In the third article in our series on realising the benefits of business change, we look at how to go beyond the hurdle rate of return. By Stephen Jenner FCMA, senior civil servant with the UK Ministry of Justice.
There is continuing evidence of a widespread failure by organisations to realise the potential benefits from their investments in change. To address this we need to face three challenges.
The first is ensuring the benefits forecast in our business cases are robust and realisable. The second is going beyond the hurdle rate of return to capture all forms of value. The third is ensuring that ‘the performance matches the promise’ and going beyond passive tracking to an active search for value.
In this article I’ll be examining the second challenge - the need to go beyond the hurdle rate of return. Why is this important? If we don’t recognise value the opportunity will drift away and funding will be limited. Ultimately we are investing other people’s money, so value creation is the name of the game.
Capturing all business value created includes:
- efficiency benefits, both time and financial savings
- effectiveness benefits, in terms of improved performance and contribution to strategic priorities
- the flexibility or options value that infrastructure investments provide
- the value of legal/regulatory compliance and maintenance of business as usual.
Identifying these benefits is not always easy, but I briefly outline some techniques that can cut through the fog by providing sound and consistent approaches to benefits realisation management.
Efficiency benefits
Efficiency savings include cash saved, time savings, and costs avoided but not all efficiency benefits are equal. While cashable benefits are relatively easy to capture in terms of budget cuts or lower unit cost, time based savings need to be examined with a little more care.
The value of time saved is what you do with the time saved not the cost of that time. The related point is that organisations rarely manage to re-direct all the forecast time savings to value adding activity. For example, in ‘Managing information technology for business value’ Martin Curley quotes one project where they reduced the time savings by a half to allow for factors such as the Hawthorne effect (subjects improving simply in response to the fact that they are being studied) at the pilot stage, and then by half again to reflect the fact that not all time saved could be converted to effective use in practice.
I said above that cashable benefits that are reflected in budget cuts are relatively easy to capture. But we also need to ensure that the claimed efficiencies are real otherwise all we have really achieved is to cut budgets with consequent impacts on the quality and amount of work undertaken.
Strategic benefits
A corporate executive board paper, ‘Building a methodology for measuring the value of e-services’ by Booz Allen Hamilton includes the following comment from one CFO: ‘Business unit leaders always find a way to justify pet projects. Our CEO defines “strategic projects” as expensive projects without a business case.’
Only marginally better are those business cases that contain a table listing the organisation’s strategies that the project is aligned to. What does this really tell us? Nothing about the scale of the contribution or how confident we are in the claimed impact or whether the price required to obtain this ‘alignment’ represents value for money. We therefore need to go beyond high level claims of strategic alignment or ‘fit’, to understand:
- what contribution the initiative will make to our strategies?
- how confident are we in this impact?
- what measures will be used to assess impact?
- any business changes beyond the scope of the project or programme on which benefits realisation is dependent.
This can be facilitated by benefits mapping or modeling in which benefits are identified and linked clearly to organisational objectives and strategic drivers. One such approach is the Benefits Dependency Network developed at Cranfield University as shown in figure 1.
Figure 1. Cranfield University Benefits Dependency Network
Foundation or potential opportunity value
Infrastructure investments generally struggle to demonstrate a positive return on investment unless they take account of foundation value, that is, the option to invest in future applications, both those currently planned and those not yet funded. Research undertaken by Booz Allen Hamilton for the US Federal Government for example, concluded: ‘Analyses that do not incorporate foundational value can make calculating and demonstrating a short term or even long term value difficult or even impossible. Decisions made based on these calculations will stifle innovation.’
So, as shown in figure 2 below, unless we take account of the dependencies of projects B and D, investment in project E is put at risk.
Figure 2: Demonstrating dependencies
The problem we face is that where such applications have yet to be fully scoped or funded, their benefits cannot be claimed with any certainty in the business case. So how do we take account of this foundation or potential opportunity value while also ensuring that we maintain our commitment to benefits that are robust and realisable?
The answer is to adopt a real options approach which considers potential future value and the probability that this value will be realised. Text book guidance on real options derived from financial options theory is complex and can be difficult to explain to business managers. The absence of reliable input data on volatility means that such approaches can run the risk of spurious accuracy. A practical solution is to use a ‘Potential opportunity value’ approach in which a proportion of the value of the project portfolio pipeline is taken into account. This proportion is based on an assessment of the likelihood that the applications that will deliver these benefits will come to fruition. There are consequently three steps involved in assessing potential opportunity value:
Firstly, the project pipeline is reviewed to identify projects that are dependent on the investment in infrastructure. Secondly, the value of the relevant potential investments is estimated. Thirdly, the probability of each relevant application being funded and delivering the claimed benefits needs to be assessed. Again estimates should be prudent and this can be facilitated by using a standard checklist of key factors such as:
- scale of stakeholder commitment to the project, how crucial the investment is to strategic priorities and whether it is a mandatory project to meet a legal or regulatory requirement
- availability of funding for the project
- current stage of project approval, that is, how far through the investment pipeline/funnel is the project?
- how compelling is the business case in the context of available funding and competing priorities?
These analyses are then combined to provide a probability adjusted, expected potential opportunity value. These assessments should be updated on an ongoing basis and performance should be monitored in terms of the extent to which projects in the pipeline are converted to active projects and the ratio of forecast benefits to benefits realised.
Benefits from ‘must do’ projects
Some projects won’t necessarily have a positive net present value. These include those designed to meet legal or regulatory requirements; to reduce the risk of major system failures; and to maintain business critical operations. Some argue that mandatory projects will happen anyway, so why bother trying to assess the value? But how do we know that the proposed project is the best way to meet the investment driver or that it will have the desired effect – or that this could not be achieved more cost effectively?
Organisations should therefore make the implicit value of such investments explicit – that is, there is an implicit assumption that the value of compliance with laws/regulations and avoidance of systemic ‘things gone wrong’ must at least equal the net cost of the project, otherwise we would not invest. The recommended approach is to make this implicit value explicit, by presenting governance bodies with three pieces of analysis in the business case:
The first is a cause and effect analysis to demonstrate the rationale for linking the project to the business requirement. This should provide a degree of confidence that the project will address the issue at hand effectively. The second is key success criteria that will be used to measure success. If we are investing to reduce risk how will we know that risk has really been effectively mitigated? The third is an options analysis demonstrating that the net cost required represents the most cost effective way of addressing the issue.
Using these analyses, the governance bodies can come to an informed decision as to whether it is worth investing the requested funds to achieve the demonstrated impact – and if it does we know that the business perceived value is at least equal to the cost on a ‘willingness to pay’ basis.
Using approaches such as those outlined above can help ensure we have recognised all potential value created. But our benefits realisation approach doesn’t stop there. We need to ensure we go beyond the forecast to optimise value creation in practice. And that’s the subject of the next article in this series.
Steve Jenner will present a CIMA Mastercourse on ‘Active benefits realisation management' in July and November 2010. He is the author of ‘Realising benefits from government ICT – a fool’s errand?’; and ‘Transforming government and public services with project portfolio management’ due to be published in spring 2010.