Cost beneit analysis Approach

The execution of a cost benefit analysis has four steps. Firstly, the parameters of the NPV method have to be determined. For the planning horizon T and the cost of capital d suitable values have to be determined. For the length of the planning horizon, five years is recommended, unless the organization uses a standardized value of different length. The value of d is organization-specific. For listed companies the cost of capital can be calculated using stock prices, interest rates and tax rates, for other organizations the finance director is the best source for the value of d.

Secondly, costs and benefits of ERP have to be estimated, for each of the combinations of ERP supplier, implementation partner and application service provider in the preselection. The first step is the identification of the benefits of the ERP implementation, and the conversion of these benefits into financial terms. The list of benefits is based upon the characteristics of ERP systems: data integration and support for best practices. In financial terms, these benefits can lead to reduction of working capital, reduction of other costs, or increase of revenue.

The third step is the estimation of costs of the ERP implementation, for each of the time periods in the planning period. The list of costs and benefits is company-specific. A good starting point for a list is presented in Table 8.2 above; other sources are checklists for project management or information management.

Finally, the results of the functional it analysis and the risk analysis are integrated into the cost benefit analysis, again for each of the combinations of ERP system, implementation partner and application service provider in the preselection.

The cost benefit analysis is the third and final subproject of the ex ante evaluation. In order to successfully conclude the subproject it is essential to have project team members with the right knowledge and experience in the following areas: finance, IT management and procurement. Moreover, close cooperation is required with the project teams that execute the functional it analysis and the risk analysis, as well as with the suppliers in the preselection.

The availability of financial skills is essential for the proper calculation of the NPV. If the organization has an IT controller, this person is a very good candidate for participation in the cost benefit analysis team. Other suitable candidates are general controllers, management accountants or business analysts.

IT management expertise is also required in the project team. During the cost benefit analysis, it is not only necessary to look at the existing IT organization, but it is also required to design a new organization.

This means that IT management that participates in the cost benefit analysis has to be able to have an unbiased look at potential changes in their organization. This may be too much to ask. When political or personal interests start to dominate the analysis, it may be useful for the project team to hire an external consultant who is experienced with the design of IT organizations.

An important part of the costs of an ERP implementation consists of externally acquired products and services. For this reason, it is important to have an experienced purchaser in the project team. If the organization has purchasers on the payroll, they are good candidates. Alternative candidates are the company legal counsel or a strong negotiator from another functional area.

Several tools and techniques are available to support a cost benefit analysis. For cost and benefit identification, workshops and interviews can be a good source. Benchmarks are often used to analyze and compare costs, and several high-quality commercial benchmarks are available on the market. The disadvantage of commercial benchmarks is that they are expensive; an alternative can be to formally or informally exchange information with organizations in the same industry. A good source for historical costs is the organization’s financial accounts.

Tools that automate the cost benefit analysis do not have to be very complex. A modern spreadsheet, which supports NPV calculations, will often be sufficient.

Two pitfalls should be avoided during the cost benefits analysis. The first pitfall is the confusion of accounting costs with cash lows. For the correct NPV calculation all amounts should reflect cash lows.

As an example: when in the first year hardware is purchased, the whole cash out has to be taken in the first year of the NPV calculation, although in the organization’s financial accounts an annual depreciation will be recorded during several years.

The second pitfall is ignoring intercompany charges. In many organizations, IT costs are recharged to the departments that use the IT services. For correct NPV calculations all costs including recharges have to be taken into account.