Payback period

I needed to find some information on Payback period which is required for the business case my client is currently developing. Here is what I found from Wikipedia.

Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment. For example, a $1000 investment which returned $500 per year would have a two year payback period. It is intuitively the measure that describes how long something takes to "pay for itself"; shorter payback periods are obviously preferable to longer payback periods (all else being equal). Payback period is widely used due to its ease of use despite recognized limitations, described below.

The expression is also widely used in other types of investment areas, often with respect to energy efficiency technologies, maintenance, upgrades, or other changes. For example, a compact fluorescent light bulb may be described of having a payback period of a certain number of years or operating hours (assuming certain costs); here, the return to the investment consists of reduced operating costs.

Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor. When used carefully or to compare similar investments, it can be quite useful. As a stand-alone tool to compare an investment with "doing nothing", payback period has no explicit criteria for decision-making (except, perhaps, that the payback period should be less than infinity).

The payback period is considered a method of analysis with serious limitations and qualifications for its use, because it does not properly account for the time value of money, inflation, risk, financing or other important considerations. Alternative measures of "return" preferred by economists are internal rate of return and net present value. An implicit assumption in the use of payback period is that returns to the investment continue after the payback period. Payback period does not specify any required comparison to other investments or even to not making an investment.

Basic formulae
Payback period = Investment / Cash flow Used if cash flows are the same for the duration of a project
Payback period = (Last year with a negative cash flow) + (absolute value of net benefits / total cash flow next year)

The one issue I have with payback is that projects or programs that take a while to payback (but have big benefits) down the line, may be missed if payback is one of the key selection criteria. Ah well, trying to explain that to my client.

IT value

Here are some key points from a good article in CIO Magazine about demonstrating IT value to the business.

There are three components to the concept of value from a business perspective
1. Understanding exactly what IT delivers,
2. Believing that the cost is fair
3. Evaluating the contribution of those deliverables to the bottom line.

In many cases, clients' poor perception of IT value is as basic as not understanding the full bundle of products and services that IT delivers.Sure, everybody knows that IT delivers essential services like desktop computers, network services, applications engineering and applications hosting. But that sounds simple. Many clients don't understand why IT has to cost so much just for that. The problem is, many IT departments don't clearly define the specific products and services they deliver for a given level of funding. Typically, there's a lot more in that bundle than clients know. When the specifics are defined, clients come to understand why IT needs the budget that it does.

Does IT contribute to business value? To optimize its contribution to the bottom line, IT must install processes that ensure two things: that the enterprise is spending the right amount on IT, and that the IT budget is spent on the right things.

What can IT do? There are two things.

First, IT can ensure that clients are in control of what they buy and are accountable for spending the IT budget wisely. This means implementing a client-driven portfolio-management process. Note that portfolio management is far more than rank ordering projects on an unrealistically long wish list. Clients must understand how much is in their "checkbook" (a subset of the IT budget), and what IT's products and services cost, in order to know where to draw the line. That is, they must work within the finite checkbook created by the IT budget as well as understand the deliverables that they will (and won't) get. Thus, true portfolio management is predicated on the above steps of defining IT's catalog, costing it, and presenting a budget in terms of the cost of its deliverables. Once all that is done, an effective portfolio-management process can be implemented.

Second, even if clients know the costs of their purchases and are working within the limits of their checkbook, they'll make better purchase decisions if they understand the returns on technology investments. IT can help clients estimate ROI of their proposed purchases. The cost side of the ROI equation was handled by calculating a budget by deliverables and rates. The remaining challenge is to quantify the benefits. Cost-displacement benefits (which include both cost savings and cost avoidance) are easy to measure. The real challenge is measuring the so-called "intangible" strategic benefits

In summary, the question of IT value is fully addressed when:

- IT has defined its product and service catalog in detail, associated all its costs with its products and services, and calculated rates that can be compared with the market.
- Clients understand exactly what they're getting for the money spent on IT, and indeed can control it by deciding what they will and won't buy from IT.
- IT can help clients assess the value of their IT purchases by measuring the benefits.


The full article can be found at : http://cio.com/article/161150

CIO Blog

Discovered a good blog written by a real CIO. He had a few topics about governance, which are a good read and related to the topic of this blog.

http://geekdoctor.blogspot.com/2007/12/it-governance.html

Benefits Realization Case Study and Outcome Management

While doing some research on-line I recently read a presentation about the Benefits Realization experience of the Government of Canada. Here are some interesting concepts raised in the presentation that are applicable to any organization - public or private.

Benefit Realization Principles:
        1. Benefits realization is the pre-planning for, and ongoing management of benefits promised to be enabled by the successful implementation of change projects.
        2. Sound project management can only enable a business owner (program) to realize intended benefits
        3. Accountability for the realization of intended benefits must rest with the business function, not with the IT project  [This is very true and I would make it my first principle]

 Outcome Management is a set of methods, processes, tools and techniques for planning, selecting, managing and realizing results and benefits:
        1, An outcome (benefit) is the desired result of an initiative undertaken to meet a need or solve a problem (e.g. to reduce gun related crime by 25% within 5 years by implementing a national gun registry system)
        2. Outcomes are final results supported by intermediate outcomes (benefits milestones).
        3. Cost benefit analysis is a subset of Outcome Management
        4. Focuses on realizing benefits not just providing the deliverables. Facilitates on-going and ex post evaluation of "hard" and "soft" benefits

I think the whole presentation is worth reading and can be found at : http://www.tbs-sct.gc.ca/emf-cag/outcome-resultat/benefits-avantages/benefits-avantages_e.ppt

Key Requirements for a Portfolio Management System

Following on from my previous post, here are the best practice capabilities to look at for a portfolio management system:

1. Managing demand. Requests for projects are generated by multiple sources in an
organization. All projects, regardless of their size, represent work efforts in the organization
that have to be evaluated and, if appropriate, planned and executed. The
portfolio management system acts as the repository of all project requests and
allows for the standardization of requests for more objective evaluation of projects
based on uniform criteria.

2. Project topologies. Within an organization, requests will be generated for different
types of projects that vary in size, cost, and deliverables. The portfolio management
system permits grouping of projects into multiple portfolios for comparison on an
equivalent basis for similar project types.

3. Stakeholder involvement. The importance of portfolio management systems has
increased with the focus on corporate governance. Organization wide decisions with
significant impact now require greater oversight. Portfolio management systems
now have workflow capabilities out-of-the-box. All stakeholders from the project
requestor to the financial managers, project managers, and finally senior leadership
can be involved in the creation of a project request, its completion, and signoff by
different participants.

4. Strategic alignment. The ability to bridge strategic objectives to projects that will
support their achievement continues to be an important capability of portfolio
management systems. With the development of more sophisticated strategic planning
models, portfolio systems have maintained the ability to define the impact of
projects on the organizational strategy.

5. Prioritization and optimization. Together with strategic alignment, prioritization
continues to be one of the main objectives of using a portfolio management system.
Although Excel is a viable alternative for ranking projects, portfolio management
systems now have more sophisticated modeling capabilities for multiple prioritization
perspectives and optimization based on different types of constraints.

6. Budgeting and cost tracking. The planning of budgets at a summary level has
always been a project attribute taken into consideration in portfolio selection and
prioritization. A portfolio management system provides the capability to disaggregate
costs by cost types and cost centers. In addition, the tracking of project cost

7. Executive dashboards. Reporting of status at the portfolio and individual project
level is a requirement for the portfolio manager and the senior leadership involved
in the governance process. Because the portfolio management system acts as the
central repository of all portfolio information, executive dashboards with summary
performance metrics can be produced directly from the portfolio management
system.

8.Integration To enable both inputs and outputs from the portfolio system to other
line-of-business systems, integration becomes a key component for leveraging
project- and portfolio-level data. Status updates of selected projects in their respective
portfolios might come from disparate systems making the need for system interfaces
even greater. Therefore, an application programming interface becomes a
critical component of any portfolio system.

Any others you can think of?

Project vs Portfolio Management

One of the first things I am doing at my new client is to get involved in the selection of a Portfolio management tool/system. The first thing to do is to differentiate between Project Management (which the client does plenty of) vs Portfolio management. This will form a key factor in differentiating the two areas and explaining the difference to senior management.

Here is a good definition provided the Project Management Institute :  " Portfolio management is the centralized management of one or more portfolios in order to achieve specific strategic business objectives. As a process, portfolio management enables organizations to identify, categorize, evaluate, select, prioritize, authorize, terminate, and review various portfolio components to ensure their alignment with current and future business strategy and goals, which in turn helps organization optimize limited resources.

As it is frequently stated, portfolio management deals with "doing the right project(s)" while project management deals with "doing the project right."

The last line is the one that sums it all up. Here is a more detailed description of the difference between Project and Portfolio management systems:

Project management and portfolio management systems have gone through significant growth and evolution in the past 10 years as technology has allowed portfolio and project
systems to merge while exhibiting capabilities that address each discipline respectively.There are, however, key differences between project and portfolio management capabilities.
Although both summarize project-level attributes, a project management system tracks individual project performance against the original project plan. The emphasis is on single project controls and resource task assignments. Updates to the project plan are reflected in the project management system. The availability of resources for project work is known to all project managers through an enterprise resource pool. From a process perspective, a project management system will enable any standard project management methodology such as the initiate-plan-execute-control/monitor-close life cycle from the Project Management Institute.

The summary of all project work in the organization is available for review; however, planned projects in the project management system are assumed to have gone through a selection and prioritization process by the senior leadership team. As a result, the capabilities of a project management system generally do not include the assessment of project opportunities, strategic alignment, and scoring and ranking according to defined prioritization criteria.  

The portfolio management system enables the creation of project opportunities, each associated with one or many portfolios in the organization. The project request will follow phases and activities in which different stakeholders provide input on the project request. All requested projects are analyzed against each new and existing project, based on defined criteria to determine whether a project (or sets of projects in the case of a program) is worth executing. Selection, prioritization (or ranking), and optimization of projects and resources are critical components of the portfolio management process. The portfolio management system provides the analytical toolset to achieve this. Once projects are reviewed and approved (or rejected) by the senior leadership, the rest of the organization is then informed, and the assigned project manager continues with the project life cycle. During the project life cycle, the portfolio level data will be synchronized with project information to ensure the accuracy of project- and portfolio-level information.

Now to find the right tools. We will be issuing a RFP to a number of vendors. While I cannot let you know which one we select (due to client confidentiality), I will let you know the vendors we looked at and what were the key selection criteria used.

Happy Newyear

Back from holidays so sorry for falling behind on my posts. Topics I want to look at early this year:

- Portfolio planning vs Portfolio governance
- Benefits metrics that are meaningful
- Business cases for Agile development projects

Let me know if you have any ideas on the above.

Sponsored Link:

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