Added-Value Analysis

The concept of expanding traditional cost “benefit analysis to address the problems detailed earlier has been explored by many experts. Of note is the work of David Osborne and Ted Gaebler (1992), who expanded the linking between project outputs and organizational outcomes , and Marilyn Parker, Bob Benson, and Ed Trainor (1988), who developed a comprehensive model of business value for IT projects. In addition, the IRACIS model and the use of primary and secondary benefits first developed by our group in 1984 is critical in developing an integrated approach to determining the added value from investments in business and IT projects.

Show Them the Money

It is amazing how quickly people become interested in a project when you focus on the benefits early in the RAP process. Too many projects get caught up in costs before they really get to look at the benefits. Positives should always come first.

Some of the key concepts and principles are given in the following sections.

The Added-Value Chain

The concepts of primary or direct and secondary or indirect benefits have proven effective in clarifying the real benefits of projects. This model is similar to concept of a value chain or value linking also documented by M. Schumann (Parker et al., 1988) and by Osborne and Gaebler (1992). As shown in Figure 9.3, the value chain in proj ects can be followed in two directions: horizontally and vertically.

Figure 9.3. Benefits or value chain

Using the Osborne and Gaebler model, an organization's objectives lead to specific outputs (products, services, etc.) and these outputs lead to outcomes that the organization desires.

For example, a government department of transportation may have an outcome of maintaining road safety. One of the strategic objectives to meet this outcome is to ensure that registered cars are roadworthy and safe. The output is to reduce the number of cars with mechanical faults. The outcome of this objective is a reduction in traffic accidents caused by mechanical failures.

A project is identified to redesign car registration and inspection procedures. One objective of this project is to redesign the inspection processes. The output of this objective is new inspection processes including more detailed mechanical inspections, and the outcome is safer cars. The project outcome is aligned with the strategic objectives, outputs, and outcomes.

In other words, there should be a link between the project's objectives, outputs, and outcomes and the organization's objectives, outputs, and outcomes. It becomes apparent that not only should this link exist, but the organization cannot achieve its outcomes without the project succeeding. This is a clear example of added value from the project.

The second link is horizontal and is implicit in the relationship among objectives, outputs, and outcomes. In our example, the meeting of the objective "to redesign inspection processes" leads automatically ( assuming the project is successfully completed) to the output "redesigned inspection processes," which is a primary or direct benefit from the project. If these redesigned inspection processes are used properly they will lead to an outcome of fewer accidents, which is a secondary or indirect benefit.

In effect, as shown in Figure 9.4, there is a linked if “then test in which the primary objective directly leads to a primary benefit and, in the case of the improve service objectives and benefits (see IRACIS later), there is a link between the primary and secondary benefits.

Figure 9.4. The linked value chain

This value chain can then be evaluated using the IRACIS model (expanded later) to develop project savings or benefits.

The Polaroid Test

One useful technique to identify the value chain is to use the Polaroid test. When analyzing the benefits chain, ask yourself this question: If I took a Polaroid of the situation before and after the project, what has changed? This can avoid claiming outcomes (secondary benefits) as outputs (primary benefits) ”a very common mistake. For example, in an office automation (OA) project, the savings of management time in using the OA software (avoided costs) is claimed as a savings. However, the Polaroid test shows that after the project, the management have only received the OA hardware and software as the direct primary benefit (improved service). It is not until the managers use the primary benefit (i.e., the new technology) that the secondary benefit (avoided cost) is achieved. In the Osborne and Gaebler model, the delivery of the OA technology is the output and the savings of time is the outcome.

Projects don't realize benefits, people do.

It should also be noted that some objectives will have multiple outputs and outcomes that also need to be identified and modeled as shown later.

The IRACIS Model

The IRACIS model was first described by Gane and Sarson (1979), who argued that there were only three classes of benefits:

Table 9.1. Application of the IRACIS Model

Objective	Output	Outcome
To redesign inspection procedures	Redesigned inspection services	Reduced accidents caused by mechanical failure
	Improved service (to vehicle inspectors and car owners )	Avoided costs (estimated% reduction of accident incident and cost)
	Avoided costs (more efficient inspection process)

• Increase revenue (IR): The objective directly leads to an increase in revenue.

• Avoid costs (AC): The objective directly leads to a decrease in cash outflow or costs.

• Improve service (IS): The objective directly leads to a quantifiable improvement of service to the organization's internal or external customers or organizations.

There are a number of benefit taxonomies (for example, Appendix C in Parker et al. (1988) lists more than 100 specific benefits), but use of the IRACIS model in numerous IT and business projects has confirmed that all benefits can be expressed in the simpler IRACIS model.

The IRACIS model can be applied in our transport example, as shown in Table 9.1.

Assuming there is a cause and effect of safer vehicles having fewer accidents, the saving of the costs of accidents caused by unsafe vehicles can be claimed as a secondary benefit.

It is important to remember that the financial analysis of the outcome or secondary value link or chain should only be applied to improve service or primary benefit objectives as increased revenue and avoided costs or primary benefits can be financially quantified at the primary benefit level.

Provided that stakeholders are held accountable for the secondary benefits, this model can eliminate the use of intangible benefits (see "Benefits Realization" later).

Actual Versus Notional Costs

One issue with the avoided costs class of benefit is the difference between actual and notional or potential costs. For example, in Figure 9.5, the projection for rises in staffing levels in a branch is mapped against transaction volumes in the branch office. When a new IT system or redesigned business process is introduced, the traditional growth in staff numbers is reduced while transaction rates increase. Although there are no actual cost savings (staff size was not reduced), the potential savings of staff can be estimated and the extrapolated savings can be claimed as a notional avoided cost (often called cost avoidance ).

Figure 9.5. Notional cost avoidance

Given that the sustained use of IT over the past 20 years to automate manual and older technology systems has resulted in many organizations gaining most avoided cost-type benefits, there is an expectation that the demand for improved service-oriented projects (client relationship management) will increase and, as identified by value chain analysis, the concept of notional savings will become critical.

It should be noted that some traditional accounting and finance people would not allow this approach, as "real" money is not saved. We come back to this concept later.

Shadow Pricing: Hedonic Costing and Contingent Valuation

These techniques have been developed to assist in the quantification of intangible benefits. In general, shadow pricing involves determining whether other organizations or areas have a similar service and product and determining the "market" price or value for the proposed service or product using the market or shadow price as an implicit cost benchmark.

Shadow or Hedonic Costing

This technique was developed to assist in quantifying the value of complex variables such as the value of land and houses . Any person who has purchased a house understands the hedonic model. It is a well-known adage in real estate that there are three important factors in considering to buy a house: location, location, location. Clearly, the location of a suburb or a house in a suburb has some implicit but definite value, which through the use of shadow pricing or contingent valuation can be measured. In effect, the hedonic model breaks a house into certain factors such as size, location, size of garden, proximity to transportation and facilities, and so on, and places a financial value on the components .

Proof of Concept

In many projects, especially those involving innovative technology or procedures, the development of a realistic benefits and cost analysis can be difficult. If there are no similar projects that could be used to develop shadow costs or prices, the organization may need to fund a pilot project to prove the concept and, more important, provide data for a more accurate ROI analysis. This approach is common in other industries where new products are trialed in limited and controlled environments. In addition, it will be common that surveys, interviews, use of focus groups, time analysis, and other investigative processes may be required during the feasibility study phase to develop data for avoided cost and improved service objectives.

Peter Sassone and Perry Schwartz (1986) modified the hedonic model to analyze the benefits of OA and their model is extremely useful in evaluating certain avoided cost benefits.

Sassone and Schwartz linked the hedonic model with work profile analysis, where people use diaries to analyze and determine the relative amount of time they spend on various categories of work, typically classified as follows :

• Nonproductive: Waiting, searching for information, rework , traveling, and so on;

• Clerical/administrative: Time recording, typing, general meetings, and so on;

• Professional: Systems analysis, basic research, programming, and so on; and

• Expert professional: Project management, complex data and function analysis, and so on.

Using both the work profile and hedonic analysis techniques, the avoided cost class of benefits can be more accurately and realistically quantified.

Contingent Valuation

Contingent valuation involves the use of focus group or a representative sample of the project's clients . The members of the group are asked what they would be prepared to pay if the proposed service or product was available. There are really two questions that are explored in a contingent valuation process. The first is the people's willingness to pay (WTP) and the second is their willingness to accept (WTA) what they will accept doing without. Some experts argue that WTP can be distorted as a result of equity. For example, a poor person may not have the same WTP as a rich person. Using WTP, the focus group is asked, "How much are you prepared to pay for safe vehicles?" Using WTA, the focus group would be asked, "What lowering of government fees would compensate for having unsafe vehicles?" Clearly, WTA would tend to provide higher figures than WTP. In general, WTP would be a better approach provided the issue of equity (in this case, equity of ability to pay) was understood in the focus group. The WTA approach is more useful in projects where government services such as clean water, lower pollution, parks, conservation, and so on are involved.

For example, a project is proposing to integrate some information into CD-ROM technology and sell the CD-ROM with the information presented in multimedia format. Using a contingent valuation approach, a focus group of target clients would be interviewed and asked to place a value on the information and the CD-ROM packaging. Other packaging options could also be valued in the same process.

Then, using the implicit value gained from the focus group, a search could be made to see if similar products exist in similar markets and the shadow price could be compared against the contingent valuation price.

Let's assume that a competitor sells similar information in floppy disk (text-only) format for $4.50 a disk. The focus group puts a WTP value of $6.00 on the CD-ROM version. Given the difference between the multimedia version and the text-only version, an implicit value has been determined for the multimedia option ($6.00 “$4.50 = $1.50) and there is confirmation of $6.00 as an estimated benefit (increased revenue).