***Economic Justification: Measuring Return on Investment (ROI) and Cost
Benefit Analysis (CBA)***

**Introduction**

Your business plan must have some type of economic justification to
provide your executives and elected officials with financial
information. It will help them know that they are doing the "right
thing" by implementing the requested program. A popular economic
calculation for the "attractiveness" of an investment is Return On
Investment (ROI). ROI is a calculation of the most tangible financial
gains or benefits that can be expected from a project versus the costs
for implementing the suggested program or solution. Cost Benefit
Analysis (CBA) is more comprehensive than ROI, and attempts to quantify
both tangible and intangible (or "soft") costs and benefits. The purpose
of this guide is to make these measurement techniques a little more
understandable.

**Calculating ROI**

ROI is represented as a ratio of the expected financial gains (benefits)
of a project divided by its total costs. As a formula it appears as:

**ROI = (net benefits/total cost)**

In the equation above, net benefits equals total benefits minus total
cost. It is the incremental financial gain (or loss).

If a parcel mapping project costs \$50,000 to implement, and you
demonstrate \$25,000 in net benefits, then the calculation would appear
as follows.

ROI = (25,000/50,000)

The ROI in this example is 50% which represents a positive return on the
investment. An ROI ratio should be greater than zero is necessary for a
program to be economically attractive. A sub-zero ratio may not
automatically "kill" a project, because it may result in a required
capability that doesn't currently exist. Not all government functions
are required to have a positive rate of return as they are in the
business world. Government is required to provide certain services to
the public, and is more tolerant of losses in terms of ROI.

Calculating the ROI on various options will help to ensure that you
select the most cost effective technology. You can provide additional
support for negative (and positive) rates of return with the qualitative
benefits identified by your planning team. Later in this guide, a
discount factor will be applied, to show the Net Present Value (NPV) of
future costs and benefits, which is an important consideration when
comparing alternatives.

**NOTE:** Even a project with an outstanding ROI may be controversial or
doomed to failure if the investment cost is very high.

**Calculating CBA**

These calculations are more comprehensive than ROI, in that they attempt
to quantify both tangible and intangible costs and benefits.
Historically, CBA has been applied to large public works projects with
societal benefits that are more difficult to quantify than "hard"
technology costs. These intangible benefits are very relevant to an
overall determination of what is a good investment for the public
well-being. SSDI implementation includes both types, and is therefore a
candidate for applying CBA, if the expertise and resources are available
to support the effort.

Like an ROI calculation, the result of CBA is a ratio expressed as a
percentage, and economic attractiveness is determined the same way:
above zero is attractive, and below zero is not. The equation is the
same, although more costs and benefits are included. That is the
essential difference between the two methods.

**Effect of Time on ROI and CBA Calculations**

In most cases, executives and elected officials expect to see an
economic justification based on phased benefits and costs over a three
to five year window. Being able to show a positive ROI in a one or two
year timeframe will probably make your project an instant hit, but this
is an unusual circumstance.

Given the time value of money, a dollar is worth more today than it will
be tomorrow. To account for this economic fact, future costs and
benefits need to be "discounted" in order to calculate today's value
(a.k.a., Net Present Value, or NPV).

The discount factor, also known as the cost of capital, might be
specified by various state authorities. Generally, the selected discount
rate should be less than the Prime Rate. The Prime Rate is the interest
rate charged by banks to their most creditworthy customers. The last
reported rate (as published in the Wall Street Journal) was 7.5%, as of
January 31, 2006. By comparison the Office of Management and Budget
(OMB) recommends the following discount rates for federal programs,
depending on the length of the program.

  ------------------ ------------- ------------- ------------- -------------
  Duration           3 Yrs         5 Yrs         7 Yrs         10 Yrs

  Discount Rate      2.5%          2.6%          2.7%          2.8%
  ------------------ ------------- ------------- ------------- -------------

Source: OMB Circular A-94

In the parcel mapping calculation of ROI, to apply a discount factor to
determine the Net Present Value (NPV) of a future stream of benefits and
costs, the following equation and factors would be used:

B = Benefits; C = Costs; r = discount rate; t = time period; n = number
of time periods.

NPV equals the summation from t = 0 (the initial start-up of the
program) to t = n (the final year of the program) of \[(B~t~ - C~t~) /
(1 + r)^t^ \].

For a 3 year program, the equation would be as follows:

NPV = \[(B~0~ - C~0~)\] + \[(B~1~ -- C~1~) / (1 + r)\] + \[(B~2~ --
C~2~) / (1 + r)^2^\] + \[(B~3~ -- C~3~) / (1 + r)^3^\]

In the table on the parcel mapping example, the above equation was
applied, and the resulting NPV calculated out to be \$22,120 (which is a
somewhat lower ROI, but more accurate, than when the time value of money
is not considered).

Projects with a long pay back period (i.e. greater than three years)
have inherently higher risks due to changes in work process flow and
other external factors that may lead to a new project design and
additional costs.

  ---------------- ----------- ----------- -------------- ----------- --------------
                   **Initial   **Year 1**  **Year 2**     **Year 3**  **Cumulative
                   Costs**                                            Total**

  **Total Costs**  \$35,000    \$5,000     \$5,000        \$5,000     \$50,000

  **Total          \$0         \$25,000    \$25,000       \$25,000    \$75,000
  Benefits**                                                          

  **Net Benefit**  -\$35,000   \$20,000    \$20,000       \$20,000    \$25,000

  **Net Present                                                       
  Value**                                                             

  **Initial Year**                         -\$35,000                  

  ***Year 1***                             \$19,512                   

  ***Year 2***                             \$19,036                   

  ***Year 3***                             \$18,572                   

  ***NPV =***                              **\$22,120**               

                                                                      

  **Discount                               0.025                      
  Factor (2.5 %)**                                                    

  ***Initial                               1.000                      
  Period                                                              
  Denominator***                                                      

  ***Year 1***                             1.025                      

  ***Year 2***                             1.051                      

  ***Year 3***                             1.077                      
  ---------------- ----------- ----------- -------------- ----------- --------------

This table feeds our earlier example calculation of ROI =
(\$25,000/\$50,000) where the ROI is calculated to be 50% for the parcel
mapping project. By adding a discount factor and calculating NPV (see
aforementioned formula), the economic attractiveness diminishes only
slightly (\$22K vs. \$25K), but is still positive, and more accurate
given the time value of money.

**Calculating Costs**

Most organizations have effective methods for identifying their costs.
Information on personnel costs can be obtained from fiscal officers,
there are often contracts in place (or as historical references) for
certain services, and managers can turn to their counterparts in other
organizations to obtain valid cost figures.

You should include the following costs when determining your total cost:

-   Labor Including Fringe Benefits

-   Overhead (if appropriate)

-   Additional Equipment Cost (not including additional costs for
    existing equipment)

-   Additional Software Cost (not including additional costs for
    existing software)

-   Physical Facilities (if additional space is required)

-   Contracting Costs

You should also consider the various phases of a project and account for
all of the costs incurred during each phase. Many people ignore the
"built-in" costs and only account for large contractual expenditures.
Examples of built-in costs include:

-   Project Management

-   Contract Management

-   Quality Assurance and Control

-   Personnel Training

-   Project Maintenance

-   Security (if appropriate)

**Calculating Benefits**

This is the most difficult part of completing an economic justification
for people in geospatial fields. There are very few guidelines that
provide you with average benefit factors for implementing applications,
data development, or coordination activities. One example reviewed for
this project, from NASA, reported that adherence to open standards and
interoperability specifications during project implementation resulted
in 119% ROI as a "savings to investment" ratio. (See
[http://gio.gsfc.nasa.gov/docs
/ROI%20Study.pdf](http://gio.gsfc.nasa.gov/docs /ROI Study.pdf))

The types of benefits that you may list in your study include "internal"
or "external" costs to your organization. It is generally much easier to
document the internal costs, because you should have a good
understanding of the work process flow and where the savings will occur.
It can be extremely difficult (or nearly impossible) to identify the
"downstream" benefits that are accrued by other users and the general
public.

Examples of the internal benefits you should measure include:

-   Savings from new capabilities

-   Decreased time to perform repetitive tasks

-   Decreased travel

-   Decreased wait times

-   Decreased mistakes

-   Increase in billable services

-   Increased customer base

-   Improved customer satisfaction

-   Decreased training costs

-   Improved regulatory compliance (i.e. reduction of fines)

-   Reduced reporting requirements

-   Reduced telecommunications charges

-   Reduced dependency on consultants

As already noted, accurately identifying benefit values can be very
difficult and time consuming. It may be beneficial to list out all of
the expected benefits and then prioritize them in terms of your
"hunches" on the largest expected paybacks. After that, make your best
guess on the ease of obtaining the information required to complete the
calculation. Use these lists to set your priorities for working on
economic justification.

Examples of external and downstream benefits that you might measure
include:

-   All of the above benefits that can be quantified in other agencies
    or levels of government.

-   Public and Private Sector benefits that can be clearly defined (i.e.
    by having assessment data on-line, appraisers can perform
    assessments in their office and not have to drive to county or state
    tax offices, thereby saving them time and travel expenses)

-   Private sector benefits from being geospatially enabled (i.e. a
    company specializing in road centerline data gets access to better
    road geometries and provides more added values for other customers)

-   Public benefits from being geospatially enabled (i.e. being able to
    locate a hotel near a business appointment on a web based mapping
    system that saves time and travel expenses)

These external and downstream benefits can be very complex to calculate
and will probably be beyond the scope of your planning efforts. However,
the members of your planning team should think about these benefits and
when they can be readily calculated, include them in your business plan.

**Putting it in Perspective**

ROI and CBA calculations are useful, because they allow you to examine
your options and make wise choices. They are also an essential component
of your business plan, because they become the "proof" that implementing
a project is a sound business decision. ROI is useful when costs and
benefits are tangible and tightly focused on a specific program with
boundaries. CBA is more comprehensive, and is useful when both tangible
and intangible costs and benefits need to be considered.

Before you begin development of your business plan, you should determine
what statutory or other requirements you have for developing ROI or
other types of calculations in prescribed formats. Many states have
specific guidance and formats identified in their budget or IT plans. In
addition, you should determine the threshold for project value at which
you must perform these calculations. Spending a week's worth of your
time to gather information and crunch numbers may not be a wise
investment of time in order to justify a project expenditure of
\$10,000.

As already noted, examples of ROI and CBA calculations for geospatial
projects can be very elusive. Please share any information, tools, or
new concepts with your peers.