Secure your share

Aug. 3, 2004
A rock-solid cost justification will solidify your place at project-funding time


It was about 36 years ago that Andy Warhol made his comment about everyone getting their 15 minutes of fame. On the grand stage we call the world, a quarter of an hour may well be adequate, but in the smaller domain we know as the manufacturing plant, a person needs a bit more long-term career-bolstering exposure. For example, being the driving force behind the "next great thing" can generate another hard-hitting bullet point on a resume. But if you can't lead the parade, a good fallback position is getting your name associated with a winner.

There are two problems with introducing and implementing a great idea. First, it generally takes money to pull it off. Second, there are probably several ranks of entrenched gatekeepers standing between you and the corporate gold.

It doesn't matter if it's so bloody obvious that your proposed investment will improve the profitability of the plant infrastructure, you're going to have to play the game and compete for a scarce resource: cold hard cash. To do that, you've got to speak the language the gatekeepers understand, the language of money, pure and simple. Please join me for a dive into the morass we call the Web in search of a few practical, zero-cost, non-commercial, registration-free resources about cost-justifying your next big thing. Remember, we search the Web so you don't have to.

Selling the project
Believe it or not, everyone is involved in sales. It's hard to argue with the reality that getting a job involves selling oneself. Then, once hired, many people find it necessary to develop effective project cost justifications that need to be "sold" to upper management before funding becomes available. You might want to take some advice from the quintessential salespeople, telemarketers, who sometimes have trouble getting past a customer's cost justification hurdle. In his article from the February 2000 issue of Satellite Direct, "Inquiring Minds Want to Know - Brief Article," Michael A. Brown answers relevant questions from telemarketers. Scroll to the middle of the page for the third entry after you dial your way to http://articles.findarticles.com/p/articles/mi_m3815/is_5_12/ai_62498788 for Brown's advice.

Getting started
Holistic Management, Bangalow, New South Wales, Australia, offers "Persuasion, decision, commitment," a series of pages taken from a much larger work this management consultant firm posted to its site. Hop your desk marsupial to www.implementer.com/implementer/web/step4_c/persuade.htm and scroll down to the "Cost justification" subhead. Four phrases you'll find there , problems with current cost justification methods, the process of economic evaluation, the costing of tangible benefits, the costing of intangible benefits , are links, although they don't have the underscore that is typical of most linked words. Nevertheless, they will take you to some basic commentary about the subject.

From the dock inward
Software represents one of the more problematic cost-justification efforts because it's hard to quantify some of the benefits that follow from adopting a technological solution to a problem. "Warehouse Management System Cost Justification Document" is a 25-page white paper that IBM wrote to describe one way to cost-justify the purchase of warehouse software. The document highlights some principles that apply to any cost-justification effort. For example, it recommends assessing current operations because proving a savings demands the availability of baseline data covering the relevant metrics, such as productivity, one of the main drivers of any savings initiative. The document even includes a template for gathering the data required. With some modification, the template can be used for other projects. The article also advises eliminating existing process inefficiencies before gathering baseline data. The idea is to base the cost justification on a single change -, the installation of the next big thing. You don't want to contaminate the analysis with the effects of dozens of process changes that distort the accurate financial picture you're trying to develop.

Load www.1.ibm.com/mediumbusiness/pdf/cost_justification.pdf into your browser for the details.

More than labor savings
Cost justification requires a tabulation of more than the obvious out-of-pocket costs and some wild guesses about the monetary benefits expected as a result of implementing a project. Nello Zuech of Vision Systems International, in Yardley, Pa., explains using a machine vision project as an example and offers a list of relevant cost elements in his article, "Cost Justification Strategies for Machine Vision," that appears on Machine Vision Online, a production of the Automated Imaging Association, based in Ann Arbor, Mich. Focus your gaze on www.machinevisiononline.org/public/articles/archivedetails.cfm?id=44 for the 24 questions that feed the 10 numbers that should appear on any spreadsheet you use for analysis and funding requests.

Justifying hardware
Belgravium Ltd. in Bradford, West Yorkshire, England, offers "A Guide To Cost Justifying Automatic Identification" at www.belgravium.com/New%20Products/A_guide_to_justifying_automatic_identification_draft2.0_.pdf. The document highlights a hypothetical company that's considering the installation of a shop floor data collection system. There are several references to Table 1, which, inexplicably, doesn't appear to be linked to the document. However, if you go to www.belgravium.com/New%20Products/html/cost_justification_example.html, you'll find it.

Online book
Check out "Managing the New Electronic Information Products," a book by Linda Rosen and Stephen E. Arnold from Arnold Information Technology, an online information consultant in Harrod's Creek, Ky. Chapter three discusses cost-justifying a library's CD-ROM system. Although the details are different from those a plant engineer would consider for an industrial project, the thought process that underlies the justification is similar. Head to the library at www.arnoldit.com/articles/book/books.htm.

Engineering economics
If you hold an engineering degree, it's likely you studied engineering econ in the ivied halls of academe. It's an important element of a comprehensive cost justification and, as a refresher, consider investigating "Engineering Economics Overview" by Oscar Lopez, Adjunct Professor in the Industrial and Systems Engineering department at Florida International University in Miami. Put on your thinking cap and walk over to http://faculty.eng.fiu.edu/~olopez/EIN3334/ENGINEERING%20ECONOMICS%20SLIDES.pdf for a 72-page PDF that presents a set of class notes covering relevant economic concepts -- linear breakeven model, time value of money, economic study techniques, after-tax analysis, replacement analysis, and inflation and its impact ,- each of which can play a role in helping you to get your hands into the corporate money bag.

Online tools
Professor Chan S. Park, the Ginn Distinguished Professor of Engineering in the Department of Industrial and Systems Engineering at Samuel Ginn College of Engineering, Auburn University, Auburn, Ala., posts a series of Web pages designed for instructors who teach using his book, "Contemporary Engineering Economics." Send your mousie to www.eng.auburn.edu/~park/cee/, then click on "Excel files and Computer Notes" listed under the "Study Guides" heading. This gives you access to a set of fully functional Excel spreadsheets and explanatory notes that address the financial issues of cost justification. The other resource you should know about is the set of online financial calculators listed under "Analysis Tools." What might be of particular interest is the package called EzCash Software, which is an integrated engineering economics software package written for MS Windows 95 and 98.

The cookbook
"Project Cost Justification," an article that appeared in the April 1999 issue of Quality Digest magazine, was excerpted from the book of the same title. Written by Stephen Arnett of DataNet Quality Systems, Southfield, Mich., the article provides a road map for preparing your documentation. According to Arnett, a comprehensive, ironclad cost-justification must include a project income statement, a cash flow statement showing a positive net present value, ROI and payback period calculations, financial documents, execution plan and explicit list of assumptions used to justify the project. The resulting transparent project would be a fresh breeze that blows away any doubt the gatekeepers might have. Waft your browser in the general direction of www.qualitydigest.com/apr99/html/body_teams.html, where you can find the info.

EVA
The money you request via cost justification doesn't, as shareholders and other funders say, grow on trees. A standard cost justification for a capital project ought to demonstrate a positive net present value, the calculation of which requires a discount rate that reflects the funder's cost of capital. As it turns out, NPV can be rather sensitive to small changes in the particular value selected as a discount rate. Sometimes it doesn't take much of a change to run your perfectly good NPV into the ground, or send it to even more subterranean locales. That discount rates aren't arbitrary is highlighted in "Cost Justification of Capital Equipment Using 'Economic Value Added' Analysis" by Dr. H. Fred Walker, CQE, CQA, CSIT, an article that appeared in the February - April 1999 issue of the [i]Journal of Industrial Technology[i]. Walker claims that NPV by itself is insufficient to guarantee a benefit to the shareholders. Decision-makers should have access to a calculation showing the project's economic value added. Sharpen your pencils and poke them around at www.nait.org/jit/Articles/walk0299.pdf for a six-page read that will take some concentration on your part, but will yield a more ironclad justification that might be more useful for your purposes.

Sunk costs
Suppose, for a moment, that your great idea involves replacing someone's ongoing, perhaps not-so-great idea. Assume the company spent a bundle last year to install it and it's clear to everyone that it won't reach payback, ever. Be aware that any unrecoverable red-ink is irrelevant to your cost justification and shouldn't be included therein. For the reason, I refer you to "Sunk Cost and Marginal Cost: An Auction Experiment" by Michael J. Haupert in the Department of Economics at University of Wisconsin, La Crosse, Wis., which is posted at www.marietta.edu/~delemeeg/expernom/s94.html and "Sunk Cost Bias," an article at www.maxwideman.com/guests/portfolio/sunkcost.htm by Dr. Miley W. (Lee) Merkhofer at Lee Merkhofer Consulting, Cupertino,Calif.

Payback metrics
The gatekeepers who stand between you and the funds for your project have a certain penchant for wanting to communicate in financial terms. And I'd be willing to bet that they're going to want so see metrics that quantify the project's payback potential. Each of the possible measures purport to be useful for ranking proposals to ensure that only the best are implemented. Well, there are metrics and there are metrics, and they're not equivalent. To see the differences, point your browser at www.owlnet.rice.edu/~econ448/protected/Extended_Notes/, where you'll find a set of links to class notes for Economics 448, Corporate Finance, as it's taught at the Economics Department at Rice University in Houston. I'd like to direct your attention to a specific pair of links. Class note No. 4 is a good how-to that explains the mechanics of calculating a net present value for your project's cash flow. Then, class note No. 6 addresses the validity of some of commonly-used alternative metrics for project evaluation.

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