Cost Analysis

Yale Braunstein
School of Information

How does this course differ from all other

project-related courses at the i-School?

We explicitly look at alternatives.

We care about economic feasibility.
[others ?]

Why do we want to know costs?

We need to measure and understand costs
To help the organization
Operate efficiently & effectively
Allocate scarce resources
Choose between competing projects

To meet legal & organizational requirements

General introduction to our

approach
Identify opportunities & alternatives for
meeting them
Agree on selection/evaluation criteria
Apply the criteria
Make choices/decisions and monitor results
A nine-step, more detailed approach is on the
web and in the handout. A complete manual
is available in the computer lab.
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Special problems
with new technologies
New technologies, in general, and IT, in
particular, often cause problems
Exact costs are unknown/unknowable
Only some benefits are quantifiable
New technology projects can change the
organization, its outputs, etc.

Making sense of costs

Costs vary with level of output
Therefore, we focus on fixed and variable costs

Costs vary over time

Therefore, we discount future costs back to
the present

Costs can vary with technology and market

conditions
Therefore, we distinguish between the shortand long-run
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Costing terms
Costs are misleadingly concrete. It is important to
understand:

Fixed, variable & total costs

Opportunity costs (what really matters)
Sunk costs (what is past is past)
Marginal or incremental costs (the true cost of producing
the next unit of output)
Joint costs (with multiple outputs)
Allocated vs. out-of-pocket costs (accountants & economists
view costs very differently)

Consistency is VERY important

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Costs depend on your perspective

Department costs vs. project costs
Current costs vs. future costs; upfront costs
vs. continuing costs; etc.
(More on this later)

For public projects: CTA, CTG, CTN

Costs vs. Prices

We need to distinguish between costs and
prices
Proposed fees for extra units at UC, CSU
DSL (component-by-component)

Fully distributed costs or allocated

costs are very popular and can easily
mislead
The leased-line anecdotea true story of faulty
economic logic in a major university
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Where to Get Cost Information

Statistical studies
Engineering studies
Simulations
Bills of Materials

Comparables
Case studies
Previous experience (at your organization &
elsewhere)
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Additional considerations
We do a sensitivity analysis to identify those
factors that have the major impacts on costs
Try to understand the issues relating to economies
of scale and scope.
Computer automation in publishing example
See Morton * :
IT potentially increases productivity by lowering
transaction costsif you reorganize work.
* Michael Scott Morton, How Information Technologies can
Transform Organizations, in Rob Kling, Editor,
Computerization and Controversy (San Diego: Academic Press
1996) 148-160.
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Cost-benefit analysis
We distinguish between cost-benefit
analysis and cost-effectiveness analysis
In CBA, both costs and benefits are measured
in dollars
In CEA, only the costs are measured in dollars;
we use non-monetary measures for the benefits
Examples: increased reliability, reduced lag times

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Time value of money

General rules:
Dollars spent at different times have different
costs to the organization
Dollars received at different times have
different values to the organization
Therefore, we need to explicitly account for
timing of cash flows (in & out)

We discount future flows to the present to

obtain their present value
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Calculating PVs
CF1
CF2
CFn
PV CF0

...
2
n
(1 r) (1 r)
(1 r)
Logic:
Take each years cash flow and discount it
back to the present using the discount rate
See spreadsheet with examples
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Three ways to compare projects

Payback period NEVER use this
Internal rate of return very common, but
has problems
One: assumption about re-investment
Two: multiple solutions possible
Three: (most important) can lead to incorrect
choices with MX projects

Net present value the preferred approach

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Review: General principles

1. Focus on total costs OR incremental costs,
whichever is appropriate

Are we introducing something entirely new or

a change in an existing system?

2. Comparability of data is important

Timing matters
Have similar start & end points

3. Know what is in and what is out

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Using the principles

Sunk costs are sunk ignore them
You need to know the purpose of the
analysis
Planning for the future vs. benchmarking
current operations

Forecasting & Projections

Know what is changing
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