Geographic information systems (GIS) are in widespread use by both public and private organizations. any more organizations would like to implement the technology, but they must first justify this major purchase. The most commonly used technique to justify any capital investment (including GIS) is cost benefit analysis (sometimes called benefit-cost analysis).
Image Source: esri.com/news/arcuser/1006/graphics/zuni_2_lg.jpg
Cost-benefit analysis is just what its name implies: a balance sheet for a capital expenditure that includes costs on one side and benefits on the other, along with a comparison of the economic (dollar) value of each. This entry presents the basic elements of cost-benefit analysis, providing examples of specific benefits and costs associated with GIS implementation. The entry also discusses enhancements to basic cost-benefit analysis with the addition of a discussion of discounting. Finally, the entry discusses the intangible costs and benefits associated with GIS.
Basics
Economists use the terms cost-benefit analysis and benefit-cost analysis interchangeably to describe the technique of assigning an economic value to both the costs and the benefits of a capital expenditure, and then comparing the two numbers. In the most basic application of the technique, one simply sums the value of the costs, sums the value of the benefits, and compares the sum of the costs to the sum of the benefits. If the economic value of the benefits exceeds the economic value of the costs, then the capital expenditure is justified. If the economic value of the costs exceeds the economic value of the benefits, then the expenditure is not justified. There may be additional hurdles to overcome before making the expenditure, such as finding money in the budget, but at least the organization has crossed the first threshold. Many organizations require a cost-benefit analysis as a prerequisite to adopting any new technology. Despite some critiques, the use of cost-benefit analysis’s well established in the GIS literature, and it remains the gold standard as a means to justify the purchase and implementation of geographic information systems.
ADVERTISEMENTS:
Tangible Costs of GIS
Traditional cost-benefit analysis begins with an organization’s identifying, listing, valuing, and summing the tangible costs associated with purchasing and implementing a GIS. These costs include expenditures on computer hardware and software, the transformation of paper maps and data into digital format along with collection of new data as needed, and hiring GIS professionals or training existing staff members to use 52———Cost-Benefit Analysis the technology competently and efficiently. These costs are considered to be tangible because there is a firm, relatively fixed price (economic value) for each item that the GIS adopter learns from the vendor of each component of the technology. The prices of such products are determined on the open market and thus are readily quantifiable.
Tangible costs for GIS begin with the hardware needed for the operation, including computers, servers, and extensive data storage capacity to accommodate the vast quantities of both raster and vector data associated with GIS. Furthermore, there may be a need for a dedicated server, and other peripheral devices, such as printers, monitors, global positioning systems (GPS) devices, and perhaps even digital recording devices (such as a camera, for example). Once the organization has determined what hardware it needs, it may work with vendors to agree on prices. GIS software is another key part of the implementation.
When an organization chooses its GIS software, it must first have a clear understanding of the tasks the GIS will perform in order to ensure that the software is adequate and appropriate. The costs for maintaining the site license as well as for software updates and upgrades will add to the annual cost of maintaining the GIS and must be counted as a recurring cost. Closely related to software is the cost of technical support from the software vendor.
Like annual site license fees and software upgrades, these may be provided as part of a full-service agreement. It will be necessary to know what is (and is not) included in the package. Like software upgrades, technical support will also normally add to the annual cost of maintaining the GIS. There will also be costs either to train existing staff to use the GIS or to hire one or more GIS professionals to implement the technology. These costs must also be included.
ADVERTISEMENTS:
Tangible Benefits of GIS
Just as important to the analysis are the anticipated tangible benefits of implementing GIS. There are three major categories of tangible benefits that a cost benefit analysis for GIS should include: cost reduction, cost avoidance, and increased revenue from sale of data; however, there may be legal restrictions on data sales, and any organization that wishes to sell data is advised to seek a legal opinion before proceeding. Like costs, many benefits of GIS implementation are tangible; that is, it is relatively easy to identify their economic value. Any anticipated reduction of staff hours, for example, can be calculated based on the cost of the compensation package’s) of the employee’s) whose positions will be eliminated or reduced through the use of GIS. When undertaking cost-benefit analysis, organizations must rely on objective and verifiable figures.
Intangible Costs and Benefits
Some costs and benefits will be intangible and therefore difficult to assess. Among intangible costs are temporary disruptions of service within the organization caused by the changeover to GIS, uncertainty and hardship caused to staff members by the adoption of new technology, and other potential organizational dislocations created by the implementation of GIS. Intangible benefits may include better decisions— decisions that are more readily accepted by stakeholders and client groups, for example.
ADVERTISEMENTS:
By definition, it is difficult to place an economic value on intangible costs and benefits. In many instances, intangible costs fall under the heading of short-term, transitional disruptions to the organization associated with the shift to GIS technology from a paper- and analog-based system. Some of these transitional disruptions may have a real economic cost; however, the level of uncertainty regarding possible costs is problematic. At the very least, it is important to identify any foreseeable intangible costs and benefits. If these intangibles are organizational disruptions, as described above, it is important both to identify them and to suggest strategies to mitigate their effects.
Where possible, the analysis should make an effort to estimate the value of intangible costs and benefits. Some economists have criticized cost-benefit analysis for its reliance on rote numbers in a sterile quantitative exercise, often to the neglect of qualitative values such as ethics and behavior. Careful, thoughtful cost-benefit analysis should encompass both science and art by incorporating qualitative consideration of ethics and values in the implementation of GIS and taking into account interesting and complex questions of economic theory.
Refinements of Cost-Benefit Analysis
Generally, implementing GIS imposes high front-end costs with long-term benefits. In addition to the upfront purchase of hardware, implementing GIS also requires either the conversion of existing data into Cost-Benefit Analysis———53 digital format or the collection of new data, and usually both. Even though there has been an exponential increase in the quantity and quality of free digital data, including high-quality government-produced base maps, realistically, new users will need to add data that is specific and unique to both their applications
and their jurisdictions.
For example, local governments typically need parcel-level base maps and data in order to meet their GIS needs; in the United States, these are not available “off-the-shelf,” but must be built from scratch. Because of these hardware and onetime data conversion and/or creation needs, the initial costs of GIS implementation are usually high in the first 1 to 3 years. In contrast, the long-term benefits are smaller on an annualized basis and are more slowly realized, even though they are enduring.
One refinement of basic cost-benefit analysis to address this problem is the use of a “payback period.” As the name implies, the idea of the payback period is to calculate the savings and/or benefits over a period of years with the idea of comparing them to the new costs that would be incurred with the purchase of the new technology. To calculate the payback period, it is necessary to divide the total cost of implementing a GIS by the estimated annual value of the benefits of using the technology.
The resulting figure tells how many years it takes to accumulate enough economic benefits (or cost savings) to pay for the cost of the system. Another significant problem that arises in performing cost-benefit analysis is caused by the effects of time and inflation. Even when the annual rate of inflation is low, the cumulative effects of inflation over a period of years diminish the economic value of the long-term benefits of the adoption of GIS. Moreover, people perceive immediate benefits as having greater value than benefits far off in the future. Similarly, a cost that occurs far in the future is perceived as less significant than the same cost today.
Discounting is designed to address this problem. The idea behind discounting is to deflate the costs and benefits of a capital expenditure in order to adjust for the effects of inflation. In short, discounting providesa mathematical means to address the old saying that “money doesn’t go as far as it used to.” The formula for discounting includes three elements: present (or future) value, the length of time appropriate for the project, and an appropriate discount rate. It is normally left up to the manager to choose— and justify—an appropriate discount rate. Choosing a discount rate is a challenge with two distinct approaches.
The first approach is to choose a discount rate based on the projected rates of inflation, usually based on current and recent historical rates. The second approach is to choose a discount rate based on the investment productivity in which the value of future returns offsets the cost of investment today. Normally, a discount rate that reflects the rate banks charge their investment borrowers is used; these rates are typically higher than savings account rates. Sometimes a sensitivity analysis is performed by repeating the discounting of benefits and costs using two or more different interest rates.
Future Trends
As the front-end costs of GIS adoption diminish because of technological innovations, it will become easier to justify implementation of GIS. Increasingly, GIS is becoming a basic tool for organizations that handle spatial data. As GIS becomes more commonplace, adopting the technology has the added intangible organizational benefit of making the organization look modern rather than appearing as though time has passed it by. If this trend continues, it will become easier to justify adoption of GIS. Until then, cost benefit analysis will continue to be a necessary step on the road to GIS adoption.