Document Group 6

Measurement Methods and Analysis Facilities Planning

Group 6 : • (Kusumantoro,Heribertus Rudi-Nr.2217457) • (Saragih,Frando R- Nr.2206655) • (Putra, Adhi Tharsia Nr.2217858) • (Susilo,Martin – Nr. 2221237) • (Gunawan,Marantika Nr.2221228)

University Duisburg – Essen 2006

Chapter I Cost Benefit Analysis 1.1. Definition and Purpose It is a technique that can be used to evaluate government projects and programs. It encompasses an appraisal of a policy based on the costs and benefits of the project A CBA should be performed for each investment alternative to enable the evaluation and comparison of alternatives. However, some mandatory systems will not provide net benefits to the government. In such cases, the lowest cost alternative should be selected. If functions are to be added to a mandatory system, though, the additional functions should provide benefits to the government. 1.2. Measurement in the Cost Benefit Analysis (Blanchard, Benjamin S, Logistic Engineering and Management, Pearson Education International, 2004) Three measures are used in the cost benefit analysis to indicate the outcome of each project in an economic sense: 1. Net Present Value The net present value of a project is the sum of the present value of each cost and other effects of a project. A positive NPV indicates that benefits outweigh the costs of a project. Generally speaking, a project with a positive NPV should be implemented and if two options are being compared, the option with the highest NPV should be selected. 2. Benefit Cost Ratio The BCR is the ratio obtained by dividing of the sum of the present value of the benefits by the sum of the present value of the costs. A BCR greater than 1 indicates that the benefits outweigh the cost of a project. 3. Net Present Value per unit of Investment The NPVI is the net present value divided by the present value of a project’s capital cost. This ratio provides an indication of the effectiveness of a given level of investment.

1.3. PROCESS The CBA process can be broken down into the following steps: 1. Determine/Define Objectives The CBA should include a problem definition; pertinent background information such as staffing, system history, and customer satisfaction data; and a list of investment objectives that identify how the system will improve the work process and support the mission. 2. Document Current Process The current process should be thoroughly documented and address these areas: •

•

Customer Service —Each customer’s role and services required should be clearly documented and quantified, if possible (e.g., in an average month, a customer inputs two megabytes (MB) of data and spends 10 hours on database maintenance). System Capabilities—Resources required for peak demand should be listed. For example, 100 MBs of disk storage space and Help Desk personnel to support 50 users. • System Architecture —The hardware, software, and physical facilities required should be documented, including information necessary for determining system costs, expected future utility of items, and the item owner/lessor (i.e., government or contractor).

Table 1. Cost Elements for Systems Cost Category Equipment, Leased or Purchased

Cost Elements

Supercomputers, mainframes, minicomputers, microcomputers, disk drives, tape drives, printers, telecommunications, voice and data networks, terminals, modems, data encryption devices, and facsimile equipment. Software, Operating systems, utility programs, diagnostic programs, application Leased or Purchased programs, and commercial-off-the-shelf (COTS) software. Commercial Services Commercially-provided services, such as teleprocessing, local batch processing, on-line processing, Internet access, electronic mail, voice mail, centrex, cellular telephone, facsimile, and packet switching. Support services Commercially-provided services to support equipment, software, or (Contractor services, such as maintenance, source data entry, training, planning, Personnel) studies, facilities management, software development, system analysis and design, computer performance evaluation, and capacity management. Supplies Any consumable item designed specifically for use with equipment, software, services, or support services identified above.

Cost Category

Cost Elements

Personnel (compensation benefits)

Includes the salary (compensation) and benefits for government and personnel who perform IT functions 51percent or more of their time. Functions include but are not limited to program management, policy, IT management, systems development, operations, telecommunications, computer security, contracting, and secretarial support. Personnel who simply use IT assets incidental to the performance of their primary functions are not included. Intra-governmental All IT services within agencies, and between executive branch services agencies, judicial and legislative branches, and State and local governments. (www.ocio.usda.gov/cpic/doc/ Appendix_E_COST_BENEFIT_ANALYSIS.doc)

3. Estimate Future Requirements Two items to consider are: •

Lifecycle Time—Determine the system lifecycle, or when the system is terminated and replaced by a system with significant changes in processing, operational capabilities, resource requirements, or system outputs. Large, complex systems should have a lifecycle of at least five years, and no more than ten to 12 years. • Lifecycle Demands—Identify the most appropriate demand measures and use the measures to determine previous year’ demands, calculate the change in demand from year to year, average the demand change, and use the average to make predictions. In a complex situation, more sophisticated tools, such as time-series and regression analysis, may be needed to forecast the future.

4. Collect Cost Data Data can be collected, from the following sources, to estimate the costs of each investment alternative: •

• •

•

Historical Organization Data—If contracts were used to provide system support in the past, they can provide the estimated future cost of leasing and purchasing hardware and hourly rates for contractor personnel. Contracts for other system support services can provide comparable cost data for the development and operation of a new system. Current System Costs—Current system costs can be used to price similar alternatives. Market Research—Quotes from multiple sources, such as vendors, Gartner Group, IDC Government, and government-wide agency contracts (GWACS), can provide an average, realistic price. Publications—Trade journals usually conduct annual surveys that provide general cost data for IT personnel. Government cost sources include the General Services

•

Administration (GSA) pricing schedule and the OMB Circular A-76, “Performance of Commercial Activities” supplemental listing of inflation and tax rates. Analyst Judgment—If data is not available to provide an adequate cost estimate, the CBA team members can use judgment and experience to estimate costs. To provide a check against the estimates, discuss estimated costs with other IT professionals. • Special Studies—Special studies can be conducted to collect cost data for large IT investments. For example, the Federal Aviation Administration (FAA) used three different in-house studies to provide costs for software conversion, internal operations, and potential benefits. These data sources became the foundation for a CBA.

5. Choose at Least Three Alternatives A CBA should present at least three viable alternatives. “Do nothing” or “Continue current operations” should not be considered as an alternative. Each viable technical approach should be included as an alternative. However, the number of technical approaches may be limited if only one or two are compatible with the architecture or if some approaches are not feasible for reasons other than costs and benefits. 6. Document CBA Assumptions It is important to document all assumptions and, if possible, justify them on the basis of prior experiences or actual data. This can be an opportunity to explain why some alternatives are not included. If an alternative is eliminated because it is not feasible, the assumption should be clearly explained and justified. 7. Estimate Costs Many factors should be considered during the process of estimating costs for alternatives. Full lifecycle costs for each competing alternative should be included, and the following factors should be addressed: • • •

•

Activities and Resources —Identify and estimate the costs associated with the initiation, design, development, operation, and maintenance of the IT system. Cost Categories—Identify costs in a way that relates to the budget and accounting processes. The cost categories should follow current USDA object class codes. Personnel Costs—Personnel costs are based on the guidance in OMB Circular A-76, “Supplemental Handbook, PART II—Preparing the Cost Comparison Estimates.” Government personnel costs include current salary by location and grade, fringe benefit factors, indirect or overhead costs, and General and Administrative costs. Depreciation—The cost of each tangible capital asset should be spread over the asset’s useful life (i.e., the number of years it will function as designed). OMB prefers that straight-line depreciation be used for capital assets. • Annual Costs—All cost elements should be identified and estimated for each year of the system lifecycle.

Work Process Evaluation

DefinitionRequirements

Security Plan

MeasuresPerformance

AnalysisCost-Benefit

Total

Hardware Software Services Support Services Supplies Personnel Inter-Agency Services Total

5,000

10,000 100 10,000

4,000 100 6,000

1,000 0 500

6,000 100 5,000

3,000 100 8,000

24,000 400 34,500

5,000

20,100

10,100

1,500

11,100

11,100

58,900

DefinitionProblem

Activties/Cost Categories

Table 2. Sample Cost Estimates for an Investment Initiation Activity

Table 3. Sample System Lifecycle Cost Estimates Year Startu p 1 100,00 0 2 3 4 5 6 7 8 9 10 Tota 100,00 l 0

Acquisitio n

Developmen t

Operatio n

Maintenanc Total e

100,000

200,000 800,000

50,000 50,000

200,000

800,000

200,000 200,000 200,000 200,000 200,000 200,000 200,000 200,000 1,600,000

80,000 60,000 50,000 50,000 40,000 30,000 30,000 30,000 370,000

800,000 280,000 260,000 300,000 300,000 240,000 230,000 230,000 230,000 3,070,00 0

8. Estimate Benefits The following six activities are completed to identify and estimate the value of benefits: 8.1. Define Benefits—Benefits are the services, capabilities, and qualities of each alternative, and can be viewed as the return from an investment. The following questions will help define benefits for IT systems and enable alternative comparisons: •

Accuracy—Will the system improve accuracy by reducing data entry errors?

•

Availability—How long will it take to develop and implement the system?

•

Compatibility—How compatible is the proposed alternative with existing procedures?

•

Efficiency—Will one alternative provide faster or more accurate processing?

•

Maintainability—Will one alternative have lower maintenance costs?

•

Modularity—Will one alternative have more modular software components?

•

Reliability—Does one alternative provide greater hardware or software reliability? •

Security—Does one alternative provide better security to prevent fraud, waste, or abuse?

8.2. Identify Benefits—Every proposed IT system should have identifiable benefits for both the organization and its customers. Organizational benefits could include flexibility,

organizational strategy, risk management and control, organizational changes, and staffing impacts. Customer benefits could include improvements to the current IT services and the addition of new services. Customers should help identify and determine how to measure and evaluate the benefits. 8.3. Establish Measurement Criteria—Establishing measurement criteria for benefits is crucial because the Government Performance and Results Act (GPRA) and the ClingerCohen Act (CCA) emphasize tangible measures of success (benefits) related to the organization’s overall mission and goals. 8.4. Classify Benefits—Benefits that are “capable of being appraised at an actual or approximate value” are called tangible benefits. Benefits that cannot be assigned a dollar value are called intangible benefits. 8.5. Estimate Tangible Benefits—The dollar value of benefits can be estimated by determining the fair market value of the benefits. An important economic principle used in estimating public benefits is the market value concept. Market value is the price that a private sector organization would pay to purchase a product or service Quantify Intangible Benefits—Intangible benefits can be quantified using a subjective, qualitative rating system. A qualitative rating system might evaluate potential benefits against the following: 9. Discount Costs and Benefits After costs and benefits for each system lifecycle year have been identified, convert them to a common measurement unit by discounting future dollar values and transforming future benefits and costs to their “present value.”

Table 4. Sample Weighted Benefits Score Benefi t

Alternative Alternative Weighting 1 Raw 2 Raw Factor Score Score

Alternative 1 Alternative Weighted Weighted Score Score

A

4

2

10

40

20

B

3

2

9

27

18

C

4

3

8

32

24

D

2

3

6

12

18

E

3

4

5

15

20

Total

16

14

126

100

2

Table 4—shows annual costs and benefits for a system lifecycle, along with the discount factor, the discounted costs and benefits (present values), and the discounted net present value [NPV]. The discounted costs and benefits are computed by multiplying costs and benefits by the discount factor. The net benefit without discounting is $380,000 ($3,200,000 minus $2,820,000) while the discounted NPV is less than $60,000 because the biggest costs are incurred in the first two years, while the benefits are not accrued until the third year. When evaluating costs and benefits, be cautious of returns that accrue late in the investment’s lifecycle. Due to discounting, benefits that accrue in later years do not offset costs as much as earlier-year benefits. Also, these later-year benefits are less certain. Both the business and IT environments may experience significant changes before these later-year benefits are realized.

Table 5. Sample Discounted Lifecycle Costs and Benefits Year

Annual Cost (AC)

1 2 3 4 5 6

150,000 600,000 280,000 260,000 300,000 300,000

Annual Benefit (AB)

Discount Factor (DF)

400,000 400,000 400,000 400,000

0.9667 0.9035 0.8444 0.7891 0.7375 0.6893

Discounted Discounted Cost (DC) Benefit ACxDF (DB) ABxDF 145,005 542,100 236,432 337,760 205,166 315,640 221,250 295,000 206,790 275,720

Discounted Net DB - DC (145,005) (542,100) 101,328 110,474 73,750 68,930

7 8 9 10 Total

240,000 230,000 230,000 230,000 2,820,00 0

400,000 400,000 400,000 400,000 3,200,000

0.6442 0.6020 0.5626 0.5258

154,608 138,460 129,398 120,934 2,100,143

257,680 240,800 225,040 210,320 2,157,960

103,072 102,340 95,642 89,386 57,817

10. Evaluate Alternatives Many benefits cannot be quantified in dollar terms. As a result, evaluating alternatives cannot always be done using present values, but valid evaluations can be made using a combination of dollar values and quantified relative values (values that are numeric, but do not represent dollar values). Evaluate All Dollar Values—Once all the costs and benefits for each competing alternative have been assigned dollar values and discounted, the NPV of the alternatives should be compared and ranked.

Table 6. Sample Investment Comparison (Lowest Cost System Provides Highest Benefit) Alternativ Discounte e d Cost (DC) 1 1,800,000 2 1,850,000 3 2,000,000 4 2,200,000

Discounted Benefit (DB) 2,200,000 1,750,000 2,000,000 2,100,000

Discounted Benefit-Cost Net (DB - Ratio DC) (DB/DC) 400,000 1.22 (-100,000) 0.95 0 1.00 (-100,000) 0.95

Discounted Net—There will probably be very few cases where the alternative with the lowest discounted cost provides the highest discounted benefit. The next number to consider is the Discounted Net (Discounted Benefit minus Discounted Cost). If one alternative clearly has the highest Discounted Net, it is considered the best alternative; however, it is usually advisable to look at other factors. Benefit-Cost Ratio—When the alternative with the highest discounted net is not a clear winner, the benefit-cost ratio or BCR (discounted benefit divided by discounted cost) may be used to differentiate between alternatives with very similar or equal Discounted Nets. In Table E-9— Alternative 4 would be the winner because it has a higher BCR than

Alternative 5. Alternatives 4 and 5 are clearly superior to other alternatives because they have the highest discounted net. Evaluate With Intangible Benefits—When all the benefits are intangible, evaluation will be based on quantifying relative benefits. 11. Perform Sensitivity Analysis Sensitivity analysis tests the sensitivity of input parameters and the reliability of the CBA result. Sensitivity analysis should assure reviewers the CBA provides a sound basis for decisions. The sensitivity analysis process requires the following: Identify Input Parameters—The assumptions documented earlier in the CBA are used to identify the model inputs to test for sensitivity. Good inputs to test are those that have significant (large) cost factors and a wide range of maximum and minimum estimated values. Some common parameters include: •

System requirement definition costs

•

System development costs

•

System operation costs

•

Transition costs, especially software conversion

•

System lifecycle •

Peak system demands.

Repeat the Cost Analysis—For each parameter identified, determine the minimum and maximum values. Then, choose either the minimum or maximum value as the new parameter value (the number selected should be the one that most differs from the value used in the original analysis). Repeat the CBA with the new parameter value and document the results. Prepare a table like Table E-10—to summarize the different outcomes and enable the results to be quickly evaluated. Table 7. Sample Sensitivity Analysis Parameter Development Cost ($) Transition Costs ($)

Parameter Value 1,500,000 2,000,000 2,500,000 100,000 200,000

Best Alternativ e A A B A A

System Lifecycle (Years) Benefits ($)

5 10 15 1,500,000 2,250,000 3,000,000

A B C A A B

Evaluate Results—Compare the original set of inputs and the resulting outcomes to the outcomes obtained by varying the input parameters. In the previous table, the original values are the first value listed for each parameter. Sensitivity is measured by how much change in a parameter is required to change the alternative selected in the original analysis. The sensitivity guidelines include the following: • •

A parameter is not considered sensitive if it requires a decrease of 50 percent or an increase of 100 percent to cause a change in the selected alternative. A parameter is considered sensitive if a change between 10 and 50 percent causes a change in the selected alternative. •

A parameter is considered very sensitive if a change of 10 percent or less causes a change in the selected alternative.

In the previous example, the analysis would appear to be somewhat sensitive to the development costs, but not sensitive to the transition costs and benefits. 12. Compare Investments Even if the CBA shows that benefits will outweigh costs, using Payback Period and Return on Investment (ROI) analysis help demonstrate an investment is a better utilization of funds than other proposed investments.

1.4. References • • • • • • • • • • • • • • • • •

Blanchard, Benjamin S, Logistic Engineering and Management, Pearson Education International, 2004 https://wwwagse.informatik.uni-kl.de/ teaching/seminar/ws2005/Vorbesprechung.pdf – www.ifi.unizh.ch/ikm/Vorlesungen/ IM3/WS0203/IM3_files/5projektmanagement.pdf – www.aib.ws.tum.de/lehre/ws0203/innotech/ Veranstaltung%204%2020012002%20Folien.pdf www.wm.tu-berlin.de/~mig/files/2003.teaching.ss/ GSF/2003-0625_Programmevaluationen30www.ira.uka.de/teaching/ coursedocuments/3/antsched-sosp.pdf www.ifu-kybernetik.de/downloads/ NOWS_Technique_Gothenburg_eng.pdf www.lhconsulting.com/fileadmin/downloads/company_information/Company_Se rvices.pdf www.hwwa.de/Projects/Res_Programmes/ RP/Klimapolitik/Papers%20Workshop/Panigrahi.pdf www2.sjsu.edu/faculty/watkins/cba.htm - 27k www.waisman.wisc.edu/cls/HS2002D.PDF www.win.tue.nl/~mchaudro/cbse2004/Reuse%20Economics.pdf www.itcinfotech.com/binaryfiles/ Portfolio%20Analysis.pdf https://webportal.saalt.army.mil/ asb/studies/2003-forceprotection-exec-brf.pdf www.ext.vt.edu/pubs/nutrition/490-403/490-403.html - 202k www.smdm.org/Repository.html - 18k www.ocio.usda.gov/cpic/doc/ Appendix_E_COST_BENEFIT_ANALYSIS.doc

Chapter 2 Cost Effectiveness Analysis (CEA) 2.1 Introduction Large employers face a challenging future in managing health care benefits. Managers have many program and coverage options, but are limited by budget constraints and data availability. Traditionally, decision-makers have used return on investment calculations to help guide their investment choices, but they can also consider another tool — costeffectiveness analysis. Cost-effectiveness analysis refers to the consideration of decision alternatives in which both their costs and consequences are taken into account in a systematic way. It is a decision oriented tool, in that it is designed to ascertain which means of attaining particular educational goals are most efficient. For example, there are many alternative approaches for pursuing such goals as raising reading or mathematics achievements. Developed in the military, CEA was first applied to health care in the mid-1960s and was introduced with enthusiasm to clinicians by Weinstein and Stason in 1977.

2.2 Basic of Cost Effectiveness Analysis Cost Effectiveness Analysis is a technique for comparing the relative value of various clinical strategies. In its most common form, a new strategy is compared with current practice (the "low-cost alternative") in the calculation of the cost-effectiveness ratio. Cost-effectiveness Analysis, or CEA, is a comparison tool to help evaluate choices. It will not always indicate a clear choice, but it will evaluate options quantitatively based on a defined model. For managers, CEA provides peer-reviewed evidence for decision support. Cost-effectiveness analysis is closely related to cost-benefit analysis in that both represent economic evaluations of alternative resource use and measure costs in the same way (see Cost Benefit Analysis). However, cost-benefit analysis is used to address only those types of alternatives where the outcomes can be measured in terms of their monetary values. For example, educational alternatives that are designed to raise productivity and- income, such as vocational education, have outcomes that can be assessed in monetary terms and can be evaluated according to cost-benefit analysis. However, most educational alternatives are dedicated to improving achievement or some other educational outcome that cannot be easily converted into monetary terms. In these cases, one must limit the comparison of alternatives to those that have similar goals by comparing them through cost-effectiveness analysis.

2.3 Measuring Cost Effectiveness The basic technique has been to derive results for educational effectiveness of each alternative by using standard evaluation procedures or studies (Rossi and Freeman 1985) and to combine such information with cost data that are derived from the ingredients approach. The ingredients approach was developed to provide a systematic way for evaluators to estimate the costs of social interventions (Levin 1983). It has been applied not only to cost-effectiveness problems, but also to determining the costs of different educational programs for state and local planning (Hartman 1981). 2.3.1 Assessing Effectiveness Before starting the cost analysis, it is necessary to know what the decision problem is, how to measure effectiveness, which alternatives are being considered and what their effects are. If a problem has risen on the policy agenda that requires a response, a careful understanding of the problem is crucial to addressing its solution Once the problem has been formulated, it will be necessary to consider how to assess the effectiveness of alternatives. For this purpose, clear dimensions and measures of effectiveness will be needed. Table I shows examples of effectiveness measures that respond to particular program objectives Program Objective Program Completions Reducing Dropouts Employment of graduates

Measure of Effectiveness Number of Students complete program Number of potential dropouts who graduate Number of graduates placed in appropriate jobs Test scores in appropriate domains utilizing appropriate test instruments

Student learning .

Table 8.

Given the problem and criteria for assessing the effectiveness of proposed solutions, it is necessary to formulate alternative programs or interventions, The search for such interventions should be as wide-ranging and creative as possible. This procedure sets the stage for the evaluation of effectiveness of the alternatives, a process which is akin to the standard use of evaluation methods (e.g., Rossi and Freeman 1985). Estimates of effectiveness can be derived from previous evaluations or from tailored evaluations for the present purpose. It is important to emphasize that the evaluation of effectiveness is separable from the evaluation of costs. Most standard evaluation designs for assessing the effectiveness of an intervention are also suitable for incorporation into cost-effectiveness studies. 2.3.2 Cost Estimation The costs of an intervention are defined as the value of the resources that are given up by

society to effect the intervention. These are referred to as the ingredients of the intervention, and it is the social value of those ingredients that constitute its overall cost. At a later stage the distribution of these costs among the decision-making agency and other entities can be assessed. Accordingly, the method sets out systematically to identify and ascertain the value of the ingredients that are required for each alternative that is under consideration. The ingredients approach to cost estimation entails three distinct phases: (a) identification of ingredients; (b) determination of the value or cost of the ingredients and the overall costs of an intervention; and (c) an analysis of the costs in an appropriate decision-oriented framework. The first step is to ascertain which ingredients are required for an intervention . Most educational interventions are labor-intensive, so an initial concern is to account for the number and characteristics of personnel. It is important to stipulate whether personnel are part-time or full-time and the types of skills or qualifications that they need. Beyond this it is necessary to identify the facilities, equipment, materials, and other ingredients or resources which are required for the intervention. Identification of ingredients requires a level of detail that is adequate to ensure that all resources are included and are described adequately to place cost values on them. For this reason, the search for ingredients must be systematic rather than casual. The primary sources for such data are written reports, observations, and interviews. Written reports, usually contain at least a brief history and description of the intervention. Other sources of information must be used to corroborate and supplement data on ingredients from evaluations and descriptive reports. If the intervention is present at a nearby site, it may be possible to visit and gather additional data on ingredients through observation. A third valuable source is that of interviews, where present or former personnel are asked to identify resources from among a number of different classifications. The three principal types of information reports, observations, and interviews-can be used to assure the accuracy of the data by comparing the findings from each source and reconciling differences, the process of triangulation. Once the ingredients have been identified and stipulated, it is necessary to ascertain their costs. In doing this, all ingredients are assumed to have a cost, including donated or volunteer' resources. That is, they have a cost to someone, even if the sponsoring agency did not pay for them in a particular situation. At a later stage the costs will be distributed among the constituencies who paid them, but at this stage the need is to ascertain the total costs of the intervention. Ingredients can be divided into those that are purchased in reasonably competitive markets, and those that are obtained through other types of transactions. In general, the value of an ingredient for costing purposes is its market value. In the case of personnel, market value may be ascertained by determining what the costs would be for hiring a particular type .of person. Such costs must include not only salary, but also fringe benefits ' and other employment costs that are paid by the employer. Many of the other inputs can also be cost by using their market prices. These include the costs of equipment, materials, utilities, and so on. Clearly the cost of leased facilities can also be ascertained in this way. Although the market prices of some ingredients such as personnel can often be obtained from accounting data for educational

enterprises, such data are not reliable sources for ascertaining overall program costs. The accounting systems that are used by schools were designed for ensuring consistent reporting to state agencies rather than for providing accurate and consistent cost data on educational interventions. For example, they omit completely or understate the cost of volunteers and other donated resources. Capital improvements are charged to such budgets and accounts during the year of their purchase, even when the improvements have a life of 20-30 years. Normal cost accounting practices would ascertain the annual costs of such improvements by spreading them over their useful lives through an appropriate method. Thus, data from accounting and budgetary reports must be used selectively and appropriately and cannot be relied upon for all ingredients. There exist a variety of techniques for ascertaining the value of ingredients that are not purchased in competitive markets. For example, the method for ascertaining the value of volunteers and other contributed ingredients is to determine the mark-et value of such resources if they had to be purchased. The value of facilities can be determined by estimating their lease value. The annual value of facilities and equipment can be estimated through a relatively simple approach that takes account of depreciation and interest foregone by the remaining capital investment.

2.4 Common Application 2.4.1 Evaluating Program Options In the case of health screening, it is often difficult to determine the most cost-effective frequency. Too frequent screening has high cost and possibly limited health benefits, while too infrequent screening has low cost, but poor health outcomes. Determining appropriate screening frequencies is a useful application of cost-effectiveness analysis. The following table taken from an analysis on cervical cancer screening shows that life years are saved at a relatively low cost in the first comparison (screening versus no screening), but at a very high cost in the second comparison (the marginal cost and benefit of decreasing the interval between screenings). Typically, an intervention that costs less than $30,000/life year gained is considered cost-effective medicine. Based on this analysis, cervical cancer screening every four years is a relatively cost-effective benefit to cover. It is certainly more cost-effective than screening every three years.

Life expectancy increase, days Life expectancy increase, days (discounted 5%) Cost Increases, dollars Cost per Life years gained

Screen every four years vs No Screening 93.8 9.5

Screen every three years vs Screen every four years 1.6 0.2

$ 264 $ 10,101

$ 91 $ 184,528

Table 9. Example Data from an Analysis of Cervical Cancer Screening Frequency

2.4.2 Justifying Program Implementation When building a case to justify the use of funds, strong data is often compelling evidence. Cost-effectiveness analyses can be used to support qualitative arguments for health interventions. The following table examines a depression treatment improvement program. Treatment facilities in the study were offered training for practice leaders and nurses, enhanced educational and assessment resources, and trained psychotherapists for patient follow-ups. Not only was the intervention relatively cost-effective, but it also increased attendance in workers suffering from depression.

Quality-adjusted life increase, years Cost Increase Cost per quality-adjusted life Days of Employment Increase

Quality Improvement Program vs Usual Care 0.0226 $ 485 $ 21,460 20,9

Table 10. Example Data from an Analysis of a Depression Treatment Improvement Program

2.5. References • • • • • • • • • • •

• •

Carnoy M, Levin H M 1975 Evaluation of educational media: Some issues Instr. Sci. 4(3/4): 385-406 Cook T D, Campbell D T 1979 Quasi-Experimentation. Houghton Mifflin, Boston, Massachusetts Jamison D, Klees S, Wells S 1978 The Costs of Educational Media: Guidiness for Planning and Evaluation. Sage, Beverly Hills, California Levin H M 1970 Cost-effectiveness analysis of teacher selection. J. Hum. Resources 5(l): 24-33 Levin H M 1983 Cost-Effectiveness: A Primer. Sage Beverly Hills, California Levin H M, Glass G V, Meister G 1987 A Cost-effectiveness analysis of computer-assisted instruction. Eval. Rev. 11(l): 50-72 Mayo J, McAnany E, Klees S 1975 The Mexican telesecundaria: A costeffectiveness analysis. Instr. Sci. 4(3/4): 193-236 Quinn B, VanMondfrans A, Worthen B R 1984 Cost-effectiveness of two math programs as moderated by pupil SES. Educ. Eval. Policy Anal. 6(l): 39-52 Rossi P H, Freeman H E 1985 Evaluation: A Systematic I Approach, 3rd edn. Sage, Beverly Hills, California Tatto M T, Nielsen D, Cummings W, Kularatna N G, Dharmadasa K H 1991 Comparing the Effects and Costs of Different Approaches for Educating Primary School Teachers: The Case of Sri Lanka. Bridges Project, Harvard Institute for International Development, Cambridge. Gold M. R., Siegel J. E., Russell L. B., Weinstein M.C. Cost-Effectiveness in Health and Medicine. New York: Oxford University Press, 1996. Neumann P.J. “Why Don’t Americans Use Cost-Effectiveness Analysis?” American Journal of Managed Care 2004; 10: 308-312.

Chapter 3 UTILITY ANALYSIS 3.1.1. UTILITY The satisfaction of wants and needs obtained from the use or consumption of goods and services. The terms utility and satisfaction are, for the most part, used interchangeably in economics. The concept of utility is integral to utility analysis, consumer demand theory, and the microeconomic analysis of consumer behavior and market demand. Utility is another term for the satisfaction of wants and needs obtained from the consumption of goods. Two other economic terms that are also frequently used to capture this notion are welfare and well-being. Whichever term is used, the underlying concept is the same: Utility is the extent to which unlimited wants and needs are fulfilled using the goods and services produced from society's limited resources. The utility concept is an integral part of consumer demand theory and the in-depth study of market demand, the demand curve, and the law of demand. 3.1.2.Beyond Useful The official, technical economic use of the term "utility" is NOT interchangeable with the common, everyday synonym "useful." When used in the analysis of consumer behavior, utility assumes a very precise meaning. For example, a common "utility" knife is one with many uses, something that is handy to have around. In baseball, a "utility" player can perform quite well at several different positions and is thus useful to have on the team. Moreover, a public "utility" is a company that supplies a useful product, such as electricity, natural gas, or trash collection. In contrast, the specific economic use of the term utility in the study of consumer behavior means the satisfaction of wants and needs obtained from the consumption of a commodity. The good consumed need not be "useful" in the everyday sense of the term. It only needs to provide satisfaction.In other words, a frivolous good that has little or no practical use, can provide as much utility as a more useful good. An OmniStraight Shoestring Straightener is a useful good. It can be used to straighten even the most severely tangled shoestrings. It can also straighten telephone cords, computer cables, and fishing lines.In contrast, a FlexStar Interactive Trophy Plaque that periodically blares out "Congratulations, you took third place in the 27th Annual Shady Valley Badminton Tournament," is not very useful. It hangs on the wall broadcasting the same proclamation to every passerby.Is the FlexStar Interactive Trophy Plaque useful? Hardly! But it does provide utility. By noting a past accomplishment that took years to achieve, this plaque provides utility. Each time the message is broadcast, the owner gets a warm, fuzzy felling inside. It satisfies the owner's desire to be recognized for this

wondrous achievement. It does provide utility.In fact, both items provide utility. Both items satisfy wants and needs. 3.1.3.But Not Quantifiable When analyzing consumer demand, economists are prone to use phrases like "level of utility." However, in spite what this phrase implies, utility is NOT, strictly speaking, quantifiable like many other human characteristics, such as height and weight. For example, the height and weight of Maurice Finklestein can be quantified at 54 inches and 347 pounds. These measures suggest a mental image of Maurice as being somewhat short and somewhat heavy--a rolly, polly fellow--with the geometric configuration of an overinflated beach ball. This mental picture of Maurice can be had without actually knowing Maurice or having ever seen Maurice up close and personal. The reason is the existence of standard height and weight benchmark measures--inches and pounds. But these are standard benchmarks because they measure characteristics (height and weight) that ARE measurable. Not only are they measurable, but they are also comparable between people. Lisa Quirkenstone, by contrast is 70 inches tall and 118 pounds. The image of a runway fashion model might come to mind with these quantified dimensions.Moreover, a direct comparison between Lisa and Maurice can be had with these numbers. Lisa is somewhat taller and definitely thinner. In fact, Lisa is 16 inches taller and 229 pounds lighter, which also means that Lisa is 30 percent taller and 66 percent lighter than Maurice. Utility, however, is NOT a quantifiable, measurable, comparable characteristic--at least based on a current understanding of human psychology. It falls into the same "unmeasurable" category as happiness, beauty, and love. There are no benchmark measures for these notions. Much like "beauty is in the eye of the beholder," so too is utility. Even though economists make extensive use, for instructional purposes, of the utility measurement unit termed "util," any such utility unit is purely hypothetical and only designed to make the presentation of assorted utility-related concepts easier. 3.2.UTILITY ANALYSIS: A subset of consumer demand theory that analysis consumer behavior and market demand using total utility and marginal utility. The key principle of utility analysis is the law of diminishing marginal utility, which offers an explanation for the law of demand and the negative slope of the demand curve. Utility analysis, a subset of consumer demand theory, provides insight into an understanding of market demand and forms a cornerstone of modern microeconomics. In particular, this analysis investigates consumer behavior, especially market purchases, is based on the satisfaction of wants and needs (that is, utility) generated from the consumption of a good. Utility analysis is primarily taught in introductory courses. A more sophisticated version of consumer demand theory relies on the analysis of indifference curves and is more commonly found at the intermediate course level and above.

3.2.1.Utility and Satisfaction The primary focus of utility analysis is on the satisfaction of wants and needs obtained by the consumption of goods. This is technically termed utility. The utility generated from consumption affects the decision to purchase and consume a good. When used in the analysis of consumer behavior, utility assumes a very precise meaning, which differs from the everyday use of the term. In common use, the term utility means "useful." For example, a "utility" knife is one with many uses, something that is handy to have around. In baseball, a "utility" player can perform quite well at several different positions and is thus useful to have on the team. Moreover, a public "utility" is a company that supplies a useful product, such as electricity, natural gas, or trash collection. In contrast, the specific economic use of the term utility in the study of consumer behavior means the satisfaction of wants and needs obtained from the consumption of a commodity. The good consumed need not be "useful" in the everyday sense of the term. It only needs to provide satisfaction. In other words, a frivolous good that has little or no practical use, can provide as much utility as a more useful good. • An OmniOpen Deluxe Can Opener is extremely useful, especially when a sealed can needs to be opened. • An autographed photo of Brace Brickhead, Medical Detective, is not very useful. It does nothing but rest peacefully in a picture frame. Both items, however, provide utility. Both items satisfy wants and needs. The OmniOpen Deluxe Can Opener obviously makes it possible to open cans of food which satisfy the hunger need. The autographed photo of Brace Brickhead provides the owner with a warm, fuzzy feeling and a reminder of the time spent enjoying the thrilling exploits of Brace Brickhead, Medical Detective. 3.2.3.The Law of Demand The primary focus of utility analysis is an understanding of market demand and the law of demand. The law of demand, which gives rise to a negatively-sloped demand curve, is an essential principle underlying market analysis. Modern microeconomic theory, among other topics, is concerned with understanding and explaining the law of demand. The explanation of the law of demand using utility analysis is relatively simple. Consumers purchase goods that satisfy wants and needs, that is, generate utility. Those goods that generate more utility are more valuable to consumers and thus buyers are willing to pay a higher price. The key to the law of demand is that the utility generated declines as the quantity consumed increases. As such, the demand price that buyers are willing to pay decreases as the quantity demanded increases.

3.2.4.Total Utility Utility analysis begins with the total utility derived from the consumption of different quantities of a good. Total utility is simply a measure of the total satisfaction of wants and needs obtained from the consumption or use of a good or service. It is often convenient to present total utility for a range of quantities in a table such as the one displayed to the right. Utility analysis is based on the presumption that the amount of utility generated from the consumption of a good can be explicitly measured. The standard hypothetical measurement unit is "utils." Suppose, for example, that Edgar Millbottom spends a day riding the Monster Loop Death Plunge roller coaster at the Shady Valley Amusement Park, then records the amount of total utility achieved at the end of each ride. The two columns presented in the table measure the number of rides and the total utility accumulated by Edgar at the end of each ride (in utils). .

Before his first ride, Edgar receives no utility. No activity, no utility. Edgar's first ride generates 11 utils of utility.The total utility generated if Edgar takes 8 rides is 32 utils.Edgar's utility increases for the first 6 rides, reaching a high of 36 utils, before declining back to 32 utils for the 8th ride.Presumably Edgar's utility continues to decline after the 8th ride.Edgar obtains the highest total utility from 6 rides on the roller coaster. The motivation that guides Edgar's roller coaster riding is to maximize utility, that is, to consume the quantity of the good that generates the highest level of utility. In this example, utility is maximized at 6 rides. In many situations, however, the consumption of a good faces constraints. Edgar, for example, might face a time constraint because he plans to attend a live concert of the rock-and-roll group, Live Headless Squirrels, that prevents him from riding more than 4 times. Or he might face an income constraint because the amusement park charges $1 per ride and he has only $5 in his pocket. In these situations Edgar, as well as other consumers, might pursue constrained utility maximization. This means achieving the highest possible utility, given certain restrictions that prevent the highest overall level of utility from being achieved.

3.2.5.Marginal Utility Total utility is used as a starting point for utility analysis. However, a great deal of additional insight is gained from marginal utility. Marginal utility is the additional utility, or extra satisfaction of wants and needs, obtained from the consumption or use of an additional unit of a good or service. Marginal utility is, in other words, the extra satisfaction gained from an extra unit of good. Marginal utility is specified as: marginal utility = change in total utility change in quantity If, for example, total utility increases from 20 to 27 utils, then marginal utility is 7 utils.

The far right column of this table presents marginal utility values derived from each ride Edgar undertakes. Marginal utility from the first ride is 11 utils. The extra utility generated by the second ride is 9 utils. The third ride provides another 7 utils. The remaining numbers in the right column are interpreted in a similar manner. Marginal utility provides a direct link between utility analysis and demand. The demand price a buyer is willing to pay for a given good is based on the marginal utility derived from consuming the good. In this example, Edgar is most likely willing is to pay more for the first ride than the fifth ride, in that the first ride generates 11 utils of satisfaction, but the fifth ride generates only 3 utils. 3.2.6.The Law of Diminishing Marginal Utility A clear pattern is displayed by the marginal utility values in the far right column. Marginal utility decreases as Edgar takes more rides. This decreasing marginal utility reflects the law of diminishing marginal utility. The law of diminishing marginal utility states that marginal utility, or the extra utility obtained from consuming a good, decreases as the quantity consumed increases. In essence, each additional good consumed is less satisfying than the previous one. This law is particularly important for insight into market demand and the law of demand.

If each additional unit of a good is less satisfying, then a buyer is willing to pay less. As such, the demand price declines. This inverse law of demand relation between demand price and quantity demanded is a direct implication of the law of diminishing marginal utility. 3.3.UTILITY MAXIMIZATION: The process or goal of obtaining the highest level of utility from the consumption of goods or services. The goal of maximizing utility is a key assumption underlying consumer behavior studied in consumer demand theory. Consumers are assumed to make choices, especially concerning the purchase of goods, such that they obtain the highest possible level of satisfaction. Utility maximization can be achieved at the peak of the total utility curve. Utility maximization is the guiding notion underlying consumer choices analyzed with consumer demand theory and utility analysis. It makes sense to think that people are generally motivated to do what is best for them, to purchase the most satisfying goods, to make the decisions that do more good than harm, to improve their overall living standards and well-being, that is, to maximize their utility. Working through the logical consequences of this assumption, when combined with other principles of consumer behavior especially the law of diminishing marginal utility, makes it possible to gain insight into such things market demand and the law of demand. 3.3.1.The Scarcity Connection The utility maximization goal is based on the seemingly obvious presumption that people prefer more to less. This presumption is tied to the unlimited wants and needs aspect of scarcity. In other words, because people have unlimited wants and needs, satisfying those wants and needs is a desirable thing to do. Someone like Duncan Thurly would rather have a full belly than an empty one. He would rather live in a cozy, climatecontrolled house than in a cardboard box under a bridge. Of course, if wants and needs are unlimited, can anyone actually maximize utility? That is, can Duncan ever achieve the absolute pinnacle of satisfaction? Can he actually maximize utility. In terms of the scarcity problem, probably not. He might be able to boost utility a little higher by satisfying another unfulfilled want or need. But he is unlikely to maximize utility totally and completely. This is one reason why it is reasonable to think of utility maximization as a process of seeking what is ultimately unreachable. However, in the analysis of consumer demand theory, utility maximization has a more pragmatic interpretation--obtaining the highest possible satisfaction from consuming a given good or undertaking a specific activity. While Duncan might not be able to maximize his OVERALL utility, he can maximize the utility obtained from eating Hot Momma Fudge Bananarama Ice Cream Sundaes. It is this pragmatic interpretation of utility maximization that pervades the study of economics.

3.3.2.Utility Analysis The accompanying table can be used to illustrate utility maximization. The numbers indicate the total utility obtained by Edgar Millbottom while riding the Monster Loop Death Plunge roller coaster at the Shady Valley Amusement Park. The right-hand column is the accumulated satisfaction Edgar receives from riding the Monster Loop Death Plunge roller coaster 8 times during his day at the amusement park. Roller Coaster Utility

The numbers indicate that Edgar receives the greatest total utility, 36 utils, by riding the Monster Loop Death Plunge roller coaster 6 times. Click the [Utility Max] button to highlight this quantity. Taking 5 trips around the Monster Loop Death Plunge roller coaster track generates only 35 utils. Likewise, 7 rides generate only 35 utils. Maximum utility comes from 6 rides and only 6 rides. Anything else comes in less. 3.3.3.The Peak of the Curve Total Utility Curve

Utility maximization can be visually identified with a total utility curve, such as the one presented in this exhibit. In this case the maximum level of utility obtained by

Edgar riding the Monster Loop Death Plunge roller coaster is relatively obvious. The total utility curve reaches its highest point for 6 roller coaster rides. the curve increases up to the sixth ride, then declines for subsequent rides. Click the [Utility Peak] button to highlight this quantity.

3.3.4.Real World Constraints In the real world, the goal of utility maximization often encounters obstacles that prevent obtaining the highest overall level of utility. In many circumstances, consumers are unable to reach the peak of the total utility curve. Under these circumstances, consumers face a constrained utility maximization. The constraints could be physical or legal. For example, Edgar might not be able to ride the Monster Loop Death Plunge roller coaster 6 times because a bolt of lightning struck the track destroying a large section or perhaps the Shady Valley Amusement Park obtained a court order preventing Edgar for entering the park. However, the constraints facing most consumers most of the time are economic-that is, they have limited income and cannot afford to buy as much of a good as they want. If Edgar is charged $1 per ride and has only $5 of cash, then he is not able to achieve the utility maximizing 6 rides. 3.3.5.The Essence of Life While regular, everyday, noneconomist folks seldom use the term utility maximization, it is a powerful motivation force underlying a great deal (if not all) of the decisions people make and the actions they take. Again make note of the close connection between utility maximization, unlimited wants and needs, and the pervasive problem of scarcity. While Duncan might buy a freshly prepared Hot Momma Fudge Bananarama Ice Cream Sundae because it just "sounds tasty," what he is really trying to do is to raise his utility level to its maximum. He is motivated to eat the hot fudge sundae because it adds more to his utility total. And if he can add to his utility total, then he is not AT the maximum. 3.4.UTILITY MEASUREMENT: A quantification of the satisfaction of wants and needs achieved through the consumption of goods and services. In principle, utility measurement can take one of two forms: (1) cardinal, which is based on numerical values (1, 2, 3, etc.) and (2) ordinal which is based on rankings (first, second, third, etc.). While the hypothetical instructional analysis of utility relies on cardinal utility, ordinal utility is a more realistic way to measure satisfaction. Utility measurement provides a basis for discussing the satisfaction of wants and needs derived from consumption, which then enables an understanding of the role utility plays in market demand. When economists began looking into the influence utility has on

price in the 1800s, they presumed that utility was a characteristic, like height and weight, that could be measured in a cardinal manner. However, as the study of consumer demand theory progressed, economists realized that cardinal utility was both unlikely and unneeded. Ordinal utility, the ranking or preferences, was not only more realistic, it also provided a sufficient theoretical basis for analyzing the connection between utility and market demand. 3.4.1.Cardinal Utility Cardinal utility is the measurement of satisfaction using numerical values (1, 2, 3, etc.) that are comparable and based on a benchmark or scale. Height and weight are common cardinal measures. Suppose, for example, that Winston Smythe Kennsington III is 72 inches tall and weighs 180 pounds. In contrast, Pollyanna Pumpernickel is 64 inches tall and weighs 100 pounds. Anyone can easily conclude that Winston is taller and heavier than Paula.However, these cardinal measures also make it possible to compare how much taller and heavier Winston is than Paula. In fact, Winston is 12.5 percent taller and 80 percent heavier than Paula. Now consider the height and weight of Barton Broadway, a hulking professional athlete, who is 81 3/4 inches tall and weighs 324 pounds. These cardinal measures indicate that Barton is 12.5 percent taller and 80 percent heavier than Winston. The proportional difference between Barton and Winston is exactly the same as that between Winston and Paula. Herein lies the benefit of cardinal utility. It is (or would be) based on a fixed scale that allows for comparisons among consumers. Unfortunately such cardinal measurement does not presently exist for utility. The theoretical prospects of generating such a measurement are also slight. Although early economists worked from the presumption that utility could be quantified with a cardinal measure similar that used for height and weight, the subjective nature of utility makes cardinal measurement unlikely. Utility is inherently subjective. The satisfaction Pollyanna Pumpernickel obtains from eating a hot fudge sundae is based on her own personal wants and needs, her likes and dislikes. There is no way to compare her satisfaction with that received from an identical hot fudge sundae consumed by Winston Smythe Kennsington III or Barton Broadway. There is no way to measure how much more or less satisfaction each person receives. Does Barton receive 12.5 percent more utility than Winston? Does Winston receive 12.5 percent more than Paula? Who can say? Moreover, there also is no way to compare the satisfaction Paula receives from a hot fudge sundae versus watching Barton Broadway participate in his professional sporting pursuit. Does Paula receive 80 percent more utility from a hot fudge sundae than from watching Barton? Who can say?

3.4.2.Ordinal Utility Ordinal utility is the ranking of preferences (first, second, third, etc.) that are only comparable on a relative basis. Sporting events are commonly subject to ordinal measures. Suppose, for example, Pollyanna Pumpernickel, Winston Smythe Kennsington III, and Barton Broadway engage in a friendly footrace. Being a highly trained, wellconditioned athlete, Barton finishes first. The petite, but tenacious, Paula comes in second. Winston, hobbled by an old knee injury comes in third. The ranking achieved by these three runners depends only on the order of their finish. It matters not how swiftly each one covers the distance.Suppose that Barton edges out Paula by the slimmest of margins for first place, while Winston finishes well behind.Or alternatively, suppose that Barton finishes well in front, while Paula edges Winston by the slimmest of margins for second place.Or lastly, suppose that each finishes the race at almost the same time, with Barton coming in just ahead of Paula, who is slightly in front of Winston. The absolute difference between each runner is irrelevant to the order of finish. Barton is awarded the gold medal for first. Paula receives the silver medal for second. And Winston has the bronze medal for third. Ordinal utility applies this ranking to preferences. In the modern analysis of consumer demand, the actual level of utility generated from the consumption of a good is irrelevant. Only the ranking of preferences is important. Does Paula like hot fudge sundaes 80 percent more than watching Barton perform athletic activities? It matters not. It only matters that she likes hot fudge sundaes more than Barton's endeavors. 3.5. Reference http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=utility Bernstein, Allen L. (1966) A handbook of statistical solutions for the behavioral sciences. New York: Holt, Rinehart and Winston. Burke, Michael J. & Frederick, James T. (1986) A comparison of economic utility estimates for alternatives SDy estimation procedures. Journal of Applied Psychology, 71, 334-339. Myers, Jerome L. (1966) Fundamentals of experimental design. Boston: Allyn and Bacon, Inc. Rossi, Peter H.; Freeman, Howard E.; & Wright, Sonia R. (1979) Evaluation: a systematic approach. Beverly Hills: Sage Publications.

Chapter 4 Balanced Scorecard 4.1. Introduction 4.1.1. What is a Balanced Scorecard? A new approach to strategic management was developed in the early 1990's by Drs. Robert Kaplan (Harvard Business School) and David Norton. They named this system the 'balanced scorecard'. Recognizing some of the weaknesses and vagueness of previous management approaches, the balanced scorecard approach provides a clear prescription as to what companies should measure in order to 'balance' the financial perspective. it is a method for measuring a company's activities in terms of its vision and strategies. It gives managers a comprehensive view of the performance of a business. The balanced scorecard is a management system (not only a measurement system) that enables organizations to clarify their vision and strategy and translate them into action. It provides feedback around both the internal business processes and external outcomes in order to continuously improve strategic performance and results. When fully deployed, the balanced scorecard transforms strategic planning from an academic exercise into the nerve center of an enterprise. o o o o o o

Balanced Scorecard as a measurement tool: It allows the organization to assess progress in implementing strategy It allows the organization to benchmark its progress against great practices and inside the organization, and over time It provides a diagnostic framework for tracking relationships and impact strategies BSC is a measurement tool It allows the organization to assess progress in implementing strategy It allows the organization to benchmark its progress against great practices and inside the organization, and over time It provides a diagnostic framework for tracking relationships and impact strategies Balanced Scorecard as a communication tool :

outside among

outside among

o It allows an organization to articulate its chain of value creation within the organization and to the world at large o It provides a platform for planning and communication of planning BSC is a communication tool o It allows an organization to articulate its chain of value creation within the organization and to the world at large o It provides a platform for planning and communication of planning activities Kaplan and Norton describe the innovation of the balanced scorecard as follows: "The balanced scorecard retains traditional financial measures. But financial measures tell the story of past events, an adequate story for industrial age companies for which investments in long-term capabilities and customer relationships were not critical for success. These financial measures are inadequate, however, for guiding and evaluating the journey that information age companies must make to create future value through investment in customers, suppliers, employees, processes, technology, and innovation." Three keys to make implementation of Balanced Scorecard successful: Get Buy-In at All Levels: They know you've got those at the top signed on. Here's an easy way to get everyone else on board: Tie Scorecard objectives to individual compensation. Works like a charm – and gets employees to think strategically about their jobs. Follow Through: Don't let the Scorecard metrics languish. Update them as major company goals shift with the times. Use the Right Tools: You can buy or build an application that will help you track metrics. The Balanced Scorecard Collaborative certifies vendor offerings, which you can check out on their website.

•

• •

What is needed is a system that provides real insight into an organization’s operations, balances the historical accuracy of financial numbers with the drivers of future performance, and assists us in implementing strategy. The Balanced Scorecard is the tool that answers all these challenges. In the remainder of the chapter we will begin our exploration of the Balanced Scorecard by discussing its origins, reviewing its conceptual model, and considering what separates it from other systems. 4.1.2 Why We Use Balanced Scorecard? • • • • • •

Kaplan and Norton found that companies are using the scorecard to: Clarify and update strategy Communicate strategy throughout the company Align unit and individual goals with strategy Link strategic objectives to long term targets and annual budgets Identify and align strategic initiatives Conduct periodic performance reviews to learn about and improve strategy

Companies that use the Balanced Scorecard methodology get a more accurate, comprehensive view of their business performance. Balanced Scorecard approach relies on the monitoring of critical business-strategy-oriented metrics, such as quality, customer satisfaction, innovation, and market share—measurements that can often reflect a company’s economic conditions and growth prospects better than its reported earnings. Balanced Scorecard benefits according to Kaplan & Norton, 1992: Make strategy operational by translating strategy into performance measures and targets. Helps focus entire organization on what must be done to create breakthrough performance. Integrates and acts as an umbrella for a variety of often disconnected corporate programs, such as quality, re-engineering, process redesign, and customer service. Breaks down corporate level measures so local managers, operators, and employees can see what they must do well in order to improve organizational effectiveness. 4.1.3 Who Are Using Balanced Scorecard? The Balanced Scorecard, introduced in 1993 by Kaplan and Norton, has served as the foundation for the Performance Management systems of many fortune 1000 companies and government organizations. A well designed scorecard bridges the gap between long-term strategies and day-to-day action by aligning performance measures with the critical perspectives of the organization. Although by the end of 2001 about 36% of global companies are working with the balanced scorecard (according to Bain), much of the information in the commercial sector is proprietary, because it relates to the strategies of specific companies. Publicsector (government) organizations are usually not concerned with proprietary information, but also they do not usually have a mandate (or much funding) to post their management information on web sites. Below are organizations who implemented Balanced Scorecard as measuring method : Organization

Sector

Country

Bank of Tokyo-Mitsubishi

Banking

Japan

BMW Financial Services

Financial Services

Germany

DaimlerChrysler

Manufacturing

Germany

ExxonMobil Corp.

Energy

USA

Hilton Hotels Corp.

Hospitality

USA

IBM

Information Technology

USA

Philips Electronics

Manufacturing

Netherlands

Sears Roebuck & Company

Retail

USA

Siemens AG Southern Gardens Citrus Processing Corp.

Manufacturing

Germany

Food Processing

USA

St. Michael's Hospital

Health Care

Canada

UK Ministry of Defence

Government

UK

Unicco Service Co. United Way of Southeastern New England

Industrial Services

USA

Humanitarian

USA

University of California, Los Angeles

Higher Education

UPS

Shipping

USA United States

US West

Telecommunications

USA

Walt Disney World Company

Entertainment

USA

www.balancedscorecard.org 4.2. Balanced Scorecard as Management System Balanced scorecard is a management system (not only a measurement system) that enables organization to clarify their vision, strategy and translate them into action. Balanced scorecard is cascaded from the company to divisional / unit / functional objectives, this generally involves all employees contributing to reaching the objectives. 4.2.1 Four Fundamental Perspectives In organization decision making is dominated by financial parameters. There are two difficulties with this : • Financial parameters reflect past decisions or factors or trends, which had created value in the past. These factors may or may not add value in future. • Financial measures motivate short term behavior at the expense of long term health of the organization. In order to address the difficulties, balanced scorecard proposes four perspective which enables management to define key perspectives that will drive the business to success.

Financial perspective How do we perform according to our shareholders? Customer perspective How do our customer see us?

Vision and Strategy

Business proses perspective What must we excell at?

Learning and growth perspective Can we continue to improve & create value? www.balancedscorecard.org By viewing the company from all four perspectives, the balanced scorecard provides a more comprehensive understanding of current performance. to higher education. •

Four perspectives of Balanced scorecards are : Learning and Growth Perspective Learning and Growth Perspective is to achieve our vision, how we will sustain our ability to change and improve.  What infrastructure must we build to create long term growth, improvement and break through performance?

•

Business Proceess Perspective Business Process Perspective is to satisfy our shareholders and customers, and to know what business processes we must excel at.  Decide what processes and competencies we must excel at and specify measures  What are the critical internal operations that enable us to meet our customers’ needs?  What factors affect cycle time, quality, employee skills and productivity?  What core competencies and critical technologies are needed to ensure we are Best in class?

•

Customer Perspective Customer Perspective is to achieve our vision and to know we should appears to our customers  How effectively and efficiently do we satisfy the needs of our customers?  How would you define customer satisfaction?

 What customer service factors really matter to your customers? •

Financial Perspective Financial Perspective is to succeed financially and to know how we perform according to our shareholders.  How will our strategy, implementation and execution contribute to our financial improvement?  What are our financial themes?

4.2.2 Double Loop Feedback in Balanced Scorecard In order to shield the customer from receiving poor quality products, aggressive efforts were focused on inspection and testing at the end of the production line. To establish such a process, feedback data should be examined by managers to determine the causes of variation, what are the processes with significant problems, and then they can focus attention on fixing that subset of processes. This creates a double loop feedback process in the Balanced Scorecard. Metrics must be developed based on the priorities of the strategic plan, which provides the key business drivers and criteria for metrics that managers most desire to watch. Processes are then designed to collect information relevant to these metrics and reduce it to numerical form for storage, display, and analysis. Decision makers examine the outcomes of various measured processes and strategies and track the results to guide the company and provide feedback. • • • • •

The value metrics is in ability to provide a factual basis for defining : Strategic feedback to show the present status of the organization from many perspectives for decision makers Diagnostic feedback into various processes to guide improvements on a continuous basis Trends in performance over time as the metrics are tracked Feedback around the measurement methods themselves, and which metrics should be tracked Quantitative inputs to forecasting methods and models for decision support systems

4.2.3 Revolution in Strategic Planning Balanced scorecard is creating a revolution in the profession and practice of strategic planning. We can compare the some differences between the balanced scorecard to traditional strategic planning in the table below :

No.

TRADITIONAL STRATEGIC PLANNING

1

The standard planning cycle : typically 5 years, or as short as 3 years

2

Innovation and major change is not likely to occur

3

The strategic plan contains a large number of goals, objectives, actions items, etc

Strategic plan is focused on a 3 or 4 strategic themes

Managers tend to focus on short term financial goals 5 Planning is goal or project oriented Planning is mostly aimed at improving 6 processes and operations ("doing things right"), not strategies The budgeting process is disconnected from 7 performance measures

Managers have a balanced view of the major perspectives of performance Planning is results oriented

4

8

Collection of performance measures is reactive and ad hoc, driven by data calls

9 No performance reporting mechanism 10 Not transparent

BALANCED SCORECARD The agile planning process : shorter than 3 years, and strategies can be revised as necessary without being tied to any annual cycle Innovation emerges from across functional teams composed of employees at all levelsworking level

Planning is aimed at crafting and improving strategies ("doing the right things") Budgets are guided by performance measurements Performance measures are collected systematically and continuously throughout the organization Performance data is widely reported via a distributed software system Transparent

4.2.4 Deployment of the Balanced Scorecard There are two sets of more or less continuous data flows required in the Balanced scorecard system : •

Downward information flow Line managers desired outcomes, initiatives, metrics, targets, and schedules. The goals, metrics, targets, and schedules are aligned with those specified in the top level strategic plan and balanced scorecard performance plan.

•

Upward information flow Define collection methods for each of the balanced scorecard metrics. This is the most expensive, labor intensive, aspect of the balanced scorecard system, and has the most impact on the rank and file employees.

In figure above, the top strategic goals, metrics, and targets are in red, and they flow downward from the headquarters strategic planning office. The balanced scorecard measurements, in blue, are collected starting at the branch level and flow upward. At each level of the organizational hierarchy, data are aggregated across the lower levels. Aggregation serves to reduce information overload. Periodically, measurements are collected, aggregated and analyzed at each management level. Performance evaluations are not only for the top level managers but also in each level. Each level has its own responsibility. 4.2.5 Advantage and Disadvantages of Balanced Scorecard

•

Advantages of applying balanced scorecard : A framework to focus on key perspectives that will lead to success and provides a framework to constantly assess performance against targets Helps align key performance measures with strategy at all levels of organization Provides management with a comprehensive picture of business goals and strategies at all levels of an organization Gives a new way to executives of a company to assess how well their organization is functioning, how to predict future performance, how to align the organization toward new strategies to achieve breakthrough performance Transforms the strategic plan from an attractive but passive document into the marching orders for the organization on a daily basis Enables executives to truly execute their strategies

• • •

Disadvantages and problems of using balanced scorecard : Lack of time for the decision makers to focus on strategy Confusion between operational efficiency and strategy Difficult in creating well defined metrics and connecting them to deliverables

• • • • •

• • •

Cascading the objectives down to the staff that can deliver the results Difficult and time consuming to implement a comprehensive balanced scorecard system in a large organization Require sustained top level support and commitment to ramp up and put the system in place

4.3. Implementing Balanced Scorecard 4.3.1 How to Implement the Balanced Scorecard To implement balanced scorecard, it has been developed an effective nine steps processes for building and implementing the balanced scorecard. These steps are : • Organizational assessment • Identify strategic themes • Define perspectives and strategic objectives • Develop a strategy map • Derive performance metrics • Craft and prioritize strategic initiatives • Automate and communicate • Cascade the balanced scorecard through the organization collect data, evaluate, and revise 4.3.2 Cost to Implement the Balanced Scorecard • • • • • •

To implement balanced scorecard, the total cost may be estimated as follows : Number of team members x time on team activities Facilitator cost Request for proposal and software evaluation labor cost Software licensing cost Installation and testing cost Annual maintenance and upgrade cost (typically 20% of initial cost)

4.3.3 Example Balanced Scorecard Here is the example of Balanced scorecard : Regional Airline Mission : Dedication to the highest quality of customer service delivered with a sense of warmth, friendliness, individual pride, and company spirit. Vision : Continue building on our unique position - the only short haul, low fare, high frequency, point to point carier in America.

www.balancedscorecard.org

4.4. Conclusion • • • • • •

Defines the strategic linkages to integrate performance across organizations. Communicates objectives and measures to a business unit, joint venture, or shared service. Aligns everyone within an organization so that all employees understand how what they do supports the strategy Provides a basis for compensation provides feedback to senior management if the strategy is working The Balanced Scorecard is part of a performance management system to enable organizations to achieve their goals. Translates vision and strategy

4.5. References • • •

http://www.balancedscorecard.org http://www.balancedscorecardsurvival.com http://www.qpr.com

• • • • • • • • • • •

Chow, Chee W., Kamal M. Haddad, and James E. Williamson, "Applying the Balanced Scorecard to Small Companies", Management Accounting, August 1997, p. 21. Curtis, Carey C. and Lynn W. Ellis, "Balanced Scorecard For New Product Development", Journal of Cost Management, May/June 1997 Vol. 11, No. 3 Drucker, Peter F., "The Theory of Business", Harvard Business Review, Sep.-Oct. 1994, p. 95. Gaiss, Michael, "Enterprise Performance Management", Management Accounting, December 1998, p. 44. Hoffecker, John & Charles Goldenberg, "Using Balanced Scorecard to Develop Companywide Performance Measures", Journal Cost Management, Warren, Gorham, & Lamont, Vol 8, No. 3, Fall, 1994 Kaplan, Robert S. and David Norton, Translating Strategy Into Action The Balanced Scorecard (Boston, MA: HBS Press 1997) Maisel, Larry , "Performance Measurement: The Balanced Scorecard Approach", Journal Of Cost Management, Warren, Gorham, & Lamont, Volume 6, No. 2, Summer, 1992, p. 47. Porter, Michael E., "What is Strategy"What is Strategy", Harvard Business Review, Nov.-Dec. 1996, p. 61 Schneiderman, Arthur, "Why Balanced Scorecards Fail", Strategic Performance Measurement, January 1999, Special Edition Silk, Scott, "Automating the Balanced Scorecard", Management Accounting, May 1998, p. 38. Thomson, Jeff and Steve Varley, "Developing A Balanced Scorecard at AT&T", Journal of Strategic Performance Measurement, Aug/Sep 1997 Vol. 1, No. 4, p. 14.