Session 9 Commentary 

Agenda
Outsourcing -- an overview: 
                      --Remaining students present the web page assigned to them:

Procurement  

• RFP (Request for Proposal)
• Software Selection

Break

• Sourcing Strategies
• Cost Benefit Analysis
• Capital Budgeting

Remember: 
probability of an event occurring + probability of an event not occurring = 1 
so  if  probability of rain today is .8 then the probability of no rain = 1- .8 or .2.  

RFP  Request for Proposal -- aka RFQ Request for Quote

.. The Process                                    

1]  Pre-RFP aka as "Requirements Definition"

Preliminary Analysis for Management (not given to vendor) on the RFP
Process

• The most important step in the system procurement process
• Serves as the basis for RFP and evaluation criteria
• Information flows into and throughout the organization considered
• ---  How the information is used 
• ---  Who uses the information
• Projected growth rates in the volume of information and transactions
• Starts usually with a problem
• In smaller firms the Pre-RFP may be a simple presentation

Steps in the Pre-RFP

• Problem is noticed,
• Ramifications of problem are determined
• Preliminary Alternatives are proposed
• RFI (Request for Information) 
  -- Vendors are called to determine what alternatives that vendor can handle
• -- usually done before the RFP but can be done in the beginning phase of the RFP
• -- identifies vendors // can also be accomplished from consulting support or preliminary research
• Ideally 3 to 6 vendors are found for each alternative -- those with less are noted but not usually recommended in the Pre-RFP report.-- collect info from each vendor for the PreRFP Report to management

Sections of the Pre-RFP Report to management

• Problem Statement of:
• ----------- the current situation, briefly stated  
• ----------- the needs that are unmet (quantified and qualified)
• ----------- Current Risks stemming from the current situation 
                (usually this tells management how things can and probably will get worse
• Alternative Solutions Summary looked at for meeting the current situation's needs 
  -- there are certain generic-type solutions -- (a=scrap the old, get a new.. b= scrap the old.. c=fix the old with bells and whistles, d=fix the old minimally)
• For Each Alternative, the analysis rates them using "ballpark" estimates (ranges are usually better than one number)  and rankings of what should be pursued with an RFP
  (1= best, 5=worst)
• -- The potential costs  given in a range 
• --------- one-time
• --------- on-going or recurring
• -- The potential benefits given in a range
• ---------  one-time
• ---------  on-going or recurring benefits  
• -- The potential risks with their probability
• The Selected Alternative for the RFP with rationale for its selection

2]  RFP -- for the vendors -- 

• A "blueprint" of system functionality
• Crystallizing business requirements
• Serves as evaluation criteria
• Limited distribution to selected vendors to:
• -- protect confidentiality
• -- protect the procurement process
• Contains a Statement of Work to be done (see below for details)

--  The sections of the Pre-RFP and the RFP (3 versions given)

--  The guidelines for assignment III - RFP

3]  Proposal Submissions

• Questions about RFP from vendors
• -- written / oral
• Vendor Conference
• Number of copies
• Delivery methods
• Response content and format
• Right to reject

4] Proposal Evaluations

• Business Functional Requirements analysis
• Technical Requirements analysis including
    User Ratings (End User and IS User)
  Software Overview & Demo
  Software Support
  Implementation
  Training
  Software Functionality
  Report Writing
  Data Conversion Interfaces
  Technical Architecture
  Software & Implementation Costs
     Rating Scale (0 = unresponsive, 1 = unsatisfactory, ... 5 = exceptional)
  Strengths and Weaknesses
• Vendor qualification
• Proposal Reference Check
• Litigation Search (find out what problems vendor is having)
• Preliminary Cost, Value and Risk Analysis
• Vendor Demo
• Personnel assignment
• The Process

5] Vendor Selection

• Vendor Site Visits
• Weighted Score Method
• Cost-Value-Risks Analysis
• .. Cost Elements
• ---- One-Time Costs
• --------- Software Products [license fees {concurrent users, named users}, software modules]
• --------- Implementation Services
• --------- Software Services
• --------- Technical Support
• --------- Training Services
• --------- Other [hardware, auxillary resources]
• ---- Recurring Costs
• --------- Software Maintenance and Support
• --------- License (?)
• --------- Personnel
• --------- Program Development
• --------- Hardware and Network Maintenance
• --------- Infrastructure
• --------- Workstations
• --------- Operations
• --------- Communications
• --------- Insurance & Backup
• --------- Training (?)
• -- Fixed vs. Variable
• -- Tangible vs. Intangible or Accurate Projections vs. Hidden or Difficult Projections
• .. Benefit Elements
• ---- Tangible Benefits -- advantages measurable is $ that accrue to the organization through the use of the information systems// IT Cost Reduction; shorter cycle time
• ---- Intangible Benefits -- important but difficult to measure; or translate into dollars potential revenue, quality of decision

6] Procurement Methods

• Purchase -- not that popular because of fear of obsolescence -- 
  equipment is recorded as an asset while financing is recorded as a liability
  --looks cheaper but remember to do a present value (cash flow) analysis
  
• Rent -- usually short term (less than a year)
  --  only need to give 30 days notice to cancel 
  -- more expensive than leasing or purchase
  
• Lease  - usually 12 to 36 months operating lease
  -- often done with an option to buy
• .. System Lease
• ----- Spread Cash Flow Over 5+ Years
• ----- Vendor or a 3rd Party Leasing Company
• .. Capital Lease
• ----- Anticipated useful life > lease term
• ----- Intend to exercise the purchase option at lease termination
• .. Operating Lease
• ---- Technology change or needs outpace the system life
• ---- Not locked into a technology platform
• ---- Off Balance Sheet Financing
• ---- Lower monthly payment
• .. Fair Market Value
• .. Installation Date
• .. Termination Option

7] ROI Analysis  Return of Investment

Earnings on the investment / total investment = ROI

• Must be able to calculate the income stream in $.  Not usually possible to calculate for:
• ....  Stategic Investments (aims to change the way the firm competes) 
• ....  Informational Investments (provides info firm needs to manage and control the organization)
• ....  Infrastructure investments (provides the base foundation of IT capability) -- usually there is no income stream because there are no business applications
• Can calculate the income stream easily and has a short-term ROI
• ....  Transactional investments (aimed to cut operating costs and increase volumes)

Therefore, while necessary to consider it is not necessary to come up with a solid ROI.

8] Contract Negotiation

• Objectives
• .. Clarify problem areas  before contract is drawn up
• .. Agreement with vendor on a statement of work
• .. Agree on the best (and final) offer
• .. Use RFC to formalize information requests
• Strategies
• .. Cost-Value-Analysis
• .. Parallel Negotiations
• .. Prioritize issues
• .. Define Roles and Responsibilities
• Do's
• .. Establish a formal proposal evaluation methodology
• .. Include vendor responses to RFP business requirements in the contract
• .. Keep lawyers at bay till Statement of Work is complete and agreed
• .. Annual maintenance and support fee structure
• .. Leverage outside expertise in negotiations
• .. Provide for incentives / penalties related to systems implementation timelines
• .. Advice:  Look at total and component costs
• .. Advice: always maintain confidentiality
• Don'ts
• .. Buying "vaporware" instead of proven systems solutions
• .. Purchasing the low value/low bid solution
• .. Contracting with multiple parties
• .. Annual maintenance and support fee structure
• .. Let your users do "heavy lifting" during implementation
• .. Advice: Never settle on a final offer prematurely

.. Software Selection

Pre-Packaged Software

• lower license fees
• immediate availability for installation
• usually a large installed base
• regular updates

Customized Software

• integration of Updates with custom code
• support
• taxes
• confidentiality
• user involvement

Custom Software Development

• requirements
• responsibilities
• vendor personnel
• revenue sharing
• title and confidentiality

Turn-key Solutions

• OEM (Original Equipment Manufacturer)
• .. Bundle for installation as one complete system
• ...... applications
• ...... hardware
• ...... operating systems software
• System Integrator
• .. select compatible system components based on:
• ...... performance,
• ...... functionality,
• ...... price
• ...... upgrade
• ...... inter-compatbility
• Best of breed
• May not able to provide the level of post-implementation support

 

Break

Financial Analysis

Costs and Benefits Review

• Costs:
• -- One-Time vs. Recurring
• -- Fixed vs. Variable
• -- Tangible vs. Intangible
• --- accurately projected vs. difficult to estimate or hidden
• Benefits:
• -- Tangible vs. Intangible
• --- Tangible
•         Advantages measurable in $ that accrue to the organization through the use of IS/IT
•         Cost Reduction; Shorter Cycle time
• --- Intangible
•         Important but difficult to measure, or translate into dollars

Analysis Methods are based on the-

Statement of Work -- agreement between firm and vendor --

Software Performance

• Description of software
• Detailed explanation of required customization
• 3rd party products
• Standard and Ad Hoc Reporting

Implementation

• Project team structure
• Staffing assumptions
• Implementation methodology

Technical Architecture

• Infrastructure
• Data Conversion

Training Strategy

• plans
• resources

Maintenance and Support

• on-site, online support
• interface with legacy systems
• future upgrades

Cost Schedule

• detailed cost schedule by category and software; other costs
• five (?)year schedule

Cost Benefit Analysis

1. Break-even Analysis -- justification from costs, not benefits, or if benefits do not substantially improve with the proposed system
---- compares total costs against growth in volume
The break even point is when the total cost of the current system and proposed system intersect, at this point it becomes "profitable."

Pro-- useful when business is growing, volume is key variable in cost
Con -- benefits are assumed to remain the same, regardless which system is in consideration

Exs.  Current payroll system costs $1.25 /ee to process an employee for a paycheck with 1000 employees.   The new system will process up to 4000 transactions at the cost of $.35 / ee and costs $20,000.   Payroll is processed weekly.

TC_old = Total Cost of running old system
Q = number of employees processed

TC_new = .35Q + 20,000
TC_old= $1.25Q 
Breakeven is when old costs = new costs therefore: TC_old = TC_new

  .35Q +20000 = 1.25Q or .9Q=20000 or Q = 22,222 employees or 
22,222/1000 = the pay period in which breakeven is found or in the 23rd pay period, the break-even point is reached.  

2. Payback Method -- justification from improved tangible benefits
---- assess the worthiness of alternative investments in terms of time
---- length of time it takes for the benefit of the system to payback the cost of developing it.
---- determine the period of time of operation that system need  to payback the cost of investment.
---- Payback Period = Investment required / net annual cash inflow (that is, the benefits)

Pro -- gives the minimal period of time the system needs to be in operation to have system make "sense."
Con -- short term approach on investment & replacement
       -- does not consider how repayments are timed
       -- does not consider total return beyond the payback period

Exs. A new b2b system handles 1000 sales per day averaging $50 per sale or $50,000 per day after paying the variable costs.  It costs $300,000 to develop.  The payback period is 300,000 / 50,000 = 6 days for payback.

3. Cash Flow Analysis -- project is expensive relative to firm's size, or when firm can be significantly affected by large drain of funds
---- assess the direction, size and pattern of cash flow (both inflow and outflow).  
       If no revenue, only measure cash outlay
---- when will project begin to make profit or out of the red?
---- examines the direction, size and pattern of cash flow associated with the proposed systems

4. Net Present Value -- payback period is long or cost of borrowing money is high
---- considers both the time value of the investments and cash flows.
---- assess all of the costs (outlays) and revenues over its economic life and to compare cost today with future costs; and today's benefits with future benefits so different project can be compared regardless of timing
---- concept of Present Value: $1 received today is more valuable than $1 a year from now which is more valuable $1 two years from now
The present $1 can be invested and earn 7% return or $1.07 in 1 year and $1.14 in 2 years and $1.23 in 3 years  (this is known as 'opportunity cost')
  
The future involves uncertainty-- the longer the time frame, the more uncertainty on what that $1 will earn

Money has a time value: managers must have a means of expressing future receipts in present dollar terms so the future receipt can be compared on an equal basis.
    F₁   = the amount to be received in 1 year = The future value at 1 year
    F_n   = the future amount to be received in n periods = The future value at n year
    p    = the present outlay to be made
    r    =  the rate of interest
    n   =  the number of periods
                     Future Value
    F₁= p(1+r) = 100(1+.07) = 107
    F_n= p(1+r)ⁿ = 100(1+.07)⁴ = 100(1.3107) = 131.07 when n=4, r = 7% and p = 100
                    Present Value
    p = F_n/ (1+r)ⁿ


                    Discounting or the value of future expected cash receipts and expenditures at a common date, which is calculated using Net Present Value or Internal Rate of Return (IRR).  It is a factor in analyses of capital investments.
the process of finding the present value of a future cash flow
discounting $110.25 to its present value of $100 ; 5% is the discount rate. 

Capital Budgeting