1 better business cases practitioner course module two: the preferred solution 10 october 2013

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Better Business Cases Practitioner Course Module Two:

The Preferred Solution

10 October 2013

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Practitioner Course (Module Two) Housekeeping

• Welcome• Introductions• Registration• Are we comfortable?• Apologies?• Objectives – by the end of today….• Agenda• Parking lot – other expectations?

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Practitioner Course (Module Two) Objectives• To develop a working knowledge of the content and structure

of the Detailed and Implementation business cases.

• To develop the key skills required to develop Detailed and Implementation business cases, by: Identifying monetary and non-monetary benefits Identifying and presenting the preferred option by applying:

cost benefit analysis (CBA) multi-criteria decision analysis (MCDA) quantitative risk analysis (QRA)

• To appreciate the importance of involving key stakeholders, customers and suppliers in the business case development process.

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AgendaIntroductions

Learning Point: Q & A session

Detailed Business Case: Economic CasePresentation

Morning tea

Benefits and costsPresentation and Exercise One: Identifying and categorising benefits

Cost Benefit AnalysisPresentation and Exercise Two: Cost Benefit Analysis

Lunch Break

Intangibles and Risk AnalysisPresentation and Exercise Three: Multi-Criteria Decision AnalysisPresentation: Risk analysis

Afternoon Tea

Commercial, Financial, Management CasesPresentation and Exercise Four: Risk register and commercials

Implementation Business CasePresentation

Wrapping-up, parking lot and evaluation

Close at 4:00pm

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Learning Point - Q&A Session

1. What is the main purpose of the Detailed Business Case?

a) To seek final funding approval prior to implementing

b) To seek approval to issue the Request for Proposal (RFP)

c) To provide the detailed analysis omitted from the indicative business case

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2. When should a Detailed Business Case be prepared?

a) For large scale information technology investment proposals

b) When requested by Treasury

c) Once the preferred way forward is approved

d) As soon as possible

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3. On what basis should a short-listed option be preferred?

a) If the net present value of monetary benefits exceeds the net present value of costs

b) If the payback period is less than five yearsc) If it is the optimal mix of costs, benefits and

risks

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4. What is the difference (if any) between an Economic Assessment and a Financial Costing?

a) Nothing: simply terminologyb) Value for Money as opposed to Affordabilityc) The financial costing ignores benefits and

costs that do not impact on the bottom line

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5. What is the recognised standard for Economic Assessment of Public Sector spending proposals?

a) Cost Effectiveness Analysisb) Cost Utility Analysisc) Regulatory Impact Analysisd) Cost Benefit Analysise) Multi-Criteria Decision Analysisf) a robust ranking exercise

6. How many options should the Detailed Business Case address?a) 12b) 5 (the short-list

options)c) 2 (the public sector

comparator versus the PPP option)

d) 1 (if this is the only option available)

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7. Economic Assessments should reflect how many years?

a) the expected life or duration of the contract

b) the expected life or duration of the asset

c) typically 20 years

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8. When is it necessary to undertake Quantitative Risk Analysis (QRA)?a) for high risk investment proposalsb) for all investments, where fit for purposec) if two short-listed options have

indistinguishable net benefitsd) when directed by the State Services

Commissione) when planning a trip to Monte Carlo

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9. Service risks should be…?

a) transferred to the parties best placed to manage the risk

b) shared between the organisation and service suppliers

c) dealt with as they occur

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Project Strategic Assessment

Indicative Business Case

Detailed Business Case

Implementation Business Case

Programme Strategic Assessment Programme Business Case

Single Stage Business CaseSingle Stage Business CaseProject Strategic Assessment

Unpacking the Detailed Business Case: The Economic Case

Revisit the Indicative Business Case

Procurement Strategy

Indicative Costs

Management Strategy

Key:Strategic Case – future state

Economic Case

Commercial Case

Financial Case

Management Case

Benefits

Risks

Short-list Options

CSFs

Long List Options

Options Assessment

Detailed Business Case- The Economic Case

Economic Assessment

Intangible Benefits

Risk Analysis

Sensitivity Testing

Preferred Option

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The Assessment Process

Considerintangiblecosts & benefits

Risk analysis

• A systematic process to identify the best value for money option • The objective is to fully inform decision-making• Needs to be fit for purpose (cf Scoping Document)

Analyse the short listedoptions

Estimate costs and benefits

Identify costs and benefits

Multi-criteria decision analysis

Cost Benefit Analysis

Revisit the risks (80/20) identified in Indicative Business Case

Quantitative risk analysis

Monte Carlo

Bench-marking

Revealed preference methods (Hedonic pricing)

Stated preference methods (Willingness to pay)

Revisit the benefits (80/20) and indicative costs identified in Indicative Business Case

Assumptions

Scope

Appraisal period

Discount rate

Sensitivity test and present

Scenario testing

Tell the story

Trade-offs

Preferred option

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Scope Assumption - National Economy• NZ, region, sector or organisation perspective?• “NZ inc” preferred….”national economy” or “general

equilibrium analysis”• Consider ALL sectors of the economy …• … because the actions of one agency can impose costs or

benefits on individuals or the nation as a whole• Eg, Govt subsidises beef meat producers. This results in a

lower price for beef, which in turn decreases demand for sheep meat. Need to take into account both beef and sheep meat markets

• BUT – could agree to constrained scope for internalised benefits and costs (eg new payroll system)

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Appraisal Period?• The period of analysis,

typically the useful life of the asset…

• … or the contract term (if longer)

• If different options result in differing appraisal periods: – could use the shorter period and

apply a residual value to the longer asset/contract, or

– could use the longer period and assume reinvestment of the shorter asset/contract

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Discount Rate Exercise How much would you be prepared to borrow (lend) today? In return for payment (receipt) of $100,000 in one years time?

Lender: lends $PRICE today and receives $100,000 in one year

Borrower: borrows $PRICE today and repays $100,000 in one year

Discount rate %

Today’s Price Effective Interest rate

0% $100,000 0.00%1% $99,000 1.01%2% $98,000 2.04%3% $97,000 3.09%4% $96,000 4.17%5% $95,000 5.26%6% $94,000 6.38%7% $93,000 7.53%8% $92,000 8.70%9% $91,000 9.89%

10% $90,000 11.11%15% $85,000 17.65%20% $80,000 25.00%

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Discount Rate Effectively the return that an investor (eg the Crown) would expect to receive compared to the best alternative investment (eg by the Crown in other public services or by repaying Crown debt).

Investing has an opportunity cost, related to:•the cost of capital•the risk of default•administration and tax costs, and •any profit margin (eg, for a private bank).

The UK Government discount rate reflects a social rate of time preference. A lower % discount rate is used to compensate for society’s preference for shorter term benefits and consumption now, rather than longer term benefits and deferred consumption.

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Public Sector Discount Rate Category Discount

rate

Default rate (for projects that are difficult to categorise including regulatory proposals):

8.0% pa

General purpose office and accommodation buildings 6.5% pa

Infrastructure and special purpose (single-use) buildings: water and energy , prisons, hospitals, hospital energy plants road and other transport projects

8.0% pa

Telecommunications, media and technology , IT and equipment, knowledge economy (R&D)

9.5% pa

Nb: These are real, risk adjusted discount rates and should only be applied to costs and benefits that do not include general price inflation adjustments.

Updated regularly by Treasury (latest Oct 2010) and available from: http://www.treasury.govt.nz/publications/guidance/planning/costbenefitanalysis

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Benefits and Costs

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Identifying Potential Benefits (recap)

• Refer to the BBC Benefits Management GuideQ1: Are the benefit classes sufficiently comprehensive?Q2: Are benefits from a national economy perspective?

A gain or improvement…. Or a loss (ie dis-benefit)

…. by a beneficiary (group or individual)…..

…attributable as a result of the proposed investment…. - directly or - indirectly (unintended consequences)

Or not attributable to the proposed investment…. - ie by external influences

…and measurable: - quantitative only - monetary

Or observable, but non-measurable: - ie an intangible

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Categorising BenefitsQuantifiable (monetary)

Quantifiable (non-monetary)

reduced staff absenteeism/ turnover

reduced unemployment

less road deaths

NZ productivity gains

public health

public safety

stronger communities

National security

better insulated houses

workplace culture

increased access

Qualitative (intangible & non-monetary)

efficiency gains

higher revenues

reduced/ avoided costs

time savings, due to less compliance

more/ less disposable income

redundancies

lower prices

more leisure time

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Assigning Monetary Values to Intangibles?

What are your marginal benefits or dis-benefits if the neighbouring reserve was to be developed into a….?

OR OR

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Revealed and Stated Preference MethodsHedonic pricing: •uses the different prices of a traded good to estimate the value of a non-traded good. •Eg the cost of aircraft noise disturbance on the community can be estimated by comparing house prices in noise-affected areas with prices of similar houses in similar non-affected areas

Willingness to Pay: •asks people about their preferences. •Eg a survey of how much people are willing to pay to preserve a natural wilderness area.

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Revisiting the Indicative Business Case: The POSS Case Study







Depts (10) A, B, C…..KDepts (10) A, B, C…..K

Suppliers

Services and Supplies (7):

Utilities,building services, telecoms & IT,office supplies, travel, catering, andcars

MISS Investing to Improve Procurement/V4$

Public

InputsEmployed

OutputsDelivered

Outcomes Achieved (intended & unintended)

Business processes

To reduce costs

To improve efficiency of service delivery

To improve quality of services

MISS Project Team

MISS Project Team

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Base Case Status Quo/ Do nothing

Less Ambitious (Public Sector Comparator)

3 Depts: A, B, CUtilities and building servicesIn-house services (including cross-agency collaboration and lead agency delivery)Phased 18 months, Public funded

Preferred Way Forward

3 Depts: A, B, CUtilities, building services, office supplies, telecoms and IM&TOut-sourced services (including supplier panels)Phased over 18 months, Public funded

More Ambitious 3 Depts: A, B, CUtilities, building services, office supplies, telecoms and IM&TStrategic Partner (ie bundled services provided by private sector partner under a single contract)Phased over 18 months, Private funded

POSS Indicative Business Case Short-listed Options

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Unpacking the Economic Case:Cost Benefit Analysis

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The Assessment Process

Considerintangiblecosts & benefits

Risk analysis

• A systematic process to identify the best value for money option

Analyse the short listedoptions

Estimate costs and benefits

Identify costs and benefits

Multi-criteria decision analysis

Cost Benefit Analysis

Revisit the risks (80/20) identified in Indicative Business Case

Quantitative risk analysis

Monte Carlo

Bench-marking

Revealed preference methods (Hedonic pricing)

Stated preference methods (Willingness to pay)

Revisit the benefits (80/20) and indicative costs identified in Indicative Business Case

Assumptions

Scope

Appraisal period

Discount rate

Sensitivity test and present

Scenario testing

Tell the story

Trade-offs

Preferred option

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Invest or Not?

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Decision should allow for Opportunity Cost

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What does the Calculation look like?Key Assumptions:Discount Rate 8.00%Appraisal period (years) 5 years

Year 0 1 2 3 4Discount factor (mid-year) 0.96225 0.89097 0.82497 0.76387 0.70728

Total Benefits (mid-year) $100 $100 $100 $100 $100Present Value of Benefits (mid-yr) $96 $89 $82 $76 $71Present Value of Benefits $415

Total Costs (start-year) -$450 $0 $0 $0 $0Present Value of Costs -$450 $0 $0 $0 $0Present Value of Costs -$450

Net Cash Flows -$350 $100 $100 $100 $100Net Present Value (by year) -$354 $89 $82 $76 $71Cumulative NPV -$354 -$265 -$182 -$106 -$35Refer to the Tertiary Education Commission CBA spreadsheet template at:http://www.tec.govt.nz/Tertiary-Sector/Crown-Interest/Business-Cases/Step-Two--Business-Case-Development/

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What is Cost Benefit Analysis (CBA)?• an economic assessment tool• CBA quantifies all costs and benefits in monetary terms, and

discounts to today’s dollar equivalents (“Present Value”)• Present value = [cash flow ($)]/(1+discount rate)n

• Eg: $10 expected in 5 years time at 8%pa = 10/(1.08)5 = $6.81 now

• Objective = Present Value of expected benefits > Present Value of expected costs (ie “NPV positive”)

• CBA can be used to quantitatively rank alternative options (NPVA($) > NPVB($))

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Why use Cost Benefit Analysis (CBA)?Decision-makers can be provided with a consistent and systematic basis for comparing proposals with different levels of estimated benefits at different times

– Does the proposal provide a net benefit to the community as a whole?

– Should an existing project or programme be continued?– Which option is preferred (on the basis of net monetary

benefits)?– Which of various alternative projects or programmes

should be undertaken?

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Some Rules for Applying CBA• DO assign monetary values if possible (and credible!)• INCLUDE all cash flows and opportunity costs• DON’T:

– over-cook the analysis (make it fit for purpose)– double-count benefits– attribute benefits that do not result from the investment– inflate values for general inflation

• EXCLUDE:– sunk costs (interested in marginal costs & benefits only)– financing costs (included in the discount rate)– depreciation (a non-cash allowance for wear)– transfer payments (eg taxes and social benefits)– optimism bias (to the extent the discount rate is risk adjusted)

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CBA vs CEA vs CUACost Benefit

AnalysisCost Effectiveness

AnalysisCost Utility Analysis

PV of Benefits ($) PV of Costs ($)

Quantitative Benefits (n) PV of Costs ($)

Intangible Benefits (U) PV of Costs ($)

Option A < Option B Option A < Option B Option A < Option B

$150$100

$250$100

15$100

25$100

U$150

U$100

BBC preferred for monetary benefits and costs.

Only used for similar comparable options that result in a quantitative benefit (eg lives saved in transport or Quality Adjusted Life Years for health proposals)

Only used for options that provide similar intangible benefits (or utility). For example defence capability.Use multi-criteria analysis instead.

Present Value of Marginal Costs ($m)

B/C ratio = 1.0(ie NPV=0)

Presenting the Cost Benefit Analysis

Status Quo Option

Do Min Option

AspirationalOption

Non-optimal Option

Costs exceed benefits

Benefitsexceedcosts

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Analysing Intangibles

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Pros ConsEnables non-monetary impacts to be incorporated into the decision-making process

… But depends on subjective judgements of panel members

Can provide transparency and an audit trail

… But needs to be robust, eg criteria can overlap resulting in double-counting

More flexible than CBA and easy to implement

… But potentially less rigorous than a (good) CBA

Multi-Criteria Decision Analysis (MCDA)• A systematic process for ranking alternative proposals against

decision-makers’ preferences, objectives and criteria

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Examine Results

Score Options

Weight Criteria

IdentifyCriteria

IdentifyStakeholder Panel

How to Undertake the MCDA WorkshopThe choice of stakeholder panel is critical as it influences mix of preferences

Criteria should be complete, assessable and independent (to avoid double counting). Fewer is better – ie exclude redundant criteria and cluster.

The panel should assign % weights to each criteria by its contribution to achieving the investment objectives and value for money

For each criteria, the panel score each option (0 least preferred, 10 most) and then multiply by the weight. To ensure scoring is objective and consistent, use software tools that generate numeric values by comparing elements pairwise. (cf 1000 Minds Ltd, Catalyze Ltd, MACBETH (process)).

Test the robustness of the overall scoring. Does it make sense - REALLY? Document to demonstrate that the analysis is robust. Name the panel members

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Risk Analysis

Present Value of Marginal Costs ($m)

B/C ratio = 1.0(ie NPV=0)

B/C ratio = 2.0

B/C ratio = 3.0

Why Quantify Risk?

Option B – high risk

Option A – low risk

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Managing UncertaintyWhat is a Risk?

“..the chance of something happening that will have an consequence on the achievement of proposal objectives (ie prevent, delay, degrade, enhance, create)…” Measured by consequence ($) and likelihood (%)

What are our Choices for managing risk?

• To avoid it• To mitigate it• To transfer it or share it with

another party• To accept it

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Almost certain High High Extreme Extreme Extreme

Likely Moderate High High Extreme Extreme

Possible Low Moderate High Extreme Extreme

Unlikely Low Low Moderate High Extreme

Rare Low Low Moderate High High

Insignificant Minor Moderate Major Catastrophic

Categorising Risks against our Risk Tolerance Profile

Likelihood

Consequence

Why do we Identify and Quantify Uncertainty?

• To evaluate the realism of our estimates of benefits, costs and timing (of deliverables, including scheduling risks)

• To inform choices between competing short-listed options with different risk profiles

• To inform trade-offs between different risk management strategies (eg to transfer or to accept)

• To determine thresholds for triggering decisions to invest, to draw-down funding, to proceed (or NOT)

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Attempts to Quantify UncertaintyDiscount Rate Adjustment %•down-side only•impacts more on long-term cash flows

Optimism Bias %•down-side only •lacks transparency if applied inside the CBA•attempts to value the cost of risk

Hi/Lo ranges $•could be fit for purpose•could be linked to a confidence level (ie 90% of the time)•can’t model interactions between different risks

year

PV of net benefit

year

PV of net benefit

Mid-point estimate

Lower bound

Upper bound

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Monte Carlo Analysis• What is Monte Carlo Analysis?

– A quantitative risk modelling method – That aims to model the impact of varying key inputs

on the outcome of the overall investment• When to use it?

– simple techniques cannot adequately describe the range of possible outcomes

– input variation significantly impacts on outcomes – input variation can be explained by a probability

distribution • How …….?

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Input #1 Distribution: Exchange Rates

• Problem = estimate variability over a 6-month period• Distributions “fitted” to historical rates, mean= $0.61

Exchange Rate

0.000

0.010

0.0200.030

0.040

0.050

0.0600.070

0.080

0.090

$0.54 $0.56 $0.58 $0.60 $0.62 $0.64 $0.66

Exchange Rate USD

Pro

ba

bil

ity

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Outcome Distribution: NZ$ Funding Gap

Mean = $34.5m, Std Dev= $1.5m, 95% of outcomes below $36.9m

NZD Purchase Price

0.000

0.020

0.040

0.060

0.080

0.100

0.120

$29 $31 $33 $35 $37 $39

Purchase Price

Pro

ba

bil

ity

Total Project Costs ($NZ millions)$36.9mMean = $34.5m

0.00

0.95

1.00

0.50

0.25

Joint Minister approval required above 25th percentile

Cabinet approval required above 50th percentile

Department able to draw down cash to the 25th percentile

Consider termination above 95th percentile

$34m

Project Mgt: Triggering Decision Points

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Sensitivity Testing – What if?....Scenario Analysis•asks “what if” questions and recalculates the overall results•what if one or more sensitive/key variables were changed by ±10%? •3 scenarios:

– pessimistic– most probable or base scenario – optimistic

Switching valueHow much would a variable (eg the exchange rate) have to change to change the preferred option?

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Planning for Procurement and Delivery

Indicative Business

Case

Indicative Business

Case

Short-list Options


Indicative Costs

Management Strategy


Economic Case

Commercial Case

Financial Case

Management Case


Economic Assessment

Case for Change

Non-monetary

Risk Analysis

Sensitivity Testing

Procurement Plan

Financial Costing

Project Mgt Plan

Risk Mgt Plan

Change Mgt Plan

Benefits Mgt Plan & PIR

Revisit Case for Change

Benefits

Risks

Preferred Option

Funding Gaps

Balance Sheet Analysis

Chief Execs Letter

Mgt Case Workshop

MCDA Options Workshop

Commercial Case Workshop

Financial Case Workshop

Investment Objectives

Existing Arrangements

Business Needs

Scope

CSFs

Benefits

Risks

Constraints & Dependencies

Long List Options

Initial Options Assessment

Initial Options Assessment

Key:Strategic Case – current stateStrategic Case – future state

Economic CaseCommercial CaseFinancial CaseManagement Case

Economic Assessment

Non-monetary

Risk Analysis

Sensitivity Testing

Procurement Plan

Financial Costing

Project Mgt Plan

Risk Mgt Plan

Change Mgt Plan


Preferred Option

The Single Stage Business Case Roadmap

Case for change Workshop Options

Workshop #1

Commercial Case Workshop

Financial Case Workshop

Mgt Case Workshop

Benefits & Risks Workshop

Options Workshop #2

Strategic Context

Problems

Benefits

ILM Workshop #1Problems

ILM Workshop #2Benefits

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Commercial Case – Preparing for the Potential Deal

• Procurement strategy• Service requirements• Risk allocation• Payment mechanisms• Contractual and other issues• Workshop - with who?

www.Procurement.govt.nz – 8 Step Guide to Mastering Procurement

1

2

3

4

5

6

7P

LA

N

SOURCE

MANAG

E

Initiate project

Specify requirements

Plan approach to market & evaluation

Approach market& select supplier

Managecontract & relationships

Negotiate & award contract

Review 8

Identify needs & analyse themarket

needs


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Financial Case – Ascertaining Affordability and Funding Requirements• Assumptions (organisation

perspective)• Financial costing model• Best estimates of expenditure less

revenue• Balance sheet impacts?• Funding gaps (operating & capital)?• Possible user charges?• Scenarios (high, med, low)• Contingencies• Chief Executives letter• Workshop – with who?

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Management Case – Plan for DeliveryProject management strategy, methodology, framework, governance,

project structure, reporting arrangements, milestones, key personnel, roles and responsibilities

Change management strategy, framework and change management plan

Benefits Management strategy, benefits map, benefits register (including owners), and realisation plan

Risk Management strategy, framework including embedding into business processes, risk register and reporting requirements

Post-project Evaluation

process, timing and responsibility.

Chief Executives Letter formal assurance that the proposal and resource requirements are owned at a high level

Workshop With who?

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Project Implementation Business Case

Better Business Cases “Investing for change”

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Implementation Business CasePurpose• Identify the supplier that offers the best value for money• Detail the negotiated and commercial and contractual

arrangements• Confirm the proposed arrangements are affordable• Organise the detailed management and delivery arrangements

Indicative Business

Case

Indicative Business

Case

Short-list Options


Indicative Costs

Project Mgt Strategy


Economic Case

Commercial Case

Financial Case

Management Case

ImplementationBusiness CaseCase for

Change

Procurement Plan

Financial Costing

Project Mgt Plan

Risk Mgt Plan

Change Mgt Plan



Benefits

Risks

Preferred Option

Detailed Business

Case

Detailed Business

Case

Evaluate Best & Final Offers

Financial Implications

Project Mgt Plan

Risk Mgt Plan

Change Mgt Plan



Revisit Options

Negotiated Deal

Sign Contract

Issue RFPIssue RFI

(Finalise for implementation)(Planning for delivery)

www.Procurement.govt.nz – 8 Step Guide to Mastering Procurement

1

2

3

4

5

6

7

PL

AN

SOURCE

MANAG

E

Initiate project

Specify requirements

Plan approach to market & evaluation

Approach market& select supplier

Managecontract & relationships

Negotiate & award contract

Review 8

Identify needs & analyse themarket

needs


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• To develop a working knowledge of the content and structure of the Detailed and Implementation business cases.

• To develop the key skills required to develop a Detailed or Implementation business case by: Identifying monetary and non-monetary benefits Identifying and presenting the preferred option by applying:

cost benefit analysis (CBA) multi-criteria decision analysis (MCDA) quantitative risk analysis (QRA)

• To appreciate the importance of involving key stakeholders, customers and suppliers in the business case development process.

• PARKING LOT?

Did we meet our Objectives?

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Additional Background InformationFurther background information on Better Business Cases, including guides, templates and links to related guidance and web-sites, is available at: http://www.infrastructure.govt.nz/publications/betterbusinesscases

Further information on economic assessment tools is available at:•http://www.treasury.govt.nz/publications/guidance/planning/costbenefitanalysis•http://wales.gov.uk/funding/wiipindex/5cmodel/?lang=en•http://www.hm-treasury.gov.uk/data_greenbook_index.htm•http://www.finance.gov.au/obpr/cost-benefit-analysis.html

A spread-sheet cost benefit analysis template is available at: http://www.tec.govt.nz/Tertiary-Sector/Crown-Interest/Business-Cases/Step-Two--Business-Case-Development/ 8 Step Guide to Mastering Procurement at www.Procurement.govt.nz

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Where to get support?For Better Business Cases guidance, templates and training programmes,

the Treasury National Infrastructure Unit (NIU) web-site: http://www.infrastructure.govt.nz/publications/betterbusinesscases

For general Better Business Cases inquiries, email: [email protected]

For further detail on this training material:Lewis WeatherallSenior ConsultantMobile: 0274 409706Email: [email protected]

1 better business cases practitioner course module two: the preferred solution 10 october 2013

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