Better Business Cases. Guide to Developing the Single Stage Business Case

Transcription

1 Better Business Cases Guide to Developing the Single Stage Business Case 28 February 2014

2 Acknowledgements This document was created using material provided by Her Majesty s (HM) Treasury in the United Kingdom, the Welsh Government (Llywodraeth Cymru) and the State of Victoria Department of Treasury and Finance. Accordingly, ownership of any copyright in the information contained in this document belongs to the original copyright owners. Other than as provided by the applicable copyright laws in each jurisdiction, permission to copy, distribute, adapt or otherwise use the information contained in this document, must be sought from the original copyright owner. The New Zealand Treasury wishes to acknowledge that the following documents were used and adapted for the purpose of creating this guidance: The Five Case Model is the best practice standard recommended by the HM Treasury for the preparation of business cases. Refer to Making Sense of Public Sector investments (2001) by Courtney A Smith and Joe Flanagan, the Green Book at and Delivering Public Value from Spending Proposals: Green Book Guidance on Public Sector Business Cases using the Five Case Model at wales.gov.uk/funding/wiipindex/5cmodel/?lang=en. The State of Victoria Department of Treasury and Finance Investment Management Standard provides a set of tools, including the Investment Logic Map (ILM) adopted in this guidance. Refer to This material is reproduced with permission and that copyright belongs to the State of Victoria. The State of Victoria is released from any liability associated with the subsequent use of the intellectual property associated with the material. The New Zealand Treasury also wishes to acknowledge the assistance of the following agencies who contributed to the preparation of this guidance material: Internal Affairs, Department of Labour, Housing New Zealand Corporation, Inland Revenue, Ministry of Economic Development, Ministry of Education, Ministry of Health, New Zealand Defence Force, State Services Commission and the Tertiary Education Commission. Crown Copyright This work is licensed under the Creative Commons Attribution 3.0 New Zealand licence. In essence, you are free to copy, distribute and adapt the work, as long as you attribute the work to the Crown and abide by the other licence terms. To view a copy of this licence, visit Please note that no departmental or governmental emblem, logo or Coat of Arms may be used in any way which infringes any provision of the Flags, Emblems, and Names Protection Act Attribution to the Crown should be in written form and not by reproduction of any such emblem, logo or Coat of Arms. ISBN (Online) The URL for this document on the Treasury s National Infrastructure Unit website at February 2014 is The Persistent URL for this document is

3 Contents About this Guidance... 2 What this Guidance is not... 2 Questions and Feedback... 2 Further information... 2 The Single Stage Business Case... 3 When should a Single Stage Business Case be developed?... 3 The Strategic Case Making the Case for Change... 8 Strategic Context... 8 Investment Objectives, Existing Arrangements and Business Needs... 9 Potential Business Scope and Key Service Requirements Benefits, Risks, Constraints and Dependencies Economic Case Determining Potential Value for Money Critical Success Factors Long List Options and Initial Options Assessment Economic Assessment of the Short-Listed Options Non-monetary Benefits and Costs Risk and Uncertainty The Preferred Option and Sensitivity Analysis Commercial Case Preparing for the Potential Deal The Procurement Strategy Specify Requirements Risk Allocation Payment Mechanisms Contractual and Other Issues Financial Case Ascertaining Affordability and Funding Requirements The Financial Costing Model Management Case Planning for Successful Delivery Project Management Planning Change Management Planning Benefits Management Planning Risk Management Planning Post Project Evaluation Planning References Annex One: How to Develop the Single Stage Business Case? Annex Two: Reviewer Questions Better Business Cases: Guide to Developing the Single Stage Business Case 1

4 About this Guidance This guidance is intended to assist developers and reviewers to build better business cases using the Five Case Model, the New Zealand Government s accepted good practice standard. This guidance document is intended to assist investors, senior responsible owners, workshop facilitators and business case developers to prepare the Single Stage Business Case as part of applying the Better Business Cases process. This document has been written as part of the suite of Better Business Case guidance. It is part of a comprehensive and structured tool-kit of guides and templates to assist you at every stage of the business case development. This guidance can assist you whether you are considering an investment in change at the portfolio, programme or project level in either the wider Public or the private sectors. This guidance also provides a useful reference for business managers, project or programme managers, and other stakeholders who can either influence investment decisions or have an interest in the successful delivery of change. The guidance outlined in this document applies until this document is updated or replaced. What this Guidance is not This guidance is not intended to comprehensively cover all the related aspects of business case development. These may include regulatory impact, economic assessment, procurement, risk management, Public Private Partnership (PPP), Treaty, programme/project management or assurance processes. You should refer to any relevant policies, rules, expectations and practices that apply to your specific organisation or sector. Questions and Feedback General enquiries about the information contained in this guidance, and not addressed in this guidance, can be directed to betterbusinesscases@treasury.govt.nz. For Government agencies, any agency-specific questions should be addressed to your Treasury Vote team. Any comments as to how we could improve this guidance can be directed to guidance@treasury.govt.nz. Further information This document is part of the Better Business Cases suite of guidance available at the Treasury National Infrastructure Unit website at: 2 Better Business Cases: Guide to Developing the Single Stage Business Case

5 The Single Stage Business Case The Single Stage Business Case recommends a preferred option that optimises value for money and seeks approval from decision-makers to finalise the arrangements for successful implementation. The decision to develop a Single Stage Business Case typically follows from the Strategic Assessment, which justified the need to invest in change. The Single Stage Business Case: confirms the strategic context of the organisation and how the proposed investment fits within that strategic context confirms the need to invest and the case for change identifies a wide range of potential options determines the preferred option which optimises value for money, by undertaking a detailed analysis of the costs, benefits and risks of the short-listed options prepares the proposal for procurement plans the necessary funding and management arrangements for the successful delivery of the project, and informs a proposal to decision-makers to seek agreement to approach the market and finalise the arrangements for implementation of the project. 1 When should a Single Stage Business Case be developed? The Single Stage Business Case is a significant deliverable of the Better Business Cases process. The Better Business Cases process develops five cases that provide assurance that an investment proposal: is supported by a compelling case for change, the strategic case optimises value for money, the economic case is commercially viable, the commercial case is financially affordable, the financial case, and is achievable, the management case. 1 For proposals that that are likely to result in a non-traditional procurement, a different approach to market may be required. Refer to the PPP supplementary guidance to the Guide to Developing the Indicative Business Case and the PPP guidance available from Better Business Cases: Guide to Developing the Single Stage Business Case 3

6 Better Business Cases is designed to ensure that there are no surprises and that the analytical effort is fit for purpose. These two goals are achieved by adopting a staged approval process with appropriate business case deliverables that support the decisions sought. This ensures early engagement with decision-makers and means development effort is not wasted on options that can be ruled out early. Prior to commencing work on the development of the business case, the process to be followed and the amount of analytical effort needed to meet the expectations of decisionmakers should be agreed. Typically this requires a discussion with the appropriate monitoring agency or review team and is documented in the relevant Scoping Document. 2 Senior responsible owners of significant proposals in the State sector should ensure the relevant Treasury vote team (or monitoring agency) officials are fully engaged in developing and agreeing the Scoping Document. A Single Stage Business Case may be fit-for-purpose used for investment proposals that are assessed as lower risk or small scale. For a single stage process, the Indicative and Detailed business case content requirements are combined into a Single Stage Business Case, with a lower level of analytical effort required to meet decision-maker expectations. Figure 1: Overview of a single stage Better Business Cases process (for a sample project, either stand alone or as a consequence of a Programme Business Case decision). 2 The Scoping Document facilitates discussion and agreement between the senior responsible owner (SRO) and the reviewer on how the Better Business Cases process is applied. The aim is to align the expectations of both parties to be fit for purpose for the risk and scale of the proposal. The Scoping Document templates for each of the business case deliverables are available at 4 Better Business Cases: Guide to Developing the Single Stage Business Case

7 Table 1: The key process steps for a Single Stage Business Case development are highlighted to demonstrate the key focus for effort and analysis Process Stages by Case and Better Business Cases Deliverable The Five Cases Strategic Assessment Single Stage Business Case Implementation Business Case Strategic Step 1: Outline strategic fit and the need to invest Step 2: Make the case for change Revisit and confirm Economic Steps 3 and 4: Determine potential value for money Step 8: Procure the value for money solution Commercial Step 5: Prepare for the potential deal Step 9: Contract for the deal Financial Step 6: Ascertain affordability and funding Confirm the financial implications of the deal Management Step 7: Plan for successful delivery Step 10: Ensure successful delivery Procurement guidance The new Government Rules of Sourcing (the Rules) provide a simple, plain English explanation of the government s standards of good practice for procurement planning, approaching the market and contracting. The Rules came into effect on 1 October 2013 and replace the 2006 Mandatory Rules for Procurement by Departments. 3 The Rules must be applied by all Public Service departments, New Zealand Police and the New Zealand Defence Force. Wider State Services agencies are expected to have regard to the Rules as good practice guidance. Wider State Sector and Public Sector agencies are encouraged to have regard to the Rules as good practice guidance. The Ministry of Business, Innovation and Employment also provides guidance. Mastering Procurement: A Structured Approach to Strategic Procurement (2011) sets out the processes for initiating your procurement planning, identifying needs, analysing the market, and on how to approach the market. Refer to this guidance in the first instance, subject to any other mandatory procurement rules and expectations that may apply to your sector or organisation. 4 Regulatory Impact Analysis requirements In addition to the requirements of this Better Business Cases guidance, certain government agency investment proposals may also have additional Regulatory Impact Analysis (RIA) requirements. 3 4 For further information, please refer to Refer to the Ministry of Business, Innovation and Employment website at Better Business Cases: Guide to Developing the Single Stage Business Case 5

8 If projects with potential regulatory impacts are likely to be considered within the proposed programme of work, a Preliminary Impact and Risk Assessment (PIRA) may be required in the first instance. Refer to the Treasury Regulatory Impact Analysis Handbook and contact The Treasury for further guidance. 5 While the two analytical processes may be proceeding on different timelines, it is possible that some of the thinking, analysis and recommendations can be integrated to avoid duplication of effort and inconsistent advice being provided to decision-makers. This should be considered as part of the discussion to agree the initial Scoping Document. Single Stage Light process For certain investment decisions that are subject to lower levels of delegated authority, that are of very small scale and/or very low risk, the use of a Single Stage Light Business Case may be agreed as being fit for purpose. This could include compressing the three deliverables above into a single business case deliverable. In some case the Strategic Assessment requirements can also be combined into a fit for purpose Single Stage Light Business Case. Agreement on the process to be applied should be negotiated with the monitoring agency or review team and documented in the relevant Scoping Document. Figure 2: Overview of the Single Stage Light Better Business Cases process 5 For more detail on the Regulatory Impact Analysis requirements, refer to the guidance at 6 Better Business Cases: Guide to Developing the Single Stage Business Case

9 Table 2: The key process steps for a Single Stage Light Business Case development are highlighted to demonstrate the key focus for effort and analysis The Five Cases Process Stages by Case and Better Business Cases Deliverable Single Stage Light Business Case Update Strategic Economic Step 1: Outline strategic fit and the need to invest Step 2: Make the case for change Steps 3 and 4: Determine potential value for money Revisit and confirm Step 8: Procure the value for money solution Commercial Step 5: Prepare for the potential deal Step 9: Contract for the deal Financial Management Step 6: Ascertain affordability and funding Step 7: Plan for successful delivery Confirm the financial implications of the deal Step 10: Ensure successful delivery Better Business Cases: Guide to Developing the Single Stage Business Case 7

10 The Strategic Case Making the Case for Change The purpose of this part of the strategic case is to confirm the strategic context developed in the previous Strategic Assessment and to make a compelling case for change. The strategic case: revisits the strategic context for the proposed investment (where a Strategic Assessment for the proposal has been completed) establishes the investment objectives, existing arrangements and business needs considers the potential business scope and key service requirements, and identifies the benefits, risks, constraints and dependencies. Strategic Context The strategic context provides an overview of the sponsoring organisation and the outcomes that the organisation is seeking to achieve or contribute to through its operations 6. It also demonstrates alignment of the proposed investment with wider national or sectoral priorities and goals, policy decisions, other multi-agency programmes (if relevant) and linkages with organisational business strategies. This section should build on, and confirm, the initial analysis undertaken as part of the Strategic Assessment. Organisational overview Provide a brief profile of the organisation, together with a statement of what it is seeking to achieve and evidence of the nature and level of resources currently at its disposal. The key areas of focus include: What are the main outcomes, impacts and objectives that the organisation is trying to achieve and why? What is the nature and scope of the organisation s activities and services (outputs), key stakeholders and customers (including the public)? Is the investment proposal consistent with core activities? What resources are available to the organisation, including existing financial and funding arrangements, organisational structure and staffing, and how does it intend to manage this capability over time? What is the current environment in which the organisation operates, including how it intends to respond to changes and possible risks? This summary should consider external drivers for considering the investment proposal. The expectation is that a brief summary is provided rather than repeating the content of readily available documents. 6 An organisation can be a single agency or it can encompass multiple agencies, business units and groups of people structured and managed to meet a need or to achieve common goals. 8 Better Business Cases: Guide to Developing the Single Stage Business Case

11 Alignment to existing strategies Explain how the proposed investment fits within, supports and promotes the agreed strategy and work programme of which the proposal is an integral part. Key areas of focus include: Is the investment proposal aligned with all relevant strategies? Is there a good strategic fit with wider organisational, sectoral, regional, and Government strategies? Is there a good strategic fit with other projects or programmes planned or underway? All relevant strategies should be referenced including those at international (if any), national, sectoral, regional and local levels. Alignment of the investment proposal with Government priorities and policy decisions should be demonstrated, where these are relevant. Where an investment proposal is intended to contribute to shared outcomes across multiple organisations, or where expected outcomes contribute to other related projects or programmes, these linkages and inter-dependencies should be clearly demonstrated. Summarise how the investment proposal will help to achieve the business goals, strategic aims and plans of the organisation. The proposed investment should contribute to, and be consistent with strategic business planning. Highlight the high level policy aims and business goals of the organisation, which can then be used as the basis for considering the need for investment. Tip: Much of the above information will be available from existing strategic planning documents, including the latest Statement of Intent (if any), annual reports and other reporting to stakeholders. The expectation is that a fit for purpose summary is provided rather than repeating the content of readily available documents. Any recent and significant changes should be noted. Key documents can be attached as annexes or referenced by hyperlinks. Investment Objectives, Existing Arrangements and Business Needs A robust and compelling case for change requires a thorough understanding of: what the organisation is seeking to achieve (the investment objectives) what is currently happening (the existing arrangements), and problems or issues in addressing the gap between the current state and the desired future state (the business needs). Analysing a proposal in this way can help to provide a more compelling case for investment, as opposed to asserting that it is a good thing to do. This section builds on the initial analysis undertaken previously in the Strategic Assessment to justify the need to invest for change. Better Business Cases: Guide to Developing the Single Stage Business Case 9

12 Set key investment objectives Setting good investment objectives is a critical part of a compelling case for change and for informing the later assessment of potential options. Within the strategic context above, the investment objectives help to specify clearly the desired outcomes for the proposed investment and provide a direction of travel. The investment objectives must relate to the underlying policies, strategies and business plans of the organisation. Where a Programme Business Case has been completed, the programme objectives can provide part of the context for setting project-based investment objectives. The objectives should focus on what the organisation wants to achieve from the investment proposal. Procuring an asset or service is not an investment objective in itself. They should also be SMART (specific, measurable, achievable, relevant, and time-bound) to help facilitate the generation of potential options and to provide the foundation for postimplementation review and evaluation. The investment objectives should: be customer-focused and distinguishable from the means of provision focus on what needs to be achieved rather than the potential solution not be so narrowly defined that they preclude important options, and not be so broadly defined that they cause unnecessary work at the options analysis stage. A facilitated workshop approach is recommended to develop and agree the investment objectives. This ensures that key stakeholders are well-engaged and can challenge and shape the direction of the proposal. In practice, this workshop thinking builds on the earlier Strategic Assessment workshops used to identify and agree the investment drivers and the need for change. In practice, well-defined investment objectives typically address one or more of the following five generic investment rationales: To improve effectiveness. For example, by improving the quality of services, improving access or better targeting these services to meet demand. To improve efficiency. For example, by improving the relationship between the quantity of inputs employed and the quantity, quality and timeliness of services delivered. To reduce costs. For example, by reducing the underlying costs of the inputs employed to deliver existing services. To meet statutory, regulatory or organisational requirements. This can include complying with new or changing legislative requirements (or organisational policies). To re-procure services or avert service failure. For example, at the end of an existing contract or where an enabling asset is no longer fit for purpose. 10 Better Business Cases: Guide to Developing the Single Stage Business Case

13 The investment objectives should be clear and concise. Focus on the vital few. Three to five objective statements are typical, although some proposals may require either fewer or more. A large number of investment objectives, or single objective statements that encompass multiple outcomes, can undermine the clarity and focus of the proposal. As the investment objectives are used for assessing potential options, significant effort is justified in developing and agreeing them. This may require an iterative process, including revisiting and refining the objective wordings as subsequent business case development is undertaken. Any significant variations should be agreed with the original workshop participants. Examples of SMART investment objectives: To reduce departmental travel procurement costs by at least 10% before 30 June 2016 To improve the patient experience of ABC hospital catering to 95% by 30 June 2017 To reduce energy consumption by government departments by at least 5% each year from 2016 to 2020 To reduce avoidable admissions from the Emergency Care Centre by 1000 per annum by 2017 Document existing arrangements Summarise the current state. That is, describe the existing arrangements and explain how services are currently organised, provided and supplied. Include any relevant contextual details about stakeholders, competitors, suppliers, customers, turnover, and asset availability, utilisation and condition. The purpose is to provide a snapshot of where the organisation is now and the model of service delivery. This description will form the basis for specifying the status quo or do nothing option, the baseline for measuring successful change. Tip: Often what we perceive as being an issue with the current state may be a symptom or an urban myth. Requiring an evidential base can challenge existing perceptions. Specify business needs Describe the business gap, the difference between the current state and the desired future state. The current state is where the organisation is now and is described by the existing arrangements above. The desired future state is where the organisation wants to be and is described by achieving the agreed investment objectives. The gap describes the change required to be achieved. This analysis should take into account existing and future changes in the demand for the services being considered. In most cases, it will be necessary to include: confirmation of the continued need for existing business operations, including supporting evidence projections of the nature and level of demand for future services (including customer demographics and alternative sources of supply) Better Business Cases: Guide to Developing the Single Stage Business Case 11

14 deficiencies in current provision, and a summary of requirements, distinguishing clearly between the current and the future states. This analysis is intended to highlight any problems, difficulties and inadequacies associated with the status quo, of not investing in change. The analysis should also build upon the strategic context, investment drivers and supporting evidence used for confirming the need for investment. Potential Business Scope and Key Service Requirements Identify the potential scope of the proposal and the services required to satisfy the identified business needs and gaps. Define the potential business scope Specify the scope of the proposal from the perspective of the organisation in terms of affected business areas and functionality. Where the investment objectives describe the direction of travel from the status quo, this describes the degree or scale of change required for the investment proposal to be considered successful. These can vary from the core or minimum scope, through to the most aspirational. This step is important as it effectively sets out the boundaries, or limitations, of the proposal. Only options within this scope will be assessed within the economic case. These scope boundaries should be concise enough to avoid later scope creep, but broad enough to encourage consideration of innovative options or solutions. Clearly specifying the business scope ensures that the proposal focuses on those key service requirements that meet the investment objectives and are likely to improve value for money. Establish key service requirements In relation to scope, identify and prioritise the key services required to be delivered as part the proposal. The purpose is to ensure that the investment is driven by consideration of key service requirements, and not vice versa, or by service requirements that are outside the scope of the proposal. First identify the required service requirements and order by decreasing relevance compared to the investment objectives. It is useful to then classify service requirements as either being: Minimum service requirements - representing the must have or core service requirements essential for the investment proposal to be successful Desirable service requirements - considered if they represented good marginal value for money, or Optional service requirements these are more aspirational and may be included in the proposal if they can be added at low marginal cost and are likely to be affordable. Identify and discard the remaining service requirements that are out of scope or unlikely to provide value for money. For example, service requirements that may meet the needs of only a small portion of target users or result in development of excess capacity or capability. 12 Better Business Cases: Guide to Developing the Single Stage Business Case

15 Classify the potential scope and the associated service requirements in terms of a continuum of business needs: Minimum scope minimum, core service requirements only Intermediate scope minimum plus desirable service requirements (if value for money) Maximum scope minimum, desirable and optional service requirements. These alternative service requirement descriptions are useful in informing the identification of scope options in the later economic case. The example below demonstrates the analysis. Tip: Given the importance of seeking early agreement from key stakeholders on the scope of the investment proposal, it is recommended that the analysis of scope and service requirements be completed as part of the facilitated objectives workshop. Table 3: Scope and service requirements for a hypothetical proposal to expand advanced trades training provision, as agreed in a facilitated workshop with key stakeholders. Scope Assessment Service Requirements Additional advanced trades training provision Minimum Scope 200 EFTS (Equivalent Full Time Students - core) Intermediate Scope Maximum Scope Out of Scope 400 EFTS 1,000 EFTS Above 1,000 EFTS Applied research projects with industry X One on-site project (desirable) Two on-site projects (optional) More than two projects on-site exceed capacity constraints Commercial incubator X X X Determined as unaffordable for this proposal. Benefits, Risks, Constraints and Dependencies Assuming that the required services are to be delivered, identify the potential benefits, risks, constraints and dependencies associated with the investment proposal. Identify potential benefits In the wider context of investing in change, a benefit is any gain to one or more stakeholders from achieving the change in state. Undertaking a project or programme to achieve the investment objectives should result in attributable benefits of some kind. Otherwise, why do it? Benefits can also be considered as the return from the investment in undertaking a project or programme. Better Business Cases: Guide to Developing the Single Stage Business Case 13

16 Showing the logical contribution of benefits to an organisation s outcomes is a way to align initiatives with the organisation s strategy. This is an important consideration when assessing whether or not initiatives should proceed. For state sector organisations, and unless otherwise agreed with the Treasury vote team or monitoring agency, all significant benefits should be identified from a national economy perspective rather than just those that are realised directly by the organisation, stakeholders or users. This recognises the wider public value perspectives of ministerial decision-makers when making resource allocation choices. This analysis should build on the benefits and key performance indicators first identified in the Strategic Assessment undertaken previously. These can provide a useful starting point and should be revisited. Where a Programme Business Case has been completed the initial analysis of potential programme benefits should provide the context for developing projectbased benefits. The benefits should then be characterised by whether or not they are monetary or nonmonetary, direct or indirect and quantitative or qualitative 7. Benefits may be measureable in either monetary terms (such as avoided costs or efficiency savings) or non-monetary terms (either quantifiable, such as reduced customer complaints or qualitative, such as improved health outcomes). Qualitative benefits may be observable but not easily measured. Disbenefits with negative impacts on stakeholders also need to be identified and analysed. Some benefits may be uncertain or contingent on other events, and can be better classified with risks, as opportunities. This analysis is concerned primarily with identifying and describing the main benefits at this stage. The benefits need to be comprehensive (to avoid significant under-statement of the impacts) and be mutually exclusive (to avoid double-counting impacts).. Benefits may either have a direct or indirect impact and can result in both winners and losers. The analysis should identify those stakeholder groups who potentially gain or lose from the proposal, both those affected directly by the investment and those affected indirectly elsewhere in the wider economy. This recognises that sometimes those investing the most in terms of resources might not always be the main beneficiaries. 7 Refer to the Treasury Cost Benefit Analysis Primer at 14 Better Business Cases: Guide to Developing the Single Stage Business Case

17 Table 4: examples of different types of monetary benefits Monetary Benefit Examples Stakeholders Affected Direct or indirect? Efficiency gains [due to better utilisation of staff and facilities, reduced consumables, reduced maintenance costs and energy savings] Increased revenues or avoided costs [due to costs transferred to users or other parties, reduced risk of revenue loss] Organisation Organisation Direct Direct Higher incomes [due to skills or qualifications acquired] Learners Indirect Reduced user costs [due to time savings by users of web-based systems or reduced travelling times] Users Direct Table 5: Examples of different types of benefits that cannot easily be expressed in monetary terms Non-monetary Benefit Examples Stakeholders Affected Quantitative or Qualitative? Increase in staff skills [greater staff satisfaction resulting in lower turnover] Improved user outcomes [improved health outcomes resulting in higher QALYs Quality of Life Years] Improved national security [improved capability to respond to contingent events] Organisation Users Public Quantitative Quantitative Qualitative Improved community awareness [of smoking risks] Public Quantitative Improved participation [in health food and exercise programmes] Users Quantitative Identify the main risks to objectives A risk is the chance of something happening that will have an impact on objectives. It is measured in terms of a combination of the likelihood of a contingent event and its consequence. There is always likely to be some difference between what is expected and what eventually happens, because of biases inherent in the assessment and the risks and uncertainties that materialise during the development phases of a project. As a result, risk management strategies should be adopted for the assessment and implementation of proposals. This is because things can always go better than expected (upside risk) as well as worse (downside risk). The main risks associated with the proposal should be identified and assessed. The emphasis should be on the 20% of risks which are likely to account for 80% of the total risk. Risks first identified as part of the Strategic Assessment (or the Programme Business Case where these are relevant to the proposal) can be revisited and updated. Better Business Cases: Guide to Developing the Single Stage Business Case 15

18 The aim of this process is to consider risks that might create, enhance, prevent, degrade, accelerate or delay the achievement of the investment objectives. Detail the sources of potential risk, the likely consequence (high, medium or low), estimated probability of occurrence (high, medium or low likelihood) and relevant factors including possible changes in circumstances, causes and potential consequences. It is important to develop a risk register from the very beginning of the business case development process, in accordance with accepted good practice and any organisational risk management policies 8. Table 6: A model for considering different types of risk 9 Categories of Risk Possible Sources of Risk Notes External and environmental risks Business risks Service risks political economic social/demographic technological changes legislative environmental commercial cross-agency initiatives governance and stakeholders inter-dependencies (to/from other programmes and projects) resources and funding specification time-scale change management project management costs and benefits training and users suppliers, availability performance and volumes These are external to the organisation and can be more difficult to mitigate or manage. Where these are within the control of the organisation they can be mitigated. These risks are associated with the design, build, funding and operational phases of a new service. Some risks may be able to be transferred to external suppliers or partners. 8 9 For further detail, refer to AS/NZS ISO 31000:2009 Risk management principles and guidelines - available from the Standards NZ website at Based on information from the HM Treasury (UK) Green Book, available at 16 Better Business Cases: Guide to Developing the Single Stage Business Case

19 The risk register should be updated regularly and used on a consistent basis for: identifying the main risks (in the strategic case) quantifying and assessing significant risks that impact on net benefits (in the economic case) apportioning service risks (in the commercial case), and managing risks over the life-cycle of the project (in the management case). Table 7: Example of the initial risk assessment for a hypothetical proposal Examples of Risk Event Consequence (H/M/L) Likelihood (H/M/L) Risk Management Approach Demand for services less than forecast Efficiency gains are not realised Lack of community support Organisation lacks capability to implement High High Accept this risk and allow for variability in revenue projections. High Medium Manage by monitoring benefits realisation and by planning for contingencies. High Medium/ Low Mitigate this risk by early communication, via local news media. High/ Medium Medium/ Low Remove this risk by investing in appropriate capability during implementation. Change management High High Mitigate this risk by managing staff expectations and providing development opportunities. Projects over-budget or over-time Medium Medium/ High Mitigate by negotiating risk-sharing arrangements with contracted suppliers. Quantify your Optimism bias The most familiar form of risk to investment objectives is that the estimated future costs arising from the given proposal are overly conservative, the benefits are overly optimistic, or both. The early analysis may not fully reflect the possibility of cost-overruns, short-falls in demand or implementation timing delays. This is termed optimism bias. There is a demonstrated, systematic, tendency for individuals to exhibit optimism bias when preparing spending proposals. The effects of optimism bias can be mitigated by making explicit adjustments to key assumptions and variables, for example by increasing proposal cost estimates, reducing projected benefits, or by assuming benefits are delayed. The amount of optimism bias typically depends on the nature of the investment proposal and the accuracy of the estimates for proposal costs and benefits. As the business case development proceeds and estimates are refined, the level of optimism bias can be expected to reduce and incorporated as a contingency in the contracted project. Better Business Cases: Guide to Developing the Single Stage Business Case 17

20 A 2002 review by Mott McDonald of the optimism bias inherent in a sample of large UK projects resulted in the following indicative table of percentage adjustments. Table 8: Estimated optimism bias adjustments by project type (source: HM Treasury (UK) 10 ) Optimism Bias (%) Adjustments Project Type Works Duration Capital Expenditure Upper Lower Upper Lower Standard Buildings 4% 1% 24% 2% Non-standard Buildings 39% 2% 51% 4% Standard Civil Engineering 20% 1% 44% 3% Non-standard Civil Engineering 25% 3% 66% 6% Equipment/ Development 54% 10% 200% 10% Out-sourcing (operating expenditure) n/a n/a 41% 0% The above adjustments can be taken into account when estimating costs and benefits. Costs can be increased by the adjustment and benefits can either be reduced or delayed. Note that optimism bias can be expected to reduce over the business case development as the level of uncertainty around cost and benefit estimates reduce. More sophisticated forms of risk quantification and modelling is required later in the economic case. Identify and manage your constraints Constraints are limiting parameters within which the investment must be delivered. These can include relevant Government policy decisions, initiatives or rules. Affordability constraints can include funding envelopes or limits on the amount of either operating or capital expenditure that can be incurred. Likely constraints imposed on the proposal should be identified and managed from the outset, as they can limit the range and scale of the investment options that may be considered for further assessment. Identify dependencies with other initiatives Any actions or developments required of others and outside the scope of the project or programme should be considered if the ultimate success of the investment proposal is dependent upon them. For example, this could encompass the delivery of outputs associated with other projects within the same overall programme. This section should also identify outward dependencies, other things that rely on this project to deliver what it says it is going to. 10 Refer to the HM Treasury Green Book supplementary guide at 18 Better Business Cases: Guide to Developing the Single Stage Business Case

21 Economic Case Determining Potential Value for Money Having determined the strategic context for the investment proposal and having made a compelling case for change, this part of the Single Stage Business Case determines the preferred option that optimises value for money by: identifying critical success factors identifying a wide range of options available for delivering the required services initially assessing these options to determine a short-list undertaking cost benefit analysis of the short-listed options assessing any intangible benefits and costs, and assessing risk and uncertainty. The recommended approach for identifying critical success factors and for identifying and assessing options is by using facilitated (options) workshops with a representative group of senior business managers, stakeholders, users and technical specialists. This approach helps to ensure that key stakeholders are engaged early and are able to challenge and direct the preferred way forward. Given the need to access a representative mix of technical skills and judgements, a different mix of stakeholders may be appropriate than for the previous workshops. This facilitated (options) workshop process can involve: consulting widely with practitioners and experts to gather information relevant to the objectives and scope of the problem analysing the data to understand significant dependencies, priorities, incentives and other drivers considering past experience, identify best practice solutions, including international examples, if appropriate considering the full range of issues likely to affect the objectives identifying the full range of types or scales of policy interventions that may be used to meet the objectives, and developing and considering radical or innovative options. Better Business Cases: Guide to Developing the Single Stage Business Case 19

22 Critical Success Factors Critical success factors are the attributes essential to successful delivery of the investment. The critical success factors form part of the set of criteria for the initial assessment of each potential option, along with the investment objectives and potential benefits, costs and risks. The key point is that they must be crucial, not desirable. The critical success factors should be identified and agreed by key stakeholders, but not be set at a level which could potentially bias or exclude important options at an early stage of the analysis. Table 9: A starting point for identifying and agreeing critical success factors, based on the five case model. Key Critical Success Factors Strategic fit and business needs Potential value for money Supplier capacity and capability Potential affordability Potential achievability Broad Description How well the option: meets the agreed investment objectives, related business needs and service requirements, and fits with other strategies, programmes and projects. How well the option: optimises value for money (ie, the optimal mix of potential benefits, costs and associated risks). How well the option: matches the ability of potential suppliers to deliver the required services, and is likely to result in a sustainable arrangement that optimises value for money over the term of the contract. How well the option: can be met from likely available funding, and matches other funding constraints. How well the option: is likely to be delivered given the organisation s ability to respond to the changes required, and matches the level of available skills required for successful delivery. Tip: A potential option that fails to meet a critical success factor is not carried forward to the short-list. The intent is to agree an objective basis for determining which options should be included or excluded from the short-list. Hence these should be agreed prior to the initial options identification and not changed afterwards. Long List Options and Initial Options Assessment The purpose of this section is to consider as wide a range as possible of realistic options for meeting the investment objectives that lie within the identified scope, and are likely to achieve the expected benefits. This long-list is assessed against the investment objectives and critical success factors to determine a short-list of three to five options. 20 Better Business Cases: Guide to Developing the Single Stage Business Case

23 The workshop approach has proven to be a particularly useful means of engaging stakeholders and senior management early on the preferred way forward. Identify the long-list options Once the critical success factors are agreed, the second part of the facilitated options workshop should be dedicated to brainstorming as wide a possible range of realistic options for meeting the identified service needs. A suggested approach is to systematically identify possible options within each of five dimensions in turn. The five dimensions are scale, service solution, service delivery, implementation and funding. Tip: Generate potential choices within each row independently to ensure that as wide a range of possible choices are identified and considered, at least initially. In practice, some choices may be ruled out early, for example an orphan funding choice that does not relate to any identified service scope or solution choices. Table 10: Identification of options within each of the five dimensions Dimension Description Choices within each Dimension Scale, scope and location In relation to the proposal, what levels of service (supply) and coverage (user) are possible? For example, by levels of functionality, geographic coverage, population/user base, etc. SC1 (base) SC2 SC3 SC4.. Service solution How can services be provided by the organisation? For example, alternative processes, mixes of enablers, etc. SS1 (base) SS2 SS3 SS4.. Service delivery Who can help us deliver the services? E.g. in-house or out-sourced or alternative partnering arrangements. SD1 (base) SD2 SD3 SD4.. Implementation When can services be delivered? Including choices about the pace of change. For example, timing and staging, big bang, phased, modular, etc. I1 (base) I2 I3 I4.. Funding How can it be funded? Including choices of funders and possible arrangements. For example, capital or operating, privately or Crown funded, user charging, etc. F1 (base) F2 F3 F4. Better Business Cases: Guide to Developing the Single Stage Business Case 21

24 Table 11: A hypothetical example of long-list options for a new specialised vocational training proposal for a regional polytechnic within each of the five dimensions of choice Dimension Base Case Choices within each Dimension Scale, scope and location No current delivery of training Target regional atrisk year olds (200 students pa) All regional learners (400 students pa) National learners (up to 800 students pa) Service solution None Centralised on-campus delivery Delivery from multiple campuses Mix of in-work learning and block courses Include online training modules Service delivery None In-house delivery and development Out-source to external training providers Strategic partnership with another polytechnic Implementation n/a Pilot only Phased to 2016 Big bang in 2014 Funding None Polytechnic capital and operating Increased bank debt Crown capital contribution Industry contribution A base case option must be included and will act as the baseline for determining relative value for money. It can be created by combining the status quo choices from each of the five dimensions into a single option 11. This may either be the status quo, do nothing or do minimum, depending on which is the most realistic option in the circumstances. The analysis of the existing arrangements can be used to inform the specification of the base case. Impractical choices can be ruled out early to avoid undue time or effort being expended on further assessment. Impractical choices may sometimes be ruled out early for valid legal, financial or political reasons, where these were identified as constraints. Any State sector capital proposals requiring Cabinet approval and having whole of life costs in excess of $25 million must include consideration of non-traditional procurement options, which could include public private partnership (PPP) Note that the status quo option for the implementation dimension is typically meaningless as there is no change per se. 12 For proposals that that are likely to result in a non-traditional procurement, a different approach to market may be required. Refer to the PPP supplementary guidance to the Guide to Developing the Indicative Business Case and the PPP guidance available from 22 Better Business Cases: Guide to Developing the Single Stage Business Case

25 If long-list options with regulatory impacts are being considered, a Preliminary Impact and Risk Assessment (PIRA) may be required if this has not already been addressed. Refer to the Treasury Regulatory Impact Analysis Handbook and contact The Treasury for further guidance. 13 Assess the long list options to determine the short-list Following the identification of realistic long-list options, a second facilitated options workshop can be used to conduct an initial assessment of the long list options, to determine the shortlist and the preferred way forward. The extent or depth of this options assessment should be tailored to the relative size, impacts, and risks of the proposal. This will affect the choice of assessment tool and the methodology used. Due to the likely level of uncertainty in cost and benefit estimates, there is no expectation that net present values be calculated and used to screen long-list options at this initial stage. The process and depth of analysis required should be fit for purpose, agreed with your monitoring agency and be documented in the Scoping Document. One common approach is to use multi-criteria decision analysis tools to rank the options against the assessment criteria. Using an expert facilitator and proprietary tools can help ensure that the level of robustness of the ranking processes meet the expectations set out on the Scoping Document. Not all proposals will justify a full multi-criteria analysis approach. Other simpler and less expensive ranking tools may also be considered where these meet expectations. In practice the stakeholders assess the choices within each dimension in turn. Each potential choice within the dimension is assessed against the agreed assessment criteria. These suggested assessment criteria are: Investment objectives: Each choice can be ranked in terms of how well it meets each of the investment objectives. For example, one approach could be to rank the options as either strongly agree, agree, disagree or strongly disagree. More sophisticated scoring approaches can be adopted depending on the individual proposal and the agreed assessment methodology. Critical success factors: Stakeholders assess each choice as either yes, partial or no against each of the critical success factors. A fail against any critical success factor should result in the choice being disregarded and not being included in the short-list options. Advantages/disadvantages: This is a qualitative analysis approach that considers the efficacy of the option in terms of benefits likely to be delivered, the level of associated risks and costs, and any relevant constraints or inter-dependencies. This analysis should be documented separately and presented as part of the overall assessment. 13 Refer to the Treasury website at Better Business Cases: Guide to Developing the Single Stage Business Case 23

26 Table 12: Format for the stakeholder assessment of scale, scope and location choices. This process is repeated for each of the five dimensions of choice. Assessment Scores for Choices within the Scale, Scope and Location Dimension Assessment criteria SC1 (base) SC2 SC3 SC4.. Investment objectives: Investment objective 1 Investment objective 2 Investment objective 3 Critical Success Factors: Strategic fit and business needs Potential value for money Supplier capacity and capability Potential affordability Potential achievability Advantages and Disadvantages: Overall Assessment Carry forward to short-list The results of the assessment of the choices within each dimension can be presented in a summarised, tabular form. An example is shown in the annexes to this guide. Choices (long list options) are listed by dimension across the table. The rankings for each long-option are listed in each of the rows that correspond to the assessment criteria. The final row presents the overall assessment and indicates if each long-list option is discounted, preferred or carried forward to the short-list. In the example, four composite short-list options are carried forward for further consideration (along with the base case option). The preferred way forward should ideally be the composite option amalgamated from the preferred choices within each dimension of choice. The other (one to three) short-listed options may represent variations of the preferred way forward, say with less or more ambitious scope choices, alternative solutions, a faster or slower pace of implementation or alternative funding arrangements. Tip: The detailed, underlying narrative options assessment should be documented and included as an annex to the Single Stage Business Case as this will enable the reviewer to assess the level of analysis and thinking underlying the short-list assessment. 24 Better Business Cases: Guide to Developing the Single Stage Business Case

27 Economic Assessment of the Short-Listed Options An economic assessment seeks to capture all benefits and costs regardless of to whom they accrue. Economic assessments also take into account costs and benefits that may not be reflected in monetary transactions. An economic benefit is considered to be any gain in the welfare of society arising from the investment proposal. It can include the time savings from reduced travelling times on a new motorway or the increase in quality of life years remaining as a result of a new pharmaceutical treatment. Different stakeholder groups derive different benefits (and dis-benefits) from an investment proposal and will have different perspectives on the value added. For State sector investment proposals, Treasury s expectation is that the assessment of the investment proposal will be undertaken from a national, economic perspective rather than a narrower all-of-government, agency, programme or project perspective. A national economy perspective is preferred because the actions of an organisation can impose costs or benefits on individuals or the nation as a whole (for example increasing the size of a programme operated by a particular Government department may require a large increase in income tax on individuals). The New Zealand Treasury higher living standards framework provides a useful basis for thinking about and assessing the economic impacts of State sector investment proposals on the overall living standards of New Zealanders, as well as the distributional effects across the population. 14 Economic Cost Benefit Analysis is the preferred assessment method There are various forms of economic assessment tools that can be used for ranking competing investment options, with differing levels of complexity. The expectation is that cost benefit analysis (CBA) will be used, wherever possible, and undertaken from a national perspective rather than a narrower all-of-government, agency, programme or project perspective. This is termed economic cost benefit analysis. Economic cost benefit analysis is flexible and can generally be applied to assess most proposals. It is the recommended, first-best, approach. By identifying and quantifying costs and benefits in monetary terms, it is possible to demonstrate that the expected benefits of a given option exceed the expected costs. That is, to determine if there is a net benefit. Discounting should be applied to determine the net benefits in today s dollars, termed the net present value (NPV). The discounted net benefits can then be used to quantitatively rank between a given option and the base case, or between competing options. Decision-makers and stakeholders can be provided with a consistent basis for assessing the trade-offs and relative value for money of competing options, and can be better informed about the implications of using economic resources. 14 Refer to Working Towards Higher Living Standards for New Zealanders (May 2011) available from Better Business Cases: Guide to Developing the Single Stage Business Case 25

28 Cost benefit analysis has some limitations that mean it is not suitable for assessing every type of proposal. It can be difficult to assign monetary values to all costs and benefits. Where nominal monetary values cannot be assigned, it may be possible to estimate a range of monetary values for assessment purposes. A range-based approach for selected costs and benefits will generally provide a better basis for assessment than not assigning monetary values at all. If there is not a sufficient base from which to conduct a full economic cost benefit analysis, a combination approach may be used. This would apply cost benefit analysis for those costs and benefits that can reasonably be assigned monetary values. Some benefits and costs may not be reliably quantified in monetary values and may need to be assessed separately using multi-criteria analysis techniques 15. This approach is detailed below. The assessment process Undertaking economic assessment of the short-list options involves eight steps: a. Establish the assumptions and scope underlying the analysis. Should a national economic or agency-specific analysis be applied? Determine what additional economic analysis is required to produce suitable monetary estimates. b. Decide an appropriate period for the analysis. This appraisal period typically matches the economic life of any proposed asset. In some cases it may be determined by the contractual term of the services. Where options have differing economic lives, a single common appraisal period is required. Either residual values can be assumed for the longer term options or reinvestment of shorter term options. c. Identify all significant benefits and costs. The monetary and non-monetary benefits can be revisited and updated. All material direct and indirect, monetary and non-monetary costs should be included. Indirect costs as a result of the outcomes of the proposal may be incurred by the organisation, other agencies, users and other affected stakeholders. d. Assign monetary values to the benefits and costs, wherever possible. Document all assumptions made about the scale, timing and growth of benefits or costs over the appraisal period. All monetary estimates should be expressed in current dollar terms as allowance for general inflation is factored into the discount rate. GST, depreciation, capital charges and financing costs are also typically excluded. e. Discount the benefits and costs to present values using the Public Sector Discount Rates specified from time to time by the Treasury 16. Where a different discount rate is proposed, this should be tested as part of the Scoping Document discussion. f. Consider the effect of any benefits or costs that cannot be reasonably and reliably assigned monetary values. g. Assess risk and uncertainty where it can result in variations to benefit and cost estimates, and consequently on the options assessment. h. Identify the preferred option and undertake sensitivity analysis to test its robustness. 15 Refer to the Treasury Cost Benefit Analysis Primer available at 16 Refer to the Public Sector discount rates published on the Treasury website at 26 Better Business Cases: Guide to Developing the Single Stage Business Case

29 For further guidance on undertaking a cost-benefit analysis, refer to the Treasury Cost Benefit Analysis Primer. 17 Non-monetary Benefits and Costs All benefits and costs that can be quantified in monetary terms should be included in the economic assessment and subject to economic cost benefit analysis. However, some benefits and costs may not be reliably or reasonably quantified in monetary values. These are termed non-monetary benefits or costs. If they are significant, these non-monetary benefits and costs will influence the choice of the preferred option. Significant non-monetary benefits and costs should be explicitly highlighted and explained in the analysis so that decision-makers are aware of the value judgements and trade-offs involved in pursuing a particular option. This explanation can be quantitative, qualitative, descriptive, or a combination of these. One approach is to use decision modelling tools to weight and score the non-monetary benefits and costs for each option. The preferred form of qualitative analysis for comparing unvalued benefits and costs is multi-criteria decision analysis (MCDA). Multi-criteria decision analysis is a tool for assessing and ranking alternative options against a given set of investment criteria. The alternative options can be assessed and scored (typically by a representative panel of stakeholders) against the criteria. The weighted overall scores provide a ranking of alternative options. Multi-criteria decision analysis can be less rigorous than cost benefit analysis, but is relatively easy to implement and can be used to assess and compare options that involve both monetary and non-monetary impacts. It can aid decision-making by complementing the quantitative economic cost benefit analysis above. The process and the reasoning behind the scores and weightings must be documented clearly to demonstrate that a robust analysis has been carried out. Again, it is important to recognise that the assigned weights and the scores given to options are value judgements. In order to assign weights and scores, negotiation and compromise needs to take place. It is the number of people involved in the panel process and their expertise that lends credibility to these value judgements. It is, therefore, worth spending some time choosing a representative benefits team which should include stakeholders, customers (users), and business and technical representatives. The people involved should be named as part of the process. The extent or depth of the analysis should be tailored to the relative size, impacts, and risks of the proposal. A more robust assessment can be attained by using expert facilitators. Proprietary multi-criteria decision analysis tools are available and can be used to help ensure that the weighting and scoring processes are objective. 17 In addition to the Treasury guidance, a useful cost-benefit analysis spread-sheet templatel can be downloaded from the Tertiary Education Commission website at Sector/Crown-Interest/Business-Cases/Step-Two--Business-Case-Development/ Better Business Cases: Guide to Developing the Single Stage Business Case 27

30 However not all proposals will justify or require a full multi-criteria decision analysis. If two comparable options have similar benefits and it is demonstrated that a multi-criteria analysis would not add further value to the analysis of intangibles, a cost-effectiveness analysis may provide an adequate and fit for purpose alternative. Prior to commencing development work, negotiate the process to be followed, the amount of analytical effort and the decisions needed with the monitoring agency (or internal unit). These agreements should be documented in the relevant Scoping Document. Risk and Uncertainty All benefits, costs and timeframes estimated in the economic assessment are subject to risk and uncertainty. Risk can influence the choice of the preferred option. Given the choice between two competing short-listed options with similar estimated costs and benefits, a riskaverse decision-maker will likely prefer the option that provides greater certainty of costs, benefits and timings of key deliverables. For this reason, decision-makers can typically prefer options that offer shorter term realisation of benefits. The aim of this section of the guide is to consider all significant risks that might create, enhance, prevent, degrade, accelerate or delay the achievement of the objectives associated with the investment proposal. Its purpose is to support better decision-making through understanding the risks inherent in each of the short-listed options and their likely impact. Over the business case development, risks need to be analysed and managed. Risk analysis encompasses identification, estimation and evaluation. It is recommended that all significant risks should be measured and quantified (in monetary terms) as early as possible. The risks initially identified by stakeholders should be revisited and re-evaluated. Optimism bias The simplest form of quantification of risk is by applying optimism bias loadings to costs or timeframes to reflect the systematic tendency for business case developers to be overoptimistic about key parameters. The adjustments can be based on past empirical experience of similar projects and should be reduced at different stages of the business case development as progressively better estimates are made 18. While simple, the disadvantages are that it reflects downside risks only and is unlikely to be fit for purpose for this stage of the analysis. Single-point probability analysis An expected value can be calculated for each significant risk by multiplying the likelihood of the risk occurring (probability) by the size of the consequence. This risk premium is expressed in monetary terms and provides an estimate of the cost of accepting all the risk. It is best used when both the likelihood and consequence of the risk event can be estimated reasonably well. The disadvantage is that it provides no information about the underlying variability in outcomes or consequences, particularly at the extremes when decision-makers may prefer not to accept the risk of the event occurring. 18 Refer to the HM Treasury Green Book supplementary guide at 28 Better Business Cases: Guide to Developing the Single Stage Business Case

31 Quantitative risk analysis (QRA) For any risk, a range of possible outcomes (and consequences) is more likely. An output probability distribution provides a more complete picture of the possible outcomes and recognises that some of these outcomes are more likely to occur than others. Quantitative risk analysis (QRA) is a modelling technique that makes risks, and the financial impact of those risks, more explicit to decision-makers when considering the business case. This recognises that using single point estimates for comparing options can provide relatively limited information about the underlying trade-offs. QRA of costs is mandatory as part of the development of a business case for high risk major projects or programmes monitored by the Treasury. The Treasury maintains a panel of accredited quantitative risk analysis experts for use by Government agencies. 19 Quantitative risk analysis can provide a better understanding of the sources of risk to project outcomes and more accurate estimates of the likely costs or benefits. Generally a quantitative risk analysis approach is considered to be superior to an approach that solely relies on optimism bias or contingencies. Quantitative risk analysis should be used as the first-best basis and is required for high risk, large scale investment proposals. Quantitative risk analysis conducts detailed sensitivity analysis and analysis of the likely effect of these scenarios on project outcomes. This involves assessing each probability and consequence and modelling project outcomes based on simulations of each risk. The final probability distribution describes the range of outcomes and their relative likelihood. The risk modelling process involves: a. building the models b. including distributions for uncertain inputs c. simulating outcome distributions d. generating outcome graphs and tables, and e. reviewing and revision as necessary. Impacts, other than financial, must also be considered and documented. Monte Carlo analysis Monte Carlo analysis is a specific risk modelling technique that uses statistical sampling and probability distributions to simulate the effects of uncertain variables on model outcomes. The approach provides a systematic assessment of the combined effects of multiple sources of risk in key variables and can also allow for known correlations between these variables. Using Monte Carlo can require expert advice to develop the model and interpret the results. 19 Refer to the State Services Commission website at Better Business Cases: Guide to Developing the Single Stage Business Case 29

32 The Monte Carlo approach is more suited to proposals where there are several key variables with significant and/or correlated uncertainties, and when simpler sensitivity analysis approaches are unable to adequately describe the resulting variation in net benefits between competing options. Scalability of analysis effort The extent or depth of the analysis should be tailored to the relative size, impacts, and risks of the proposal. Not all proposals will require a full economic cost benefit analysis of all costs and benefits, a full multi-criteria analysis or quantitative risk analysis. An alternative to the national economy approach is to limit the scope of the analysis of costs and benefits to financial impacts on a single organisation. Examples may include the impacts of a new accounting package or a lease versus buy decision for property. This simpler form of financial analysis may be appropriate for proposals that are organisation-specific and have minimal impacts on either other organisations, individuals or the wider economy. The standard of analysis specified in the scalability matrix 20 varies from a full economic cost benefit analysis to light financial analysis, depending on the scale and level of risk of the proposal. This is detailed in the table below. Prior to commencing development work, negotiate the process to be followed, the amount of analytical effort and the decisions needed with the monitoring agency (or internal unit). These agreements should be documented in the relevant Scoping Document. 21 Table 13: Scalability of analysis effort Full Analysis Light Analysis Scope of economic analysis National economy Organisation and selected sectors All significant resource flows, including non-monetary costs and benefits Organisation All significant resource flows that can be expressed in monetary terms Non-monetary benefits and costs Multi-criteria decision analysis using expert facilitation and proprietary tools Multi-criteria decision analysis Ranking of nonmonetary benefits and costs Uncertainty Quantitative risk analysis Quantify risks and probabilities 22 Single point adjustments of costs and benefits 20 Refer to the Better Business Cases Overview booklet at available at 21 State sector senior responsible owners should ensure that the relevant Treasury officials are fully engaged as part of the Scoping Document agreements. 22 Consider risk modelling techniques that are less resource intensive than full quantitative risk analysis. For example, by using multi-point probability or decision-tree analysis to estimate the impacts of different outcomes on mid-point risk estimates. 30 Better Business Cases: Guide to Developing the Single Stage Business Case

33 The Preferred Option and Sensitivity Analysis The purpose of this section is to identify the preferred option and test its robustness using sensitivity analysis. The overall objective is to determine which of the short-listed options is likely to provide the best value for money (the optimal mix of benefits, costs and risks). Selecting the preferred option The rationale for recommending the preferred option must be clear and defensible. Sufficient evidence for the selection should be provided along with a clear audit trail for decisionmakers to check the assumptions, evidence and calculations leading up to the selection. Stakeholders and decision-makers should have assurance that the analysis and the selection processes are robust. If a full cost benefit analysis has been undertaken, to the extent that all costs, benefits and risks have been quantified and valued robustly, the best option is likely to be the one with the highest, risk adjusted, net present value. Using the net present value method is the preferred approach. Using alternative techniques, such as internal rate of return, equivalent annual cost, benefitcost ratio and pay-back period methods may be desirable in certain cases. Refer to the Treasury Cost Benefit Analysis Primer and contact your monitoring agency for further guidance. However non-monetary benefits and costs cannot easily be included in the cost benefit analysis and hence are not reflected in the net present value. If they are significant, these non-monetary benefits and costs can potentially out-weigh the net present values and influence the choice of the preferred option. Decision-makers need to be provided with a basis to inform trade-offs between competing short-listed options with different mixes of monetary and non-monetary benefits and costs. This trade-off is demonstrated in the following example. Fully involving stakeholders is very important in making judgements between monetary and non-monetary factors. A facilitated workshop process should be used to ensure that key stakeholders are engaged early and have the ability to challenge the analysis. Often a choice will remain between high cost/high benefit options and low cost/low benefit options. In these circumstances, decision-makers must be sufficiently well-informed to enable them to decide how to make these trade-offs. Better Business Cases: Guide to Developing the Single Stage Business Case 31

34 Table 14: An example of how to present a combined cost benefit analysis/ multi-criteria decision analysis with three intangible benefit criteria and prior to sensitivity testing. In this example the stakeholders need to consider the potential for the higher non-monetary benefits of option three to out-weigh the extra monetary net benefits of option four. Option 1:Do Nothing Option 2: Do Minimum Option 3: Less Ambitious Option 4: Preferred Way Forward Option 5: More Ambitious Analysis Period (years) Capital Costs ($m) $0.0 $22.5 $23.9 $31.6 $45.7 Whole of Life Costs ($m) $14.4 $34.2 $49.7 $70.7 $90.9 Cost-Benefit Analysis of monetary costs and benefits at the Public Sector Discount Rate 23 Present Value of Benefits ($m) Present Value of Costs ($m) $2 $25 $75 $115 $126 $7 $23 $40 $52 $73 Benefit Cost Ratio 0.3:1 1.1:1 1.9:1 2.2:1 1.7:1 Net Present Value (NPV, $m) ($5) $2 $35 $63 $53 NPV Rank (out of 5) Multi-Criteria Decision Analysis of non-monetary benefits and costs (score out of 10) Improved management information (20% weight) Greater inter-agency collaboration (40% weight) More competitive marketplace (40% weight) MCDA Rank (out of 5) = 3= Sensitivity analysis testing the robustness of the preferred option Sensitivity analysis is a form of quantitative analysis that examines how net present values, benefits, costs or other outcomes vary as individual assumptions or variables are changed. This approach can be used to test the robustness of the analysis. 23 Refer to the Treasury Cost Benefit Analysis Primer available at 32 Better Business Cases: Guide to Developing the Single Stage Business Case

35 Sensitivity analysis can help draw attention to those factors that require especially careful assessment or management. This analysis can address two key questions. Would the preferred option still be worthwhile pursuing if some of the key assumptions do not eventuate? What actions can be taken to reduce the risks before accepting a particular option? The sensitivity analysis needs to be well designed and clearly presented. The analysis should give a realistic picture of the extent to which the preferred option is still worthwhile pursuing even if there are significant changes in key variables. The decision about which form of sensitivity analysis to undertake and the effort to invest should be made on a case-by-case basis, depending on the scale of the proposal, the degree of future uncertainty around key costs or benefits, and the risk tolerance of stakeholders. In itself, sensitivity analysis may not change the preferred option. However, if small changes in the assumptions alter the ranking, it is an indication that the investment process should proceed cautiously, because it has non-robust elements in it. This means that a more detailed analysis and testing of the costs, benefits and risks of some of the options should be considered. Sensitivity analysis should be undertaken using two approaches: i scenario analysis, and ii switching values. Scenario analysis testing what if Scenarios are useful in considering how options may be affected by future uncertainty. Scenarios should be chosen to draw attention to the major uncertainties on which the success of the proposal depends. Are there any variables (such as exchange rates, salary costs, demand drivers, timing or assumptions) that materially influence the net benefits? These key variables should be identified using the risk assessment process above. The scenario analysis should then focus on asking what if questions and recalculating the expected Net Present Value for several scenarios. For example, what if one or more sensitive/key variables were changed by ±10%, or ±50%, or whatever is a realistic and possible variation. What if related Government policy altered or critical legislation is not passed? If these events occur, should the proposal proceed? Under what circumstances does the preferred option change? A common approach is to test three scenarios: i pessimistic or conservative scenario ii most probable or base scenario, and iii optimistic scenario. Better Business Cases: Guide to Developing the Single Stage Business Case 33

36 Switching values This is a what if scenario test that highlights how much a given variable (eg an uncertain cost, benefit or key assumption) would have to change to alter the choice of the preferred option. Judgements may be necessary to model how the change would alter the choice of the preferred option. Examples of variables that are likely to impact on the robustness of the choice of the preferred option may include growth of real wages, forecast revenues, demand, prices, and/or assumptions about the transfer of risk. An understanding of how costs fall into fixed, step, variable and semi-variable categories can also help in understanding the sensitivity of the costs of given options. Table 15: Example of an off-shore procurement of capital assets valued at $US23.9 million at an exchange rate of $NZ0.80 (based on option 3 in Table 2 above) and with different exchange rate and price discount scenarios Sensitivity Testing of Option 3 Conservative Scenario Base Scenario Optimistic Scenario Exchange Rate ($NZ per US$) $0.69 $0.80 $0.88 Negotiated purchase price discount Resultant Net Present Value (NPV) of the preferred option 3 ($ million) 10% 15% 25% $29 $35 $40 Various what if scenarios can be constructed by varying the two factors, exchange rate and price discount. The resulting impacts on the overall options analysis and the robustness of the preferred option can then be considered. In the example above and keeping the purchase price discount constant at 15%, the analyst also determines that a worsening in the exchange rate from $0.80 to $0.70 is sufficient to change the choice of the preferred option from option 3 to option 4. The exchange rate of $0.70 is then a switching value. Switching value analysis is an important input to the decision on whether or not a proposal should proceed. These risks need to be clearly highlighted to decision-makers to enable them to accurately assess the degree of robustness of the preferred option. Presenting the preferred option and analysis The rationale for recommending the preferred option should be clear and defensible. Decision-makers and stakeholders should have assurance that the analysis and the selection processes are robust. Sufficient evidence should be provided to explain: all major assumptions, including the scope of the analysis why certain costs and benefits have been included or excluded the valuation methodologies employed to estimate costs and benefits. 34 Better Business Cases: Guide to Developing the Single Stage Business Case

37 The discount rate employed (typically the Public Sector Discount Rate specified from time to time by the Treasury 24 ) : any sensitivity analysis undertaken and any significant qualitative or non-monetary impacts identified (including externalities, deadweight losses and behavioural effects) the justification for the decision criteria employed the final recommendation in a way that its implications and qualifications are easily understood by decision makers, and the biases, limitations and deficiencies of the analysis. 24 Refer to the Treasury Cost Benefit Analysis Primer available at Better Business Cases: Guide to Developing the Single Stage Business Case 35

38 Commercial Case Preparing for the Potential Deal This part of the business case plans early for the commercially viable procurement arrangements needed to implement the preferred solution, prior to issuing requests for proposals. Good outcomes depend on good procurement. Properly planned and effectively executed procurement is essential for all agencies. The term procurement covers all aspects of the acquisition and delivery of goods services and works. It spans the whole contract life cycle from the identification of needs to the end of the service contract, or the end of the useful life and subsequent disposal of an asset. The Procurement Strategy Achieving strategic procurement outcomes in the business case context involves setting strategic priorities and direction. The implementation links strategic planning with operational planning and financial planning and management. Adopting a structured approach to procurement planning results in robust, objective analysis that informs the best methodology to approach the market and achieve optimal procurement outcomes across the range of procurement activities undertaken by the agency. For agencies, strategic procurement can be identified at two levels. Firstly involving highlevel strategic thinking and business planning and secondly, at an operational level when dealing with individual acquisitions. The New Zealand Government procurement framework While New Zealand does not have any legislation or regulations governing public sector procurement, there is a framework based on the Principles of Government Procurement, Government Rules of Sourcing and other procurement guidance that collectively set out expectations and constraints. The responsibility for procurement procedures and decisions is devolved to the individual departments or agencies. 25 New Zealand s Government Rules of Sourcing, along with Office of the Auditor-General s Procurement Guidance for Public Entities and the Principles of Government Procurement provides the framework that promotes responsible spending when purchasing goods and services. The five principles of Government procurement are: 1 plan and manage for great results 2 be fair to all suppliers 3 get the right supplier 4 get the best deal for everyone, and 5 play by the rules. 25 Refer to the Ministry of Business, Innovation and Employment website at 36 Better Business Cases: Guide to Developing the Single Stage Business Case

39 The six principles that govern all public spending are: 26 i accountability ii openness iii value for money iv lawfulness v fairness, and vi integrity. Government departments, New Zealand Police and New Zealand Defence Force are required by Cabinet to follow the Government Rules of Sourcing published by the Ministry of Business, Innovation and Employment in These Rules set out Government s standards of good practice for the sourcing stages of the procurement lifecycle. The rules reflect and reinforce New Zealand s established policy of openness and transparency in government procurement. Other State Services agencies are expected to apply the Rules and agencies in the wider State Sector and Public Sector are encouraged to apply these rules in their own procurements. Relevant good practice guidance includes: Procurement Guidance for Public Entities, also published by the Office of the Controller and Auditor General (2008). This good practice guide contains principles, considerations, and processes to assist public entities when procuring goods or services. Mastering Procurement: A Structured Approach to Strategic Procurement (2011), published by the Ministry of Economic Development. This guide has been developed for Government agencies. It supports good practice and introduces the eight step procurement lifecycle. It takes a structured approach to strategic procurement. 27 Government departments and agencies are encouraged to take a strategic approach to managing public funds. This means developing an understanding of the importance of procurement to achieving its overall public policy outcomes and business objectives and developing a procurement strategy. The agency can then clearly identify the most effective and efficient ways to source and secure goods and services. Identifying how important the goods, services or works are to your agency will help inform the approach you take to the market. The Supply Positioning matrix overleaf helps this analysis. 26 Available from the Office of the Controller and Auditor General (OAG) website at 27 Refer to the Ministry of Business, Innovation and Employment website at Better Business Cases: Guide to Developing the Single Stage Business Case 37

40 Figure 3: The Supply Positioning matrix (source: Ministry of Business Innovation and Employment) Possible procurement approaches There is no one size fits all approach to procurement. At one extreme, the provision of required services and the development of any assets may be delivered utilising in-house resources. Procurement may be simply limited to the conventional purchase of inputs not already held by the organisation. Organisations need to develop an appropriate procurement process that is proportionate to the nature, size, complexity, value and risk of the service. Table 16: Choices of how to approach the market include either one-step or two-step procurement processes One-step procurement process Request for Quote Request for Proposal Request for Tender Two-step procurement process Expressions of Interest or Registration of Interest followed by Request for Proposal or Request for Tender Invitation to Participate followed by a Request for Proposal or Request for Tender in a Competitive Dialogue process. 38 Better Business Cases: Guide to Developing the Single Stage Business Case

41 Choices for contracting include: contract for the supply of goods, services or works, or a combination of goods, services or works contract a supplier from an established pool of Panel Suppliers, e.g. an agency s own Panel or a government collaborative contract such as All-of-Government contract, Common Capability contract or Syndicated contract contract for rental or lease Build-Operate-Own -type contracts, such as Public Private Partnerships. Collaborative procurement (shared services) Strategic and ad-hoc collaborative arrangements should be considered. These arrangements can be successful where the parties have shared interests and objectives and there is mutual trust, openness and transparency. Types of collaborative arrangements include Syndicated contracts, Common Capability contracts, and All-of-Government contracts. 28 Compared to conventional purchasing arrangements, collaborative approaches can potentially provide: greater flexibility better value for money through improved economies of scale reductions in procurement costs through pre-competition, reduced tendering and subsequent contract management effort cost savings and other non-price benefits achieved through collaboration, and alignment with best practice procurement. Lease agreements In the public sector context, a lease is considered to be a medium to long-term contractual arrangement for the rental of equipment or property or the on-going delivery of infrastructure needed to support government service delivery. Normally these contractual relationships would require a competitive tendering process. They may also require a business case to support decisions by Cabinet ministers. 29 A variation on this theme is a sale and lease-back transaction, in which the Crown sells an existing property to the third party which then leases the property (with improvements) back to the Crown for an agreed period. 28 More information is available at 29 Refer to Cabinet Office circular CO(10) 2 Capital Asset Management in Departments and Crown Entities: Expectations (from the DPMC website at for further detail on proposals that require Cabinet approval. Better Business Cases: Guide to Developing the Single Stage Business Case 39

42 Private Public Partnerships (PPPs) 30 Having approached the market an agency may have the option of using a non-traditional contract option such as a Private Public Partnership (PPP) arrangement. Private Public Partnerships (PPPs) are long-term (25 to 35 year) contracts for the delivery of a service (a concession) that requires the construction of a facility or asset. PPP arrangements may be combinations of up to six basic components - design, build, finance, maintain and operate. Ownership can transfer back to Government at the end of the fixed term contract. A Private Public Partnership is characterised by: life-cycle responsibility transferred to private sector parties (for the term of the contract) public sector specification of service requirements, not the form of assets, and an appropriate transfer of risks from the public to private sector consortium of specialist parties. All capital expenditure proposals requiring Cabinet approval and whole of life costs in excess of $25 million must include in the business case an evaluation of non-traditional procurement options, including a Private Public Partnership. 31 Where the initial options assessment indicates that a Private Public Partnership may be a viable option for procurement and/or funding, an alternative approach is necessary for seeking approval from Ministers and approaching the market. Refer to the supplementary guidance in the guide to Developing the Indicative Business Case and contact the National Infrastructure Unit of the Treasury for further guidance. 32 The procurement lifecycle The Ministry of Business, Innovation and Employment consider the procurement lifecycle in three distinct phases: planning, sourcing and managing. These phases are further divided into eight distinct, but interrelated stages. The eight stage process is demonstrated in the following diagram and detailed further in Mastering Procurement: A Structured Approach to Strategic Procurement (2011) Refer to the PPP guidance maintained by the National Infrastructure Unit of the Treasury and available from 31 Refer to paragraph 18 of Cabinet Office circular CO(10) 2 Capital Asset Management in Departments and Crown Entities: Expectations available from 32 Refer to the PPP guidance maintained by the National Infrastructure Unit of the Treasury and available from 33 Refer to the Ministry of Business, Innovation and Employment website at 40 Better Business Cases: Guide to Developing the Single Stage Business Case

43 Figure 4: The eight step procurement lifecycle aligns with the Better Business Cases development process Strategic Assessment and Programme Business Case 1 Initiate project Review 8 Manage contract & relationships Identify needs & analyse the market needs Negotiate & award contract PLAN 7 Indicative Business Case Specify requirements Approach market & select supplier Plan approach to market 4 & evaluation 5 Detailed Business Case Implementation Business Case Procurement planning The procurement plan should build on the business case and provide a link to implementation and delivery. A procurement plan outlines the methodology and approach, process and project management structure for implementation. The purpose of a procurement plan is to:34 provide detailed planning for the approach to the market, evaluation of offers and identification of the preferred supplier ensure the best supplier is selected for right reasons and at a price that represents value for money over the life of the contract assign roles and responsibilities, and set realistic timelines. For further details on preparing the procurement plan and the links to the business case development process refer to Mastering Procurement: A Structured Approach to Strategic Procurement (2011). 34 Reproduced from Mastering Procurement: A Structured Approach to Strategic Procurement (2011) (page 19) available from the Ministry of Business, Innovation and Employment website at Better Business Cases: Guide to Developing the Single Stage Business Case 41

44 Rule 19 of the Rules of Sourcing (2013) require agencies to submit a significant business case that details how an agency has decided to engage with the external supplier market. This will often be a procurement plan, a sourcing plan or similar and is required for procurements that fall into one, or more, of the following categories: 35 a. have an estimated total value over the whole-of-life of the contract of $5 million or more b. due to the nature or complexity of the procurement, it would expose the agency or government to significant risks if it were not delivered to specification and within budget and on time c. have the potential for cross-government collaboration or resource sharing. Specify Requirements The purpose of this section is to specify the requirements to capture the scope and content of the potential deal. It builds on the previous identification and analysis of service requirements. Generally the fundamental principles to consider include: 36 i As far as possible, requirements must be specified in terms of the desired outcomes and outputs to be produced. The focus should not generally be on the processes which produce them or the inputs and technologies required. ii Specify the quality attributes of the services and outputs required and the performance measures against which they will be assessed. iii The specification must allow scope for the prospective suppliers to suggest innovative ways of meeting the service requirements, including proposals which may require rethinking existing business processes. iv An agency must not apply technical specifications or prescribe conformance requirements in a way that creates unnecessary obstacles for suppliers. The expected outcomes are: 37 to buy the right quality and quantity to be delivered at the right time and place for the right price that the intended results satisfy the needs, and for a Request for Tender, that the right solution (goods/services) is clearly articulated, or for a Request for Proposal that the detailed business needs are clearly articulated. 35 Refer to the Ministry of Business, Innovation and Employment website at 36 State sector agencies should refer to the more detailed requirements at Rule 24: Technical Specifications in the Rules of Sourcing (2013). 37 Reproduced from Mastering Procurement: A Structured Approach to Strategic Procurement (2011) (Stage 3 Specify Requirements) available from the Ministry of Business, Innovation and Employment website at 42 Better Business Cases: Guide to Developing the Single Stage Business Case

45 The expected outputs are the detailed specification of requirements and endorsement by key stakeholders. Table 17: Three key tasks: Task Prepare the specification of requirements Quality and Standards Good practice Description From the high-level statement of needs develop the detailed scope. Consider cost and efficiency savings: incorporate improvements from lessons learned consider new technology identify alternative delivery mechanisms and review for efficiency, and amalgamate spend and decrease costs. Identify mandatory and non-mandatory requirements. Identify timeline and key deliverable dates. Specify any sustainability requirements or preferences. Specify quality standards and measures. Specify performance standards and measures Have the draft specification of requirements checked and endorsed by key stakeholders. Check that the final specification of requirements: addresses the targeted outcomes and public policy/business objectives meets the agreed stakeholder needs, and covers whole-of-life of the contract deliverables Ensure design of specification is not structured or divided to avoid the application of the Rules of Sourcing or any other government or agency procurement policy requirements. Risk Allocation Consider how the service risks (e.g. design, development, implementation, operational and termination) may be apportioned between the procuring organisation and the supplier market. This is especially important when the successful delivery of the project is subject to significant risk, regardless of whether or not a Public Private Partnership (PPP) is being considered. The key principle is that risk should be allocated to the party best able to manage it. The objective is to optimally allocate risk, rather than maximising risk transfer. For example, the Crown should not bear all the risks associated with a conventional design and build procurement. The principles that should be considered include the following. The degree to which risk may be transferred depends on the specific proposal under consideration. Successful negotiation of risk transfer requires a clear understanding by the procuring organisation of the risks presented by a proposal, the broad impact that these risks may have on the suppliers incentives and financing costs (cost drivers) and the degree to which risk transfer optimises value for money. Better Business Cases: Guide to Developing the Single Stage Business Case 43

46 Where the market has clear ownership, responsibility and control, it should be encouraged to take all of those risks it can manage more effectively than the procuring organisation. If the procuring organisation seeks to reserve control, yet still seeks to transfer significant risk, there is a danger that the supplier will negotiate a price premium. Appropriate transfer of risk generates incentives for the market to supply timely, cost effective and more innovative solutions. Consider transferring risk to the supplier whenever the supplier is better able to influence the outcome than the procuring organisation. Reinforce the transfer of risk by negotiating abatements or penalties for late or incomplete delivery. A risk allocation table should be included that illustrates the risks borne by each party. Table 18: A hypothetical example risk allocation table Risk Category Procuring Organisation Potential Risk Allocation Supplier A Shared Design risk 25% 75% Construction and development risk 25% 75% Transition and implementation risk 60% 40% Availability and performance risk 0% 100% Operating risk 100% Variability of revenue risks 100% Termination risks 100% Technology and obsolescence risks 50% 50% Control risks 100% Residual value risks 100% Financing risks 100% Legislative risks 100% Other project risks 100% Payment Mechanisms The payment mechanism is the formula against which payment for the contracted services will be made. The underlying aim of the payment mechanism and pricing structure is to reflect the optimum balance between risk and return in the contract. The approach should be to relate the payment to the delivery of service outputs and the performance of the supplier. 44 Better Business Cases: Guide to Developing the Single Stage Business Case

47 If it is properly constructed, the payment mechanism will incentivise the supplier to deliver services in accordance with the business imperatives of the procuring organisation in each of the three phases of the service: i Pre-delivery Phase up to the acceptable delivery of the service and commencement of the payment stream ii Operational Phase following acceptable delivery of the service up to the close of the primary contractual period, and iii Extension Phase post-primary contract period. The pre-delivery phase Two types of payment mechanisms are important in the pre-delivery phase: i Fixed price/costs. This involves a fixed price for the delivery of agreed outputs within fixed timescales, with appropriate penalties for delays and cost over-runs. ii Payment on the delivery of agreed outputs. This links payment to the delivery of key service outputs and does not commence until the contracted services commence, as agreed. Payments to the supplier should only commence when off-setting benefits are realised by the procuring organisation. A service that fails to perform may result in termination of all payment streams and, in extreme circumstances, pass the rights to the underlying assets for the service to the procuring organisation. The operational phase Types of payment mechanisms relevant in the operational phase include: i Availability payment: This links a proportion of the payments to the availability of the service. For example, the contract could stipulate that the service must be available for a minimum of 95% of the time between contracted hours. ii Performance payment: This links a proportion of the payment to specified performance targets. iii Transaction/volume payment: This links a proportion of the payment to the achievement of specific business benefits. For example, the number of transactions or volume of business provided. This gives the supplier the incentive to optimise the level of productivity and to invest further in the underlying infrastructure, if increased levels of productivity are required. iv Incentive payment: Payment is linked to potential improvements in the overall performance of the procuring organisations processes. This encourages the supplier to deliver new ways of working and additional benefits that can be shared by both parties. v Cost of change: The cost of change can represent a major risk to the procuring organisation and should be mitigated through the contractual obligation to benchmark and market test the contracted services at regular intervals. If it is not possible to agree prices for anticipated future changes, the process for agreeing the cost of change should be established at the outset. Better Business Cases: Guide to Developing the Single Stage Business Case 45

48 vi Third party revenues: This element of the payment mechanism gives the supplier the incentive to develop and exploit alternative revenue streams and new businesses, where appropriate. The extension phase Two payment mechanisms are relevant in the extension phase: i Technological obsolescence: Contractual devices can be employed to encourage the supplier to consistently upgrade core technology. Firstly, various upgrades can be included in the initial price to ensure that the infrastructure underpinning the service is kept up-to-date. Secondly, a proportion of the supplier s initial recoverable investment could be deferred, with prior agreement, until the end of the contractual period. ii Contract currencies: These are variable measures that demonstrate the productivity and performance of contracted services. For example, the number of complaints received, or the proportion of users of the service requiring assistance. Reduced payments for underperformance can incentivise suppliers to improve, as do enhanced payments for performing in excess of the minimum requirement specified in the contract. Contractual and Other Issues Outline the contractual arrangements for the procurement. Form of contract and key contractual issues Decide the type of contract that will best suit the nature of the procurement. It is usual to seek legal advice at this stage. Options could include, for example, a contract for services, a service level agreement or a supply agreement for goods. You may be able to use the Government Model Contract templates or already have an appropriate contract template that can be used, or your legal adviser may need to draft a bespoke contract. Check if it may be appropriate to use an industry specific contract, for example Institute of Professional Engineering NZ (IPENZ) Conditions of Contract for Consultancy Services. 38 There are three aspects to consider when choosing a contract form: i terms and conditions that are appropriate to the nature of the goods, services or works being procured ii terms and conditions that reflect fair management of risk between the buyer and the supplier, and iii control of delivery and costs. Contract management arrangements and key contractual issues should be considered and recorded. These will vary from deal to deal, but the principal areas of the contract may include: the duration of the contract and any break clauses 38 Reproduced from Mastering Procurement: A Structured Approach to Strategic Procurement (2011) (Stage 3 Specify Requirements) available from the Ministry of Business, Innovation and Employment website at 46 Better Business Cases: Guide to Developing the Single Stage Business Case

49 the agreed deliverables the respective roles and responsibilities of both the supplier and procuring organisation in relation to the proposed deal the payment mechanism, including prices, tariffs and incentive payments change control (for new requirements and updated services) the procuring organisation s remedies in the event of failure on the part of the supplier to deliver the contracted services on time, to specification and price the treatment of intellectual property rights compliance with appropriate regulations operational and contract administration elements of the terms and conditions of service arrangements for the resolution of disputes and disagreements between the parties the agreed allocation of risk, and any options at the end of the contract. Accounting treatment This section should provide details of the intended accounting treatment for the potential deal, including the relevant accounting standards. Other implications State sector organisations may have requirements to consult staff and external agencies in respect of projects involving considerable internal change. In addition to any GETS 39 reporting requirements, the Single Stage Business Case should identify any implications arising from the proposed investment. These can include implications for privacy (for information systems that hold or provide personal information), other legislative issues or Treaty of Waitangi issues. 39 New Zealand Government Electronic Tenders Service. All New Zealand public sector agencies, including local authorities, are encouraged to publish information on GETS. Government departments are mandated to use GETS for the publication of all opportunities to tender above minimum thresholds. Better Business Cases: Guide to Developing the Single Stage Business Case 47

50 Financial Case Ascertaining Affordability and Funding Requirements The purpose of this part of the business case is to determine the cost and revenue implications of the preferred option and plan the funding requirements, including driving value from existing finances. The Financial Costing Model Financial costing versus economic assessment The approach in the economic case focuses on assessing the relative value for money of alternative options, taking into account resource costs and benefits from a national economy perspective to consider the wider society impacts of the proposal. By contrast, the financial case focuses on the affordability to the organisation of the shortlisted options evaluated in the economic case, with particular emphasis on the preferred option. Table 19: Comparison between an economic assessment and a financial costing Characteristic Economic Assessment Financial Costing Focus Value for money of short-listed options, relative to the base option Affordability of the preferred option, compared to other shortlisted options Scope National economy Organisation only All resource flows, including non-monetary costs and benefits, over the appraisal period Indifferent between capital and operating Direct financial and accounting impacts, only over the period to steady state Capital and operating detailed separately GST and taxes Excluded Excluded Depreciation Excluded Included Interest, financing costs and any capital charges Excluded Included Transfer payments 40 Excluded Included Sunk costs Excluded Excluded Transfer payments are defined as payments for which no goods and services are obtained in return, for example social welfare benefits. 41 Sunk costs are costs already incurred that cannot be recovered if the proposal does not proceed, hence they do not relate to the decision being sought. Some sunk costs may be relevant to the funding sought and should be captured in the financial costing, such as the costs of developing the proposal, the business case, assurance or any decommissioning costs. 48 Better Business Cases: Guide to Developing the Single Stage Business Case

51 Assumptions and methodology The financial costing takes into account those monetary cash flows in the earlier economic analysis of the preferred option that solely impact on the organisation. These include accounting charges like transfer payments, depreciation, capital charges, interest and other financing charges. Taxes are generally excluded as these typically impact equally across alternative options. GST is excluded. For the preferred option, itemise all material financial expenditure and revenue items year by year over the period selected and show the respective sub-totals. Table 20: Structure of the financial costing table for a hypothetical Crown and third party funded information technology project. Preferred Option 000 s Year 0 Year 1 Year 2.. Total Capital Expenditure: - Fixed assets - Software - Total Capital Operating Expenditure: - Personnel - Operating - Depreciation - Total Operating Total Expenditure: Revenue: - Revenue Crown - Third Party Revenue Total Revenue: Capital funding required: Operating funding required: The completed financial costing should provide a profile of capital and revenue funding requirements for the preferred option over the analysis period. Repeat the costing for the other short-listed options and for different scenarios to test the robustness of the relative affordability of the preferred option. It is expected that specialist accounting expertise will be required to complete this analysis. If external advice is required to undertake this work, the assumptions, inputs and model need to be approved by the Chief Financial Officer. The Chief Financial Officer also needs to be responsible for updating the model as new and better information becomes available. Implications for financial recommendations and other related financial reporting also need to be managed. Better Business Cases: Guide to Developing the Single Stage Business Case 49

52 Assessing affordability issues Affordability issues are one of the main reasons for delay at the point at which business cases are submitted for approval. The financial costing should demonstrate affordability gaps over the appraisal period, the difference between the funding required in any year and funding available from other sources. Consider the risks and uncertainties that could affect the affordability of the project. This risk analysis can be based on the risk and sensitivity analysis undertaken previously. The risks and uncertainties will vary from project to project, but some key questions to consider are: Would the preferred option still be affordable if actual costs were 10% higher than expected? What if expected savings were to fall by 10%? What circumstances might cause saving targets to be breached? What if other income to the organisation were to be reduced by 10% or more? Is there a robust strategy in place to manage contingencies? Assessing affordability also requires sound judgement of the organisation s business and requires that the: balance sheet is healthy and has been correctly organised and properly accounts for current assets, current liabilities, long-term liabilities and capital organisation is solvent and is not over-trading cash flows are sound, and appropriate contingencies have been made for risks and uncertainties. The impacts of the proposal on the organisation s operating statements and balance sheet should be assessed to ensure on-going financial viability and sustainability. Both the current position and the likely outcome should be fully recorded. Various techniques can be used to help judge affordability, including financial ratio analysis. Closing the affordability gaps Affordability problems are most likely to occur in the early phases of the project, prior to realised benefits building up to the point at which they offset the initial costs of the investment. Affordability is more likely to be an issue where the pay-back period is relatively long. If the affordability analysis reveals the preferred option is clearly unaffordable at any point over the appraisal period, potential remedies include: 42 phasing the implementation of the preferred option differently adopting a different design solution 42 Note that these actions are likely to also impact on the realisation of benefits. 50 Better Business Cases: Guide to Developing the Single Stage Business Case

53 altering the scope of the preferred option, for example, its functional content or the quantity and quality of the services offered finding additional sources of funding, for example, by disposing surplus assets (if available), ceasing lower priority existing spending or further revenue support from within the organisation considering different financing methods permitted within any regulations or constraints negotiating more competitive or flexible prices from suppliers finding other ways of reducing costs and/or increasing savings, and/or allowing the supplier to create additional revenue streams and new business and sharing in the resultant revenue streams. User fees It may also be necessary to assess the implementation impact of the proposed deal on user charges in respect of services provided by the organisation. The organisation must be confident that third party revenue projections are robust. Where the organisation seeks to recover some or all of the costs of service provision from the users or direct beneficiaries of that service, stakeholders will want to be assured that the charges set both take proper account of efficiency, equity and fiscal concerns and are not excessive in relation to the costs incurred. The Regulations Review Committee has adopted a practice of asking Government departments to demonstrate that fees were calculated in accordance with the principles of the Committee and any Treasury and Audit Office guidelines. These principles are: i The Crown cannot impose taxes without the explicit authority of Parliament. This implies that the Government cannot over-recover the cost of providing a service without the authority of an Act of Parliament. ii A fee should not be so high that it defeats the purpose of the enabling statute and is not in accordance with the general objects and intentions of the principal Act. In general, public sector investments can be difficult to justify if they lead to a significant increase in the prices charged for services. Presenting the results In addition to presenting the results of the financial modelling for the preferred option, also provide: a description of the model and the costing methodology used all key assumptions in the model including how these assumptions were derived and agreed (for example, discount rates, inflation, taxation, depreciation, cost savings) a description of the proposed funding arrangements contingencies for risks and uncertainties, including scenario testing on key assumptions (where required) Better Business Cases: Guide to Developing the Single Stage Business Case 51

54 capital and operating impacts on the organisation s finances, and fiscal impacts on the Crown s baselines (where relevant). 43 Detail the capital and revenue requirements for the preferred option. This should set out: the capital and operating consequences of the preferred option over the life-span of the service and/or contract period, including any third party revenue any contingencies (in monetary terms and consistent with previous quantitative risk analysis) necessary to ensure that there is sufficient financial cover for risks and uncertainties, and capital and revenue funding sought by this business case. Consideration should be given on any break-even affordability requirements that may apply. For example, requirements that the business case is fully funded within existing revenue. Provide a funding statement showing which internal business units, partners and external organisations (if any) have agreed to provide resources. Where external funding is required, the Commissioner s letter should include a written statement of support. This should demonstrate that all alternative sources of funding have been considered and rejected, including an analysis of why all or part of the funding required cannot be met from existing resources and including identifying higher priority expenditure. Highlight to the monitoring agency if the investment proposal is likely to result in additional or unexpected funding pressures. Funding contingencies When the level of funding required is uncertain and subject to contingent events, it is possible to establish rules and limits for accessing additional contingent funding. Using quantitative risk analysis, funding recommendations can be set on the basis of a probability distribution of likely project costs. If project risks materialise, delegation limits can be set which determine the thresholds at which the organisation needs to seek approval from decision-makers, or provide additional evidence to support a request for additional funding. For the Public sector example below, initial approved funding is set at the 50th percentile but subject to requirements that specify that the project may only draw down funding to cover project costs up to the 25th percentile. Draw-downs between the 25th and 50th percentiles require the approval of Joint Ministers. Funding costs over the 50th percentile require further Cabinet approval and additional evidence. Project costs over 85% would signal consideration of early termination. The threshold limits and rules should be set as part of the discussions with the monitoring agency, and included in the recommendations made as part of approving the Single Stage Business Case. 43 Refer to the Treasury guidance Writing Financial Recommendations for Cabinet and Joint Minister Papers: Technical Guide for Departments at 52 Better Business Cases: Guide to Developing the Single Stage Business Case

55 Figure 5: An example of using estimated total nominal cumulative capital costs over a three year project development to inform draw-down arrangements for a Crown funded project. The drawdown limits and decision authorities can be altered to be fit for purpose for the nature of the proposal. Better Business Cases: Guide to Developing the Single Stage Business Case 53