Calculating minds: using precise analytical measures, insurers can compare the costs and benefits of Business Process Integration, a new technology that promises to bring incompatible data systems together. (Technology: Cost Management).
For example, consider what's needed when issuing a life insurance policy On the carrier side alone, there typically exists a contract and licensing system, an underwriting application, a billing system, and a commission system, among others. Employees often must enter data in one system and look up related information at a second workstation. If the incompatible systems could "speak to each other," manual entry would be eliminated and service would drastically improve. This is the promise of BPI. Because these inefficiencies exist in almost every line of business, insurance companies are using BPI to tackle carrier agency processes, automate procedures related to claims and annuities, provide unified views of customer and more.
Another key element behind BPI ~ is the belief that business analysts will be able to undertake many functions that traditionally have been handled by highly paid programming 2 specialists. This empowers business analysts, reduces costs, and aligns information technology projects with business needs--important considerations when looking to justify IT expenditures.
Upon reaching the conclusion that BPI technology can help improve service and turnaround times, however, insurers must do more to obtain management buy-in than parrot vendor promises about faster business processes and increased revenue. Your management will be focused on projects that can demonstrate a concrete return on investment, so it's critical to calculate the benefits and associated costs.
As with any significant outlay of funds, an extensive cost-benefit analysis is a rigorous but worthwhile exercise. ROI calculators and other tools are designed solely for this purpose; some consulting firms specialize in this area. Starting with a blank Excel sheet and conducting your own analysis is often the best approach, however.
Total Cost of Ownership
As with any initiative, BPI projects can spiral out of control unless you consider all related expenses.
Total cost of ownership is a straightforward calculation that accounts for all expenses associated with a BPI solution over a period of time. For example, the total cost of ownership might be $500,000 over five years. The shorter the time period, the larger the variance between different solutions, because the initial cash layout influences the calculation heavily.
When selecting a BPI product, pay careful attention to services mat will De required. A relatively inexpensive solution with low annual maintenance and add-on costs could sound attractive. This solution may require a surprising amount of implementation services, however-up to five or six times more than the software licensing costs. Just when you think the solution is right, calculating the total cost of ownership could price it out of your budget. Ideally, you want a one-to-one product-to-service cost ratio, which will keep the total cost of ownership down.
In addition to license and maintenance fees, factor in indirect costs, including additional hardware, software and training. Some products claim to be complete solutions, yet require investments in application servers or message brokers. Be wary of these hidden costs. Accounting for indirect costs is critical to a successful project.
Total cost of ownership is a good measure to confirm that you are within budget but alone is not enough to receive management buy-in because the calculations do not include benefits. A careful look at the benefits must also be considered to ensure the best return on your investment.
Hard and Soft Benefits
Quantifying BPI benefits or those of any technology project can be daunting. As Bob Lewis, president of if Catalysts, recently noted, "The problem with calculating the value of IT is that it's an enabler of value, not a provider of value. That is, the value comes from the improvement in business processes made possible through the use of IT, not the technology itself."
It's hard to quantify the benefits of greater customer satisfaction that will result from slashing the underwriting process from weeks to days, for example, but estimating the project savings is certainly feasible.
The types of benefits you should consider will vary by project. You might factor in savings in human labor, the ability to bring products to market more quickly, a sharp decrease in errors due to the elimination of manual entries (which might affect policy reissues, for example), lower maintenance costs, and new revenue channels, such as e-commerce with partners or self-service portals.
For example, before selecting a BPI solution, Providence Washington, a Rhode Island-based insurance company, determined that its ROI would come from quantifiable benefits, such as simplified procedures and efficiency in issuing policies, and necessary intangibles, such as strengthening partner relationships.
Providence Washington plans to use BPI in many ways, including the promotion of partner self-service. "The benefits of extranet-based self-service and automation include radically reduced cycle times, and thereby create an opportunity to drive up sales volume," explained Ed Leveille, Providence Washington's chief information officer. "Today, agents wait two or three weeks for a given transaction. We can get that down to hours. We'll also be able to process a policy from beginning to end in two hours instead of the three to eight weeks that it takes now."
In your benefit analysis, evaluate other factors such as ease of use, and look carefully at the BPI modeling tool in the solution that you are considering. If it's not intuitive, your business analysts will have trouble using it. This will lower potential benefits and therefore ROI.
Net Present Value
After quantifying the benefits, you must account for the present value of future cash flows. This metric is called net present value and is based on the principle that a dollar today is worth more than a dollar tomorrow. Lost investment opportunity, risk and inflation are among the factors that contribute to this truism. If you say that BPI will bring in a return of $25,000 each of the next three years for a total of $75,000, your chief financial officer may dismiss any further analysis.
To derive net present value, you need the discount factor, which is the rate you will use to lower the value of future cash flows. Ask your CFO or controller what discount factor to use. Then run the following calculation where the cash flow after one year is A, after two years is B and after three years is C:
Net present value = A/(1+discount rate) + B/[(1+discount rate).sup.2]+ C/[(1+discount rate).sup.3].
Applying net present value to an annual return of $25,000 using an 8% discount factor for three years works out to $64,427. Being familiar with this calculation will let your CFO know that you have done your homework.
Return on Investment
ROI is perhaps the most popular metric. In essence, ROI factors in the total cost of ownership and net present value that you calculated earlier. The difference is that ROI measures costs and benefits. It quantifies your investment's attractiveness by measuring discounted net benefits (benefits minus future add-on costs) as a percentage of initial costs. If the ROI over two years is 198%, this means within two years you will realize twice as much in benefits as you initially invested.
To calculate ROI, divide the net present value of future cash flows by your initial investment (ROI = net present value/initial investment). Expect a 100% to 200% ROI within 12 to 18 months. Otherwise, especially in today's economy, the chances of getting your CFO's approval are marginal, at best.
The payback period tells you how long it will take to recoup your costs. If your initial cost is $300,000 and your annual benefit is $200,000, your payback period is $300,000/$200,000, or 1.5 years. The payback period, while attractive due to its simplicity, doesn't account for indirect costs or discounted cash flows. A better way to achieve a similar goal is to determine how long it will take to achieve a 100% ROI.
Internal Rate of Return
If your CFO uses a "hurdle rate" (the minimum rate of return that the company expects on investments) to decide on the viability of expenditures, then you will need to know how to calculate the internal rate of return. The internal rate of return is calculated by determining what discount rate is needed to arrive at a zero net present value. As in the previous calculations, A, B and C refer to annual cash flows.
0 = A/(1+IRR) + B/[(1+IRR).sup.2]+ C/[(1+IRR).sup.3]
Use a special calculator or the standard Excel IRR function to take iterative guesses for internal rate of return until the equation results in zero (or close enough). Setting the equation to zero is done only to calculate the internal rate of return; it does not mean that a zero net present value is desirable. Replacing the internal rate of return with higher rates for the discounted cash flows will result in a negative net present value, while replacing it with lower rates will result in a positive net present value. Therefore, if your internal rate of return exceeds the hurdle rate, then your project is attractive, as it is expected to result in a positive net present value.
Adding It Up
The key to using these metrics is making proper assumptions when assessing costs and benefits.
Your instinct, research and knowledge of the company's processes and business applications tell you that BPI can help you automate many of today's manual procedures. The vendor you've selected offers a product that is easy to use and doesn't require additional hardware and software, or extensive implementation services. Compiling a laundry list of costs and benefits will in itself be worthwhile. With the proper calculations in hand, it won't be long before your company experiences greater efficiency, with a reduced cost of doing business.
Jeffrey Kern is strategic marketing manager for Metaserver Inc.
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|Date:||Jul 1, 2003|
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