Phase Two: The Analysis
In Phase Two we will develop an analytical model that identifies and blueprints multiple options for the development and operation of the different proposals.
Evaluate the Costs , Benefits, Risks, and Return On Investment for the various options. By the end of this phase, you will have one preferred option to finalise and propose to your audience.
Identify several options within the solution category and define a way to evaluate options. You’ve already introduced the concept for Your Idea (product, service, project, program, initiative, or business) at a high-level.
Now, it’s time to consider the various options that support the idea. While you should be confident in the merits of your idea there are still many detailed questions to be answered; and many ways to approach the solution.
One rational way to help identify the various options is to use the option appraisal approach (sometimes referred to as “option engineering”). This approach helps to: Identify genuine alternatives to consider; Outline contrasting options and build a comparative analysis; Avoid tunnel vision, and; Lay the foundation for contrasting to help you decide which approach is the ultimately the right one to propose.
1) Refine Objectives: Think about what you want to achieve with your idea and list three to five objectives.
2) Brainstorm Options: Begin the brainstorming process to create proposed solutions for achieving each identified objective. The more complex the initiative, the more variables to brainstorm. The brainstorming approach helps you consider the full scope of strategic, market, operational, financial, and business options. Really push yourself to get creative and consider as many ideas as possible. The initial goal here is quantity, not quality.
3) Short-list Options: Once you’ve generated multiple options, trim down the list to those that seem practical for your organisation. A good practice is to document the options in a clear sequence, such as from minimal to maximum effort. In this order, the first option can be “Do Nothing,” or “Maintain Existing Approach” and provides a baseline for all other options.
4) Establish criteria to evaluate the short-list: Establish criteria that you will use to evaluate the short-list of options. Some organisations have well-defined decision-making models for new ideas.
If your organisation doesn’t have specific criteria, consider these items: Ease of implementation, Cost, Ease of modification/scalability/flexibility, Employee morale, Cost savings, Increase in sales or market share, Return on investment, Similarity to existing organisation products, and Increase in customer satisfaction.
TIP: Sometimes, you might choose to further blueprint only one of your short-list options. However, if possible, try to do analysis on a few to make sure that you are really thinking through the options to help you select the best approach.
Outline the structure of each option (or single option if that was your decision) and how it will be developed, launched, and operated over time. A Blueprint or Project Plan serves as a bridge between the ideal and the real – its role is to take an option and show how it could be put into action.
By this point, you have short-listed the options that you plan to explore. And now you will document in detail the tactics and time line for tackling each option.
As a sound blueprint for deployment, you plan should answer the following questions: How are you going to implement this? What is the scope? How long will it take? What resources will you need? Which parts of the company will be affected? How will you manage change? How will you measure and communicate the impact?
TIP: With an organised, methodical, and disciplined approach, a project blueprint project plan translates a concept into the real world of resources, implementation schedules, milestones, and metrics. This can be an invaluable asset when it comes to convincing decision makers of the merit of your idea illustrating that it’s not only desirable, but doable.
Checklists: Blueprint Check-list,
Worksheets: Development Activities, Launch Activities, Operational Activities
Plans: Blueprint Project Plan,
Estimate the costs and benefits and how risk will be addressed along the way. Now that you’ve detailed what it will take to develop, launch, and operate each option, take a look at the costs, benefits and risk associated with each one.
The CBRA is your ally: Typically, a business unit manager can tally up the costs of whatever resource he or she wants, and then crunch the numbers for how much money that resource should be able to generate or save.
Alas, that task isn’t so straightforward for every project. Quantifying penalties never assessed, or harm never suffered is elusive, if not impossible — but asking the Board or CFO to fund a project “because we need it” doesn’t get far either. That said, we can construct a CBRA to help make your case, even with so many intangible factors at play.
An accurate CBRA answers the following questions: How much will this option cost? What materials, personnel, or other project requirements are we paying for? What are the tangible and intangible benefits to the organisation? Is the final calculation positive (benefit-oriented) or negative (cost-oriented)? What risks must be addressed along the way?
The CBRA is a balancing tool that compares cost and benefits and risks in a single report. When setting out to build one, there's no need to start with numbers. In fact, you won’t need to calculate totals until a bit later in the process. Begin by reviewing your project plan and talking to project team members about all the project components that you will need to assess, from planning through implementation.
Calculating Costs: Costs are a mixture of the obvious and the hidden. For example, the cost of additional employees is reasonably clear — but remember to consider recruiting costs, or disruption to another function from internal transfers.
Calculating Benefits: Some benefits will always be intangible. Others are measurable if you dig deeply enough. Talk to the stakeholders involved, especially those in the operating units that will use whatever system you’re proposing.
Then take the employees’ salary (which HR will know) and calculate how much payroll cost goes to that task. If your project will shave hours off the task and let the employee move on to higher-value work, you can begin to estimate the costs and benefits more precisely.
Risk may not be your field of expertise (it is mine) but addressing risk in your business case is critical. Even if you do feel confident you’ve got the knowledge you need to excel in this regard, you shouldn’t risk the success of your business case on it. So, following are some considerations as you address risks involved in your project.
Risk: Performing a thorough risk analysis will help quantify and, to a large extent, dispel the uncertainty introduced by implementing your idea.
Addressing risk through probability: To present a compelling view of potential risk, more than one number is needed when estimating cost, profit, or other key metrics.
The Monte Carlo Simulation: The Monte Carlo, known also as predictive modelling, is an automated computer mathematical simulation that can be run with an Excel spreadsheet to forecast probable outcomes. In just a few seconds, a Monte Carlo software program can run 100,000 simulations based on initial data inputs, such as estimates of cost, profit, labour, time, etc. The result is a visual display graph that shows the resulting “confidence interval” on a chart.
Charting Sensitivities: Sensitivity charts are a useful part of the Monte Carlo simulation, because they show which variables will have the greatest impact on your project. With the results from a sensitivity analysis, a project manager can focus on what’s driving a particular outcome.
A Comprehensive View of Risk: We have focused thus far on answering holistically: “How risky is this project?” While the Monte Carlo Simulation and Sensitivity Analysis will provide decision support for senior leaders, the Business Case also should outline the routine daily management approach for handling specific risks that arise within project implementation.
This is your framework for identifying, mitigating, and monitoring risks on an ongoing basis. Your solutions for this could include creating a Risk Framework that includes a Risk Management Plan and common maintenance tools such as a Risk Register, Risk Check-list, and Risk Repository.
Uncertainty: For complex Business Cases with multiple variables, many of them qualitative rather than quantitative — accommodating a degree of uncertainty is unavoidable. Uncertainty is not the same as risk. In this context risks can be calculated; uncertainty is more difficult.
We can address uncertainty in a few principal ways.
1) You narrow the knowledge gap that requires you to make assumptions.
2) Recovery strategies are another way to deal with uncertainty — that is, assume the worst outcome, and calculate the costs of recuperating from it.
3) You shorten your time horizon. Guessing what will happen farther into the future becomes ever more difficult, as uncertainties multiply and modify each other.
4) Modelling high-impact, low-probability uncertain events is another challenge. You can try to address low-risk, high-impact uncertainties by ranking them in order of predictability and impact; and then developing recovery strategies for the highest rankings.
Developing skill at financial modelling is critical to making an effective business case for a risk management project; you could even say it’s one of the best strategies to reduce the uncertainty of winning approval for Your Idea.
NOTE: Bayesian Networks: We can apply Bayes Theorem to update a prior probability for some unknown event when we see evidence about the event. That is too complex for a business case.
In Nassim Nicholas Taleb’s book, “The Black Swan: The Impact of the Highly Improbable,” he defines a Black Swan as: “an unpredictable and extreme event outside normal parameters that has catastrophic consequences.”
Think Global Financial Crisis or COVID.
The Black Swan is a good reminder that cost/benefit, risk, and Monte Carlo simulations are performed within a model of quantitative value that is the accepted practice for the day. However, these tried and true results that we rely on to prove our Business Case may be dramatically affected by a singular, unusual event outside the range of the forecast scenarios.
As Taleb writes: “Indeed, the normal is often irrelevant. Almost everything in social life is produced by rare but consequential shocks and jumps; all the while almost everything studied about social life focuses on the 'normal,' particularly with 'bell curve' methods of inference that tell you close to nothing. Why? Because the bell curve ignores large deviations, cannot handle them, yet makes us confident that we have tamed uncertainty.”
TIP: Since the Black Swan event is usually not anticipated and only fully understood with hindsight, it can cause a massive shock-wave effect in the economy or society. This calls for the project manager or business case owner to remain adaptable and knowledgeable of the market, economy, social, environmental, competitors, and political events.
Evaluate the streams of costs and benefits. Plan to run your numbers through at least three formulas Net Present Value (NPV) and Internal Rate of Return (IRR) and Payback Method (PM) calculations.
Creating financial models is always a bit of gamble amid lines of spreadsheet formulas. For people who don’t come from a financial background, the exercise can seem daunting from a distance.
The good news: many professionals have trod this path before you. Learning to use standard modelling tools and to account for uncertainty in your projections will pay dividends far into your career.
NPV compares the amount you’ll invest today with the current value of the future cash receipts from your investment. Remember, a dollar spent today is worth more than a dollar spent or earned next year, because inflation erodes the value of money over time.
Calculating the NPV of an investment helps you and your board decide which investments are worth doing. An investment needs, at minimum, a positive net present value to be worth the expense. So not only must a project that costs $100 today return $100 at some point in the future; it must return $100 plus whatever value has eroded over that time.
To calculate NPV: Start with the amount of the initial investment and the cash flow it will produce (either in added profits or reduced costs). Say you want to pay $100,000 for a four-year subscription to a due diligence service. It will save $30,000 each year since you can cancel other providers.
The Discount Rate: So far, so good. Next you need to know the Discount Rate your board applies for investments: the rate at which the value of a dollar erodes. Discount Rates vary by industry and company, and usually they are somewhere near the company’s cost of capital — what the company pays to borrow money. Your corporate finance department can give you a good discount rate to use.
Go-No-Go: In the example above, let’s say the discount rate is 10 percent. Take that rate, the $100,000 investment, and the $30,000 in annual savings, and enter them into one of Excel’s NPV formulas or an online calculator. You’ll find that after four years this investment produces a net present value of negative $4,904. That means it is a no-go.
What then? You could try to negotiate the price of the subscription. Start by entering different projections into your NPV calculator, to see what works for you. For example, bargaining the vendor down to $90,000 leads to a positive NPV of $5,096 after four years. Your Board will like that better.
Spreadsheets: NVP Calculator.
IRR shows the interest rate produced by an investment with payments and income occurring at regular intervals. IRR lets you compare the investment for Your Idea to the desired rate of return and to compare different investments.
To calculate IRR, you need to estimate the initial investment as well as the annual discounted future cash flows. The inputs can be tricky. If you don’t have much experience with corporate finance and modelling, you may want to enlist the help of someone in the finance or accounting departments or give me a call.
If you expect to sell Your Idea to your board then IRR should exceed the minimum corporate return rate, also called the hurdle rate.
For example: Your Idea involves a $500,000 computer system. Each year it should produce $160,000 in profits or savings. After four years, it will be obsolete and sold at salvage for $50,000.
If you discount the cash impact every year with a hurdle rate of 8 percent, you’ll realise $141,247 the first year, declining to $26,808 (the discounted $50,000 salvage price) the fifth year.
This produces an IRR of 13 percent. That’s above the hurdle rate of 8 percent, so Your Idea is a positive one you can pitch to the Board.
You can also compare that 13 percent IRR to other investments to see which one is best.
TIP: IRR is not fool proof. A small investment with a high IRR can be less worthwhile than a bigger investment with a lower IRR, because the larger project saves more dollars. Also consider your company’s special needs, risk tolerance and other options; your Board may ask you about them.
Spreadsheets: IRR Calculator.
Payback Period Analysis commonly known as the Payback Method tells you how many years an investment will need to pay for itself. The payback period can be determined with any standard calculator: just divide net annual cash inflow by the required investment.
For Example: Say you want $20,000 for an online training system. In 10 years, it will be obsolete, with zero salvage value. Each year you use it, you’ll save an estimated $10,000 in travel costs. Dividing $20,000 by $10,000 gives 2.
That is the payback period in years.
Payback Period Analysis is harder to calculate with more complex situations, such as investments that keep producing cash flows after the investment’s useful life. It’s good for comparing projects with varying payback periods, especially when money is tight. Your board may also have a maximum allowable payback period. You’ll want to know this before making your pitch.
Spreadsheets: Payback Period Calculator.
Completing the Blueprint, CBRA, and ROI, will help you create a thorough, data-driven framework, so you can evaluate the high-level merits of several options.
Select a Single Blueprint to finalise and propose based on a full analysis of Costs, Benefits, Risks, and ROI.
Done well, the process will help you clearly make an informed strategic decision on your recommended approach.
Pick Only One Option: After that comprehensive analysis, you now have the detailed information, facts, and data-driven insights to make an informed decision.
While it may be tempting to believe that presenting multiple options for approval will improve the chances of “something” getting approved (or, you would like to reveal how comprehensive, well-researched or thorough you were in coming up with the proposal), sharing more than one proposal is rarely successful.
Instead: Now, your time and effort should be focused on developing the Business Case for the Single Option that based on data and analysis, you genuinely believe in.
This can’t be stressed enough! Too many business cases crumble when they are presented as a menu of options with a “a little bit of this and a little bit of that” or a laundry list of possibilities. As a leader, you’ve been hired and are trusted for your judgement and analysis, not for your ability to present all possible options so that others can decide!
Now - Move Onto Phase Three
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