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Appendix 2: Constructing a Business Case for Project Investments

The construction of a business case is part of the investment management process of PRG outlined in Chapter 4. Its key purpose is to develop an argument that convinces senior management to go ahead with the project investment. The case is expressed in business terms rather than technical terms to provide executive management with a clear indication of the attractiveness of the proposition. The business case is constructed, usually by the project sponsor, and presented for consideration to the steering committee for acceptance or rejection into the project portfolio.

It is worth reflecting on the definition of the nature of a business case provided by Remenyi and Remenyi (2009:10).

A business case is a justification for pursuing a course of action in an organisational context to meet the stated organisational objectives or goals. A business case frequently involves assessing the value of an investment in terms of its potential benefits and the resources required to set it up and to sustain it, i.e. its on-going costs. One of the major difficulties in producing a business case is the fact that benefits of an investment are often a function of the values of the organisation and the executives who are making the investment decisions. Thus a business case will inevitably have a significant degree of subjectivity associated with it.

Approach to Developing a Business Case

The business case should address the following topics.

PROJECT OBJECTIVES

When developing the business case, four key questions should be answered (ITGI 2006 - they are referred to as the four 'Ares'):

• Are we doing the right things? (the strategic questions).

• Are we doing them the right way? (the architecture questions).

• Are we getting them done well? (the delivery questions).

• Are we getting the benefits? (the value questions).

The strategic question is most important because it provides the answer to 'why' the project should be undertaken. It should demonstrate that the project will contribute to the strategic objectives of the organisation. The architecture question develops and evaluates options for satisfying the strategic objectives by addressing 'what' are the alternatives and 'which' one is the best. 'How' the project is executed supports the delivery question. The value question confirms that benefits are being obtained by completing a financial and/or non-financial analysis of estimated costs and benefits.

PROJECT COSTS AND BENEFITS

A key part of creating a business case is identifying potential benefits and identifying the costs required to generate those benefits. Not only do they have to be identified but also quantified, preferably in financial terms or otherwise in some other numeric form. They are only estimates because they are expectations of future events. For this reason, best-case/worst-case scenarios are developed to indicate the range of possibilities and probabilities. Data needs to be collected empirically from internal and/or external sources and validated through plausibility checks. Estimates are developed and 'owned' by the project sponsor and his/her team.

Project costs are generally easier to estimate than benefits. They are categorised as one-time or initial costs to cover expenses that are incurred at the start of the project. This could be the acquisition of equipment, such as computers, and setting up accommodation for the project team. From then on, ongoing expenditures are incurred such as the maintenance of computing systems, rent payments for accommodation, materials used and, of course, team members' remuneration. Project costs are also incurred to respond to identified project risks.

It is generally accepted that benefits flowing from an investment in projects are becoming harder to quantify in financial terms. The following examples illustrate this conundrum. Easily quantifiable project benefits can be readily expressed in monetary figures, such as staff savings following the introduction of a computerised system. Benefits that are not easily expressed in this way can, nevertheless, be operationalised in some number. For example, improved customer satisfaction can be measured on a rating scale, before the start and after the completion of the project. An improvement in the satisfaction rating would indicate a positive outcome for the project. Unquantifiable benefits are those that are regarded as intangible, such as the improvement in staff attitudes. They can be observed but are difficult to measure.

EVALUATION APPROACH

The expected costs and benefits are subjected to either a financial or non- financial analysis, or a combination. With financial analysis, the preference is for techniques that have been used over many years and are familiar to senior management. They are applied as a 'hurdle rate' to indicate the minimum outcome deemed necessary for the project to be considered for approval.

Return on Investment (ROI). This is the annual benefit flowing from the investment divided by the total investment amount. It measures a simple rate of return expressed as a percentage. As such it is widely understood and used in business, particularly for new projects since the estimated ROI for competing project proposals can be compared and used to direct resources to those with the highest potential returns.

Discounted Cash Flow (DCF). The cash flows from the investment and their timings over the project life are 'discounted' back to the start of the project using a risk-based discount rate. The rate indicates the level of uncertainty attached to outcomes that will materialise sometime in the future. In other words, future project returns are valued lower than returns that can be earned immediately.

Net Present Value (NPV). Using the DCF estimates, a comparison is made between the discounted cash inflows and outflows, their net present values. A positive NPV means that inflows exceed outflows.

Internal Rate of Return (IRR). This is the rate of return which causes the NPV to be zero. It is also referred to as the discounted cash flow return because it is the discount rate at which the net present value of costs (negative cash flows) of the investment equals the net present value of the benefits (positive cash flows) of the investment. From a financial perspective the organisation should undertake all projects with IRRs that exceed its cost of capital.

Payback Period (PP). This divides the total investment by average annual net benefit to establish how long it takes to recoup the investment. It is widely used as a hurdle rate, i.e. a proposal will not be considered unless it falls below the nominated payback period. It is regarded particularly useful for a small project to demonstrate its obvious value, i.e. a very short payoff is equivalent to a high ROI.

The inclusion of a non-financial approach in the business case serves two purposes. It supports or even replaces the financial approach and provides additional information to the decision-making. As such it can support the financial analyses by 'strengthening' the numbers that have been calculated by providing positive supplementary information. The decision-maker will gain a better understanding of the overall strength of the proposed project because of the information that is provided.

There are essentially three types of non-financial approach to project appraisal: multi-criteria, strategic and portfolio (Harris et al. 2008). As the name applies, the multi-criteria approach combines various scores to provide multiple dimensions of project value. There are numerous dimensions that could be considered; Moutinho and Mouta (2011) claim that they could number as high as 400 for project evaluations. They arise from a wide range of sources including technical (e.g. to support innovation), commercial (e.g. to seize opportunities), political (e.g. to support environmental policies) and social (e.g. to improve the quality of life). They reflect the diversity of behavioural and organisational factors.

The strategic approach evaluates the project in the context of business goals. An example is the Balanced Scorecard (BSC) method. It measures the strategic values in four layers: financial, customer, business process and learning. Each layer has specific organisation-wide strategic objectives with defined metrics. The business case indicates how the strategic objectives will be met by meeting the expectations set out in the metrics.

Under the portfolio management approach, project investments are valued according to their contribution to a set of projects. This is akin to project programme management in which projects within the programme are related through sharing a common objective, client and/or resources, as well as through their interdependencies. The project programme achieves objectives or benefits that a single project alone cannot.

PROJECT RISK

Project risks play a critical role in the project achieving its objective, and their impact has to be dearly identified and included in the business case. They are identified, analysed and linked with response strategies and methods. Responses depend on the nature of the project risk, viz. being negative or positive. A range of response strategies (e.g. mitigate the impact of a negative risk) and associated response methods (e.g. mitigate the risks by imposing a control) have to be evaluated and costed. The cost of the risk response is included in the project evaluation approach that seeks to balance project costs with benefits.

Three types of risk should be identified in the business case: strategic, delivery and financial/non-financial. Strategic risks are linked to the likelihood of achieving project objectives. An example is managing project risk for organisational value-protecting and/or value-creating. Organisations are more familiar with the former since protecting assets through risk avoidance or reduction has been the traditional focus of risk management. With risk management taking on a proactive dimension, value-creating strategies are developed but there is less experience in their implementation.

Delivery risk is also referred to as risk associated with failure of execution and can be attributed to the novelty of the project and its size. The less familiarity there is among the project team with the nature of the project, and the larger its scope and the longer its duration, the greater is the risk of completing the project late or not at all. Some refer to the use of unproven technology by the project not as operating at the 'leading edge' but at the 'bleeding edge' in this respect.

Financial and non-financial risks are related to the accuracy with which project costs and benefits have been estimated. Tangible costs and benefits are generally easier to identify and quantify financially than intangible ones. However, they are still predictions and depend on underlying assumptions and sources of information. Variations can be established between best- and worst-case estimates, but even they depend on the quality of the data used and the ability of the estimator to include all costs and benefits. It is for this reason that estimates are not made by the project team but by the project sponsor and his/her team.

CHANGE IMPACT

The impact of the project on the organisation and/or its environment should be considered and included in the case analysis. For some project situations it may be possible to quantify the cost/benefit of the change impact, while for others a descriptive narrative becomes part of the business case. An example is the impact of the project on stakeholders and internal processes. Should the change be significant, a change management approach may be required and associated change management costs estimated and included in project costing.

RECOMMENDATIONS AND ACTION PLAN

One of the business case objectives is to address the 'architecture' question by developing and evaluating options about 'what' are the alternatives and 'which' one is the best. Each project has alternatives, even it is the most obvious one of 'doing nothing'. They provide the decision-makers with choices since they are not obliged to accept the one that is recommended in the business case report.

Each alternative is evaluated according to the same approach as outlined above. This provides a consistent framework for determining the merit of each option and for reaching a conclusion on an outcome that can be recommended to the decision-maker. While the core of the approach remains the same across all projects, variations may be introduced to take into consideration the uniqueness of individual projects and their contexts. The recommended (preferred) option is derived from the business case analysis. There needs to be a dear link between the two to justify the choice made. In other words, the recommendations flow logically from the completed analysis.

The recommendation is supported by an action plan. This addresses the decision-maker's question of 'what happens next?' Should the recommendation be accepted, a roadmap is provided on how to implement it. This would be straightforward if the recommendation were accepted as a whole, but becomes a matter of further discussion should only parts of the recommendation be accepted. Usually there is not a single recommendation but a number of primary ones supported by secondary ones to reflect the complexity of the business case outcomes.

OTHER COMPONENTS

Further material is provided in appendices. Among the more important ones are the assumptions underpinning the rationale of the business case. They include acknowledgment of the necessary conditions over which organisation has little or no control: risk events/conditions and constraints regarding costs and benefits. Detailed working sheets show how risks, costs and benefits were determined.

 
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