Intended learning outcomes: Explain the Matrix for estimating the project benefit of an investment in a software system as well as the graphic representation in overlay of nine profitability calculations, for cumulative benefits with degrees of realization 1 to 9.
Continuation from previous subsection (19.2.5)
Project benefit is the financial return that arises through the realization of the project.
As with project costs, the difficulty of determining project benefit can vary. A fundamental difficulty here is the following problem: many aspects of benefit — particularly in the target areas of quality and delivery — are not expressed primarily in monetary terms and therefore have to be converted in the end to financial quantities, that is, returns. This is also the case with introduction of a new software system.
The following description is taken from [IBM75a]. It can be applied easily to other types of projects. Here, three types of benefit are distinguished:
- Direct benefit through savings: Example: Reduction of administrative personnel by one job, reduction of the expensive maintenance costs of previous machines requiring higher maintenance.
- Direct benefit through additionally achieved profit contributions: For example, higher business volume through the processing of additional contracts with customers via EDI (Electronic Data Exchange) or via the World Wide Web, improved payment practices by customers through the charging of 0.5% interest on the invoiced amount for late payment.
- Indirect benefit: For example: Reduction of physical inventory by 3% through more exact, complete, and detailed information, 2% increase in utilization achieved in the same way, faster lead times in the flow of goods.
Figure 19.2.5.1 shows these three types of benefits in a matrix, in comparison with high, medium, or low probability of realization.
Fig. 19.2.5.1 Matrix for estimating the benefit of an investment in a software system.
The idea is to enter all expected benefits into the cells of the matrix, together with the year in which the respective benefit will occur (that is, the year of its realization), calculated from the time of introducing the software system. Sometimes, two or more cells must be used.
- For example, it is estimated that a 1% reduction in physical inventory will occur starting in year 2 with high probability, 1% starting in year 3 with medium probability, and 1% starting in year 4 with low probability. In this case, the value and the year are entered into cells 6, 8, and 9.
This technique takes the observation into account that benefits — in greater variation than costs — can be estimated pessimistically, realistically, or optimistically. The numbers from 1 to 9 indicate the sequence in which the expected benefits will be included in the calculation of the cumulative benefit.
Cumulative benefit with degree of realization d, 1 <= d <= 9, is defined as the addition of the benefits in cells 1 to d.
The different degrees of realization allow estimation of risk in the form of a sensitivity analysis.
Project profitability is comparison of the costs and benefits of a project.
This calculation is also called capital budgeting.
Following [IBM75a], the cumulative benefits with degree of realization 1 to 9 are entered on the time axis, as shown in Figure 19.2.5.2. This results in nine different benefit curves. The cost curve is entered into the same graph. At time point 0, this is the initial investment; in the following years, this is initial investment plus running costs. The result obtained is the payback period, or, in other words, the breakeven point of the investment: (and this is what makes the technique intuitively simple) de facto for nine profitability calculations shown in overlay.
Fig. 19.2.5.2 Graphic representation in overlay of nine profitability calculations, for cumulative benefits with degrees of realization 1 to 9.
According to the example graph in Figure 19.2.5.2, for degree of realization 6, the payback period is approximately two years. For cumulative benefits with degree of realization 7, the payback period is approximately one and a half years.
Continuation in next subsection (19.2.5c).
Course section 19.2: Subsections and their intended learning outcomes
19.2 Project Management
Intended learning outcomes: Present goals and constraints of a project. Describe project phase, project life cycle, and work breakdown structure. Explain scheduling and effort planning as well as organization of a project. Differentiate between cost, benefits, profitability, and risk of a project.
19.2.1 Goals and Constraints of a Project
Intended learning outcomes: Produce an overview on project performance and project deliverables. Differentiate between external constraints and internal constraints in project management.
19.2.2 Project Phase, Project Life Cycle, Project Task, Work Package, Statement of Work
Intended learning outcomes: Produce an overview on the project phases in a generic project life cycle. Identify project task, work package, and statement of work.
19.2.2b The Work Breakdown Structure
Intended learning outcomes: Describe the increasing degree of detail of tasks and work packages in a work breakdown structure. Present an excerpt from a work breakdown structure for the preliminary study for a building conversion.
19.2.3 Project Scheduling and Project Effort Planning
Intended learning outcomes: Present in detail the schematic display of project effort per organizational unit. Explain an excerpt of the Gantt chart for the project “preliminary study for building conversion”.
19.2.4 Project Organization
Intended learning outcomes: Differentiate between project coordination in a functional, or line, organization and project management in a project-based organization. Describe project management in a strong matrix organization.
19.2.5 Project Cost
Intended learning outcomes: Produce an overview on the total cost of ownership of a project.
19.2.5b Project Benefits and Project Profitability
Intended learning outcomes: Explain the Matrix for estimating the project benefit of an investment in a software system as well as the graphic representation in overlay of nine profitability calculations, for cumulative benefits with degrees of realization 1 to 9.
19.2.5c Discounting Using the Net Present Value Technique (NPV), and Project Risk
Intended learning outcomes: Identify NPV, the net present value technique. Present the issue of project risk management.
