DMReview.com would like to introduce John Doran as our newest columnist. John is the director for BI Solutions within the Energy, Utility and Chemical industry vertical at Cap Gemini Ernst & Young. He will provide thought leadership and focus on the components of a successful BI/DW solution. Look for his Business Intelligence Building Blocks column the first week of each month.
Businesses today need powerful decision-making frameworks (data warehouse, data marts, balanced scorecards, analytics, etc.). Positioning these frameworks requires a strong business case. The cash flow characteristic associated with the business case is key and requires special attention in order to strengthen the business case.
For years, organizations have been striving to leverage their vast data resources to increase competitive advantage. With the recent downturn in the economy, organizations are paying significant attention to internal processes with the primary objective being streamlining operations and reducing costs. However, since many organizations’ data assets reside in more then one transaction system, the need to develop a common data warehouse or get more out of an existing data warehouse is becoming critical in order to provide transparency into existing business operations. According to a CFO Transformation study conducted by Cap Gemini Ernst & Young earlier this year, the two top issues facing the collective group are: 1) accuracy of reporting and 2) operational decision making. Providing an organization with the right business intelligence framework is essential for supporting these business requirements and other information-driven initiatives that rely on data across multiple systems.
There are multiple components that need to come together to support this business intelligence framework. Over the next several months, this column will provide a perspective on the critical elements required for successful development and implementation of this framework. The first and most important component for success is the business case. For years many IT organizations have claimed that it is too difficult to develop a business case for better information. However, based on today’s economic climate, the strength of the business case will determine the quality of the business intelligence framework.
The Business Case
Why develop a business case? Three primary drivers behind the business case are: 1) to demonstrate the strategic alignment and urgency of the proposed project, 2) to define the proposed project scope, and 3) to demonstrate the financial and operational benefits associated with the proposed project. In addition to these areas, the business case can help identify risk and strategies for managing them, identify and better understand rejected alternatives and target resource requirements needed to accomplish the project. All of this information can be used to document and layout an implementation road map.
Not all business cases are created equal. In some organizations, the business case development process is time-consuming and rigorous. Our recommendation is to customize the effort for the level of investment under consideration. With that said, components of the well-constructed business case contain the following elements.
- Summary Provide the operational and financial highlights of the business case.
- Introduction Explain motivation for proposed project.
- Solution Description Identify the proposed actions, developments along with scope and timing.
- Benefits Discussion Identify the expected financial and operational benefits, both one time and ongoing, their magnitude, certainty and timing. Benefit estimates should be provided in terms of ranges and should indicate the associated probabilities of various outcomes.
- Costs Discussion Identifying all costs in financial and operational terms associated with the project, both initial and ongoing. As in the case of benefits, cost estimates should be provided in terms of ranges and should indicate the associated probabilities of various outcomes.
- Risk Management Discussion Identify the risks associated with the proposed project and approach for managing these risks.
- Value Creation Discussion Identifying, in financial terms, the value created by the proposed project, along with its sensitivity. This sensitivity should be expressed in terms of a probability distribution of the various outcomes.
- Discussion of Alternative Solutions Provide the description, benefits, costs, risks and valuation of alternatives to the project.
- Value Measurement Plan Identifying the approach to tracking and measuring the value created by the proposed project.
Out of all of these elements, I want to introduce an emerging perspective on measuring and estimating value creation. The heart of many financial measures (ROI, NPV, IRR) involves an understanding of discount rate, projected cash flows and the time-value of money. For the remainder of this article I want to focus on the elements that go into the cash flow projections.
Figure 1: Elements of Cash Flow Projections
Cash Flow is King
Cash flow projections for a number of business intelligence solutions (e.g., data warehouses) have a tendency to focus predominately on the changing "reporting" environment. For example, the cash flow projections are based upon the difference between the cost of supporting the current state reporting environment and the new proposed cost of supporting the future state environment. This is an acceptable approach; however, the real essence of why you are investing in such a project goes so far beyond just reporting. Establishing your business case on this alone is only providing a partial view of what the investment is all about.
If you want to build a rock-solid business case, the cash flow projections should not only include the cost difference between current state and future state, but they must include areas within the business that account for cost reduction associated with a business process and/or increased productivity (revenue focused) that is attributed to better decision making. However, the problem is getting the business executive to place a stake in the ground and stand behind an assumption statement indicating that the given solution can either reduce costs or increase productivity by a "single" point estimate. The specific single point estimate is the primary problem.
We recommend replacing the single point estimate with a range estimate that is appropriately tied to a probability distribution (normal, triangular, uniform, lognormal, etc.). In turn, this is used to calculate NPV with the results expressed in terms of a probability distribution. Subsequently, translating this result into terms that are understood by the business community provide the essential elements for strengthening the overall business case.
In the next column, I will provide a case study that expands upon these concepts and shows how to integrate them into the overall ROI calculation.
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