruments such as derivates. Each of these instruments yields a particular interest rate that is related to the degree of risk associated with it. Because the cash spent on the project will not be invested in other instruments, it creates an opportunity cost. The interest rate of this opportunity cost is the basis for the discount rate.

Alternatively, the discount rate can be set to the Weighted Average Cost of Capital (WACC) of the organization. The WACC reflects how much it costs your organization to borrow money over time. It is a function of many different factors, including the risk free rate, the organization's cost of debt, the cost of equity, the capital structure (debt/equity ratio), and the tax rate. We suggest that you ask your finance department to provide you with the WACC for your organization.

Either the interest rate of the opportunity cost or a risk-adjusted discount rate can be used as the PV discount rate for the future cash flows. Given that higher discount rates result in smaller PVs, the discount rate can be biased upward or downward to modify the project's risk profile. Higher discount rates should be employed for riskier projects, whereas lower discount rates are more appropriate for less risky initiatives.

The formula to compute the PV of a cash flow that occurs in year m, given a discount rate of r, is this:


The present value of a series of annual cash flows that start in year 0 and end in year n is computed, assuming the discount rate r, as this:


The formula can be applied to our example to compute the NPV in two different ways. Either the PV of the cash flows of the costs can be subtracted from the PV of the cash flows of the benefits, or the PV of the net annual benefits can be computed. For this example, we assume a discount rate of 10 percent. The calculation of the PV of the net annual benefits is shown in Table 2-4.

Table 2-4. Present Values of Sample 5-Year Cash Flows of WLAN Investment

(In thousands)

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Total Costs[*]

($500)

($200)

($200)

($200)

($200)

($200)

PV (Costs)

($500)

($182)

($165)

($150)

($137)

($124)

Total Benefits

$0

$400

$400

$400

$400

$400

PV (Benefits)

$0

$364

$331

$301

$273

$248

Net Benefit

($500)

$200

$200

$200

$200

$200

PV (Net Benefit)

($500)

$182

$165

$150

$137

$124


[*] All totals are in thousands

Compare the nominal cash flows represented in Figure 2-16 with the PV of these respective cash flows illustrated in Figure 2-17. The impact of compounded discounting can clearly be seen in that it decreases PV of cash flows that are further out in time.

Figure 2-16. Nominal Annual Cash Flows


Figure 2-17. Present Value of Annual Cash Flows


Application of the formula to the net benefits of our example yields the following:


Note

Fortunately, Microsoft Excel provides a built-in function for NPV computation. The function is named NPV and takes the discount rate and cash flows as inputs. It should be noted that the cash flows used in the formula start in year 1, not year 0. Hence, when calculating the NPV, you need to add the cash flow of year 0 to the result of the function. For our example, the Excel formula becomes

Net_Present_Value = 500 + NPV (10%, 200, 200, 200, 200)

The Excel NPV function takes discrete values, cell names, or cell ranges as inputs.


Because the Net Present Value computation increases the effect of current cash flows and decreases the impact of future costs and benefits, the following general conclusions can be drawn:

  • Projects with low initial expenses and higher initial benefits generate higher NPVs.

  • Projects with high initial expenses and benefits that increase over time produce lower NPVs.

Determining the NPV of a project is an often-used and accurate method for determining the financial viability of the project. The use of an appropriate discount rate not only ensures that some degree of risk is accounted for but also generates a quantified metric in today's monetary terms of the net expected gain.

However, NPV is not perfect. One of the pitfalls is that projects that generate enormous savings far in the futurecash flows of benefits look like a hockey stickwill result in NPVs that are substantial. You should remain aware of the simple fact that the further out in time you project, the more uncertainty is associated with the projection. The use of a constant discount rate cannot capture this issue. One potential remedy would be to use variable discount rates with higher discount rates further out in the future to accommodate for the additional uncertainty. Hence, you should consider not only the NPV but also the profile of the cash flows to identify whether a project that is financially attractive in NPV terms is nonetheless too risky.

Internal Rate of Return

The IRR calculation looks at the current and future net cash flows from a proposed project and determines an interest rate such that the NPV of the project becomes zero. The rate should be thought of as the interest rate that another investment would have to exceed to become more interesting than the project under consideration.

In mathematical terms, the IRR is the discount rate that makes the NPV equal to zero. The formula becomes


The cash flows are given, and the discount rate r needs to be computed. Given the fact that zeros of fourth and higher-order polynomials cannot be determined algorithmically, they need to be approximated using computer programs that perform iterative approximations. These programs guess values and perform continuous refinements until the equation results in zero or a number very close to zero.

Note

Microsoft Excel has a built-in function for computing IRR. Not surprisingly, the function's name is IRR, and its parameters are the cash flows starting with year 0. For our example, the Excel formula becomes

IRR = IRR (-500, 200, 200, 200, 200)

The Excel IRR function takes discrete values, cell names, or cell ranges as inputs.


For the sample cash flows, the discount rate (that is, the IRR) that results in an NPV of zero is 20 percent.

As is the case for the other metrics, IRR has its weakness. Similar to ROI, IRR does not provide information on the absolute value in monetary terms of the benefit generated by a project. A project with an NPV of $1,000,000 can have an IRR of 29 percent, as can a project with an NPV of $258.




The Business Case for Enterprise-Class Wireless Lans
The Business Case for Enterprise-Class Wireless LANs
ISBN: 1587201259
EAN: 2147483647
Year: 2004
Pages: 163

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