AM/FM/GIS Investment Analysis
Barbara Servatius Sales Director C. Warren Ferguson Chief Operations Officer Smallworld Systems, Inc. 5600 Greenwood Plaza Blvd. Suite 300, Englewood, CO 80111 Abstract Investment Analysis is acknowledged as the best way to properly value an investment in modem technology. The traditional cost benefit analysis provides limited information for AM/FM/GIS technology justification. An Investment Analysis includes use of investment appraisal techniques to measure all the different types of risk, flexibility and project synergy, as well as cost benefit. This paper discusses Investment Analysis methodology and demonstrates how to make more fully informed decisions. An AM/FM/GIS project example is included. Introduction AM/FM/GIS information technologies may very well become the digital information infrastructure for successful businesses in today’s new, and sure to be competitive, future. There are no road maps to follow into this uncertain future. There are three basic business drivers in the world today: (1) customers take charge, (2) competition gets tougher and (3) change is constant. It is important to note that these business drivers are universal. They occur throughout the world in somewhat different ways depending on the nature of the economy, and the political/cultural context of the area. Today’s presentation will review the traditional cost/benefit approach to valuing your information technology, look quickly at where the real benefits of AM/FM/GIS will most likely come from and then look at an improved approach to valuing your AM/FM/GIS investment -an approach that combines a modern investment analysis with the traditional costlbenefit. It is important to recognize that to value any investment, we must how today where future profik wi// be earned. Observers and pundits of the business scene are unanimous in their notion that for a business to succeed, indeed to suwive, its design and operation must include the power and the flexibility to add value in an uncertain future. The traditional approach to valuing AM/FM/GIS AM/FM/GIS has traditionally been justified on the basis of either a quantitative cost/benefit analysis (CBA) or the qualitative notion that it was a “strategic requirement.” In today’s demanding business environment these forms of 344?analysis often provide decision makers with data upon which they can take no action. There are usually several reasons for this un-actionable data, but in any case the decision maker is unable to find justification to proceed. The inability to proceed may mean a project never gets started. Or it may mean that it dries up after a pilot or prototype. Or it may mean that an on-going project never gets to upgrade its technology. The traditional costlbenefit analysis (CBA) approach to valuing project investments is to apply either a non-discounted technique or a market based discount rate to the project cash flows. The typical result of a CBA is the “payback period” or the internal return on investment (ROI). CBA is not a complete science for full and proper valuation of project investments. It is open to much abuse. Unfortunately its non-discounting techniques can produce different and often conflicting results from the same financial information. It can produce financial results that are not a true value of the investment - projects that actually produce a loss are sometimes made to appear profitable. Three critical deficiencies are worthy of brief discussion. First, CBA is a project cash flow analysis. It is a cash flow analysis of that one project; done from a historical perspective and treating the project as a standalone item. While project cash flow must be considered, a modern business makes decisions on the basis of its overall cash flows. Second, CBA is simply historical in perspective because we cannot use it to compare new ways of doing things; new, improved or re-engineered work processes. Third, CBA includes no information on markets, industry type and/or entire companies in its analysis. In traditional CBA five types of benefits are considered: Type 1- Productivity Type 2- Capability Type 3- Response to unanticipated events Type 4- Intangibles Type 5- Revenue generation However when you begin to specifically define these benefits you find the following; Type 1- Productivity - quantifiable benefits from improving efficiency of current practices and from improvements to existing processes. Type 2- Capability - quantifiable benefits that result from expanded capabilities or benefits that offer added capabilities. Type 3, 4 & 5 are intangible benefits and are un-definable in hard dollars. Accordingly, very few CBAS ever count any dollars from benefit types 3, 4 or 5 even though those benefit types are very real in the world. AM/FM/GIS Benefit Prospects AM/FM/GIS has sometimes been difficult to describe. It has been called an enabling technology. It has been called a tool-kit. It has been called a system. It has been called a solution. But for all that it has been called many implementations have simply failed to measure-up as successes in today’s terms. 345?Complex applications such as outage or work management systems, or interfaces to them, have left much to be desired. It is the implementation of complex applications within the framework of AM/FM/GIS technologies that enables a new benefits reality. The resulting simple information system architecture will provide considerable benefits including: a single set of software tools to use and maintain, a single data source and single point data maintenance, a rapid application development and deployment environment, as well as seamless and easy to use applications. Mr. Hank Emery, has recently published several articles relating to AM/FM/GIS projects and complex applications (see Emery, 1995). He evaluates projects on a number of standard factors including complex applications and interfaces to other systems. Among the complex applications he evaluates are work order processing, design engineering, job cost estimating, work print plotting, and field outage restoration. Similarly, he evaluates interfaces to work management systems, trouble and outage systems and network analysis systems, as well as others. He notes “the lack of implementation of complex applications and interfaces” and goes on to observe that “the non-implemented areas present large opportunities for development and implementation.” Legacy AM/FM/GIS systems have been rooted in mainstream computing technology dating from the late 70’s and early 80’s. The Smallworld generation of AM/FM/GIS systems is emerging based on computing technologies of the 90’s. Object-oriented programming, distributed object models, GIS CASE tools and extended database architectures are in production use today. These technologies provide an AM/FM/GiS environment where complex applications can be implemented successfully in a simple information system architecture and the benefits of complex applications can be realized. For a full discussion of these latest technical issues, please see the paper presented at the AM/FM International Conference XIX by Mr. Peter M. Batty titled “The Impact of New Technologies on AM/FM/GIS” (see Batty, 1996) An Improved Approach to valuing AM/FM/GIS New benefits resulting from complex applications operating within the AM/FM/GIS technology framework offer new directions and new dimensions for a business model fully responsive to today’s fundamental business drivers. These AM/FM/GIS solutions should be evaluated as an investment in the future for they are an investment in the creation of an adaptive business environment that has the flexibility to succeed in the years ahead. An investment analysis is the appropriate methodology for valuing your AM/FM/GIS project. An 1A, including the CBA, will produce much better information for decision-making in today’s business environment. 346?In an investment analysis (1A) we see four especially notable topics. First, 1A includes company, market competition and risk factors not included in a CBA (see Hares, 1995). It is important to understand the company mission, goals and objectives for they are the foundation upon which value judgments must be made. Knowing one’s marketplace, the opportunities as well as the competitive threats provides basic information for evaluating alternative investment opportunities. Risk is very often inadequately covered in project valuations. Most often company risk is calculated as a discount rate and an expected return formula is used to establish value. But this is not enough. There are project risks and event risks for which an additional discount rate and probabilities of occurrence need to be calculated. Second, it provides techniques for measuring market risk, project risk, event risk and flexibility, intangibles, project synergies and benefit realization. We have discussed risks. There are now valid techniques to calculate the value of any flexibility applied to a project. Flexibility will, if it costs less than the project risks, increase the benefit value of an AM/FM/GIS project. There are many intangibles. Traditional benefit types 3, 4 and 5- response to unanticipated events, generaI intangibles and revenue generation - are but three categories. The value of response to a variety of unanticipated events may be large or small depending on the event. Today it is important also to calculate the cost if a business is unable to respond to an unanticipated event. General intangibles accruing to investments in AM/FM/GIS technology can be thought of in four categories (in increasing difficulty of measurement);
Benefit realization may be valued directly as well as in many indirect ways. One indirect example is the value of object-oriented technology over the life of an AM/FM/GIS project. Cost profiles show that after the first implementation, object oriented AM/FM/GIS systems have considerably less cost and risk over the project life than conventional ones. Third, if properly performed, 1Aevaluates these items in the context of a complete business. The structure of the 1Amethod includes four modules. They are deliberately numbered Oto 3, as the Oindicates that no techniques are applied. Each module serves as an objective of the method and its title is descriptive of that objective. Module O- Corporate business strategy Module 1- Investment investigation 1. Establish investment appraisal baseline 2. Identify investment opportunities. Module 2- Investment measurement Module 3- Benefits realization The business strategy module defines the particular business strategy for the enterprise providing certain goods and services within specific market sectors. The investment investigation module is concerned with the identification and planning of investment opportunities. These are projects which are financially viable as well as enabling business objectives to be achieved. The investment measurement module is the major part of the method and is discussed in following paragraphs. The final module is the benefits realization module which assesses whether the benefits claimed for the project are being achieved once the system is installed. Fourth, it evaluates the impact of the investment on the Critical Success Factors (CSFS) for the entire enterprise. CSFS are the ultimate source of all information in the company’s computer system and hence the basis of the logical data model for the value components. CSFS are the limited areas in which satisfactory results will ensure competitive performance for the individual, department or organization. They indicate one’s “business health” vis-a-vis competitors. CFSS are often intangibles such as the following; a. Customer satisfaction d. Premium service b. Product/service quality e. Speed of service c. Product/service reliability f. Product presentation 1Aprovides a structured, three step quantification technique to convert intangible benefits into measurable dollars. Once the benefits are identified, step one is to make them measurable through their ability to; a. Maintain sales d. Save money b. Sell more e. Create new business c. Charge a higher price Step two is to then convert the measurable into actual numbers by predicting, in physical terms, the resulting numbers. This is the largest, most important and most difficult of the quantification steps. There are essentially three ways in which the measurable can be converted into actual numbers; 1. Market surveys - generally the best approach 2. Management estimates -by senior managers of operations supported by the AM/FM/GIS project 3. Comparative case studies - a similar but not identical situation, a sign of weakness Clearly either of the first two are preferable. The market survey is best because it is the market that ultimately determines the actual numbers. The third and final step is to evaluate the entire project in cash flow terms. This is a simple monetary process in which the physical volumes from the previous step are related to the monetary value of the benefit. As an example of how investment analysis can be helpful in valuing your AM/FM/GIS investment, consider the following simple situation. Starting with the traditional CBA a project enhancement plan was evaluated to have a cost of 1.2 M$ and a non-discounted benefit over a three year life of 1.8 M$. This could be thought of as a simple 50% benefit of investment. However when the project was valued using 1Atechniques it was found that a 75 K$ increase in the cost (a 6.25% increase) to 1.275 M$ to include business geographies, increased the benefits, primarily from synergies, new customers and customized service offerings, to 2.193 M$ or a simple 72% benefit of investment. Hence, in this example a 6.25% increase in cost resulted in a 44% increase in the simple benefit of the investment. Describing 1Afor valuing your AM/FM/GIS investment is neither short nor simple. 1Ais a complex undertaking. Indeed there are those who can use the methodology with their own expert skills to produce actionable results in relatively short time frames. It is most important to state strongly and clearly that 1Ais a rigorous accounting methodology. More about investment analysis can be found in the book Measuring the Value of Information Technoiocw written by two Englishmen, John Hares and Duncan Royle and published in 1995 by John Wiley & Sons. Summary Investment Analysis is a proven methodology for measuring the financial value of an AM/FM/GIS investment. It is, if we have a good sense of where tomorrow’s profits will be earned, and when combined with a cost benefit analysis, the basis of better, more informed decision-making. References Batty, P. M., 1996: The Impact of New Technologies on AM/FM/GIS: Proceedings of AM/FM International Conference XIX Emery, H.A., 1995: The Emery Chronicles: Vol. 1, No. 3: Hares, J. and Royle, D., 1995: Measuring the Value of Information Technology, published by John Wiley& Sons | ||
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