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Topics: Benefits Realization, Business Analysis, PMO
Cost Avoidance included in Cost Benefit Analysis
Hi, I'm working on a business case for a new project and I have a question on cost benefit analysis.

I've been told that while we will need to highlight the cost avoidance as a benefit, it should not be included in the calculation of the net benefit or ROI. For example, our net benefit = Total Cost Savings (tangible benefit) - Total estimated project cost

Reason I was told is that cost avoidance is not tangible and only a future benefit.

I'm hoping that the folks in this community be able to advise if this is true.

Thank you!
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Sebastian -

A lot depends on the nature of the cost avoidance. If this is a "sure thing", then I'd include it in the CBA. For example, if we are paying $100K a year for support of an obsolete system, then by replacing that system, we are saving that $100K which was a guarantee for as long as we needed to use that system.

However, if it is a "soft" cost avoidance which has a lot of uncertainty associated with whether and how much avoidance is possible, I wouldn't include it.

Kiron
I completely agree with Kiron that it depends on the nature of the opportunity to avoid cost.

Example A: The baseline cost for a project is X. A change is proposed that would reduce the baseline cost by changing vendors avoiding their known higher fee structure. In that case you are reducing the known cost structure by a known amount and once the change is accepted, the business case can now reflect the new lower cost. In this example you had already booked the higher cost in your business case, so you are reducing the cost baseline and so it will be reflected in the profit calculations.

Example B: The current plan has a significant risk. It is not certain that risk will be realized, but it can be avoided by a change in plan. Since you don't book risks as known costs (they aren't certain), by avoiding the risk it does not change the total cost. It merely increases your confidence that your actual cost will be close to the predicted cost.
Thank you Kiron and Keith! Your responses are much appreciated.

Can I enhance my understanding further with the following scenarios:

Scenario A: With the project being implemented, I expect that annual maintenance ($X/year) can now be reduced to once every 2 years. I take that this is considered cost savings and should be captured in CBA?

Scenario B: Completely different from above, another project is being implemented where we are putting in place a regular maintenance process and schedule. This results in cost avoidance of painful breakdowns and repairs, estimated at $500,000 (which is not a sure thing). I take that we don't capture this in CBA but more as an intangible benefit?

Scenario C: With a 3rd project being implemented, I expect that there will be increased ownership by line managers in employee learning, due to better experience and improved workflows. This should result in reduction of learning investment wastage. Today, as-is, the company spends $100,000 in external instructor led classes. $10,000 is 'wasted' because of last min drop outs/cancellations. With this project, we believe that the wastage can be reduced to $5K (i.e., reduction of $5K wastage) in the To-be stage.
Is the $5K cost avoidance that should be computed in CBA? 

Thanks again, and I appreciate the community's support in helping me understanding these cost components better.

Stay safe!
Sebastian,

I would argue that any expected benefit lies in the future and has a probability attached to it.
Realized benefits like a signed contract change for lower cost are certain, but they still have to deliver their value over time (accumulated cost saving per year).
ROI always is an estimate.

If the probability is unclear, a 3 point estimate may help to establish an expected monetary value including the confidence interval.

Also, what are tangible benefits for you? For me, any cost benefit is measurable and tangible.

There might be other reasons to keep data out of ROI, it often is political.
What you stated as benefit is defined as enterprise level. In my case cost avoidance is a benefit always, but as I mentioned is the way the organization consider it.
Sebastian,
The new scenarios you described are a bit more complicated and why I find the topic interesting. Whether or not you can include these avoidance measures may depend on your internal accounting rules. Sometimes they may decided to book the savings, and sometimes they won't because they've seen them not materialize as predicted.

The first two are quite common, and typical Six Sigma scenarios. If you reduce the frequency of *scheduled* maintenance, you can book the savings because the maintenance is already a planned expense. The risk is that you may also increase errors and accrue cost elsewhere, like in unplanned rework.

If you believe that regular maintenance will decrease unplanned work due to breakdowns, you may not be able to book that cost because the breakdowns were never known budgeted expenses to begin with. They fall into contingency funds. Finance people may want to validate the savings actually occurs such as after a year of data collection first. That is a reason why those sorts of projects often don't happen, because it is difficult to book the savings and as they say "That which gets measured gets done." and you can't measure it until well after you paid for it.

Waste avoidance like scenario C is a very difficult one to get Finance to give you credit, because you don't have data to show that you really will reduce the wasted overhead. I also see these where an improvement will reduce the labor time by 15 minutes for example, on a job that is typically a full 8 hour shift. The workers will still book a full 8 hours regardless, they'll just spend the time doing something else. Same with wasted training. Are they going to spend that time working billable hours instead, or will they just spend more time doing other overhead?

These kinds of scenarios can be frustrating, because you can't take credit for what you believe is a real benefit due to the accounting rules. On the other hand, they challenge the PM more to get management to pay for the investment with the belief they will see payback later, even if they can't take credit for it now.
Thank you everyone for your advice and insights. much much appreciated.

My key takeaways is that it depends on situation and the cost avoidance types. Good practice to always consult with company's finance on this.

Stay safe and take care!
cost avoidance if it is truly doing that, is tangible. It will show up in the bottom line and should be calculated in ROI.

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