Cost and Value Management - Essay Example

Cost and value management Introduction The success of projects depends as much on the creation of value for all stakeholders, as it is on the controlof costs. From a finance management perspective, appraisal of projects should consider the value creation as much as the revenue generation capability of projects. There are several reasons why value creation is an important part of management and appraisal of new projects, but the most appealing and important reasons is that it creates lasting long-term value for the business and everyone associated with it. The Taj Mahal Cycle taxi improvement project, a joint venture between an NGO and the private sector, presents an excellent example of how long-term benefits can be achieved by enhancing the overall value to all stakeholders. This paper analyzes the cost and value management processes in this project. Cost and Value management – an overview Cost and value are both important concepts that need to be considered and controlled in any project, taking an integrated view. (Venkataraman & Pinto, 2008, pp.2-3) In order understand why this is so, and to appreciate the relationship between the two, it is necessary to first recount certain basic principles. Cost Management, at the project level, is concerned with cost estimation, budgeting and cost control at the implementation phase, and the revenue streams resulting from the pricing policy and volumes, the cost of capital, and the input costs at the post implementation phase. Value management is concerned with the maximization of the value created by the project within the constraints of cost, time and other resources. On an ongoing basis, the appraisal of projects on the basis of value crated should consider the direct and indirect returns flowing form the project that create value. The aim of value management is to ensure that the total value accruing to all stakeholders is maximized. It should be remembered that the concept of value will differ from one stakeholder to the other. Cost and value management need to be integrated in order to obtain optimum results. We can define value as the benefits accruing to various stakeholders. According to Venkataraman & Pinto (2008), value is “meeting or exceeding the expectations of project stakeholders.” In financial management, value addition is the difference between the net revenue generated and the cost of capital. Although financial management perspective is traditionally limited to that of the shareholder, current thinking in strategic management favours the inclusion of perspectives other than that of the financial returns alone. From this point of view, value would be a wider concept encompassing all stakeholders. In this paper, value is therefore taken as the total benefits accruing to all stakeholders in the project, and not merely that of the investors. The Taj Mahal cycle taxi project is not merely an investment that needs to generate sufficient revenues. The involvement of an NGO, and the existence of many social issues that are highlighted, show that value in this case will extend far beyond the financial returns and investment considerations alone. At the same time, the project needs to generate sufficient surplus funds in order to benefit most of the stakeholders concerned. Thus the analysis needs to include cost, revenues and the total value addition to various stakeholders. An integrated approach is needed because increase in value to stakeholders can in many cases achieved only with some implications to the cost. A strictly cost based view may fail to provide maximum benefits for all stakeholders. Hence both these aspects need to be considered in tandem. Analysis The proposed Taj Mahal cycle taxi project has a number of social and environmental implications, and these need to be considered in addition to the commercial and cost aspects of the project, since they represent hidden value addition. At the same time, if private manufacturers are to be persuaded to adapt the new designs, the project will need to be commercially viable. The commercial aspects of the project seem to be cantered more on the selling price per vehicle and the costs of operating and owning it. No major investments have been mentioned. Thus on the one hand, the project has serious social and environmental implications, and on the other, involves higher operating costs, and investments on the purchase of the vehicles, by the rickshaw owners and in some cases by the pullers. Before considering the costs, it might be worthwhile to look at the various implications of the project. Overview of the project The Indian city of Agra is a tourist spot that is home to the world famous Taj Mahal, and a number of other monuments. The pollution caused by motorized vehicles in the area has been causing extensive discoloration of these monuments. This has already caused the Supreme Court of India to ban use of motorized vehicles in the immediate vicinity of these monuments. In turn, this has opened up a lot of opportunities to address a number of social and environmental problems in the area. A substantial improvement in the design of the cycle taxis being currently used could result in elevating the living standards of the local population, and make the experience more comfortable to the tourist. The use of cycle taxis could then be extended to other parts of Agra, where motorized vehicles area not banned, reducing the general pollution levels and eliminating serious health hazards that are present today. While the project could become commercially viable given a reasonable chance, there are several social issues that could come in the way of the acceptance of the new cycle rickshaws. These will need to be overcome, if the project is to be a success. Stakeholders in the project The first step in making an analysis of the cost and value generation from the project is to identify the stakeholders. As earlier stated, value would vary depending on the stakeholder. The aim of the project should be to maximize the value for all stakeholders, and hence the stakeholders need to be identified first. The main stakeholders in this project are: The rickshaw fleet owners The rickshaw manufacturers The rickshaw pullers, called “wallahs” The tourist The local population using the rickshaw for various other purposes such as sending their children to school The tourist agencies Hotels Local body and the government. Some of the relevant issues are briefly discussed below.. Preservation of Heritage One of the most important aspects of this project is that it will help maintain the heritage monuments and buildings in their original form, and avoid damage to these buildings. The Archaeological Survey of India, which is responsible for maintaining and protecting thousands of monuments in India, spends a large amount of money in preventing damage and restoring the monuments after damage is done. In spite of this, there is a danger of these monuments irretrievably losing their original splendour. The cost in terms of both restoration and possible loss of original splendour would be huge (Archaeological Survey of India, 2009). Environmental issues Pollution from motorized vehicles causes more than damage to monuments, and is responsible for serious health problems among the local population. The pollution also adds to global warming. Although India is not among the major contributors to green house gases at present, rapid increase in the use of motorized vehicles could make it one in the future. . Social issues The cycle rickshaw “wallahs” earn around a dollar a day, which places them below the global poverty line in accordance with the World Bank guidelines. About 10% of the population of Agra is dependent on cycle rickshaws for their livelihood. In addition, there are others who are employed with manufacturers or engaged in the maintenance of these vehicles. A sizeable population in Agra would be benefited by the introduction of a technically superior rickshaw. Cost Analysis The cost analysis in this case will have to be done separately in the case of different stakeholders. These will have to include the cost implication to the rickshaw wallah, the rickshaw fleet owners, the rickshaw manufacturers, and the user of the rickshaws. Cost –benefit analysis involves computing the returns from the project and comparing it with the investments required to be made. Project appraisal is undertaken to facilitate the process of allocation of limited capital resources to the most attractive among the alternatives available. (Arnold, 2002, 135) There are several techniques to appraise projects such as ARR, payback period, NPV and IRR. The most commonly used are payback and ARR, while NPV is gaining in popularity. In the present case, direct application of any of these techniques at the overall level will have no meaning as there is neither a clear investment proposal nor clear revenue streams from the project. However, these techniques could be used to assess the amount of capital that could be invested in the project by an interested agency, given the benefits accruing to various stakeholders. In addition, the techniques could be used for assessing the feasibility fromteh point of view fleet owners and rickshaw pullers. It is useful to remember that success in a project depends on cost, time and quality. Moreover, it is not possible to estimate costs and benefits precisely at the early stage in any project, and hence use of these methods should be done with this limitation in mind. (Gardiner & Stewart, 2000) Rickshaw wallah At present the rickshaw puller pays $0.3 per day for using the rickshaw. Average earning per day is $1.3. Hence the net earnings to the rickshaw puller are $1 per day. If the improved version of rickshaw is introduced, the rickshaw puller would be able to make three trips a day in place of one that he currently makes. A survey among the tourists has shown that they would be willing to pay substantially more for travelling in an improved version of rickshaw. This means that in fact the rickshaw puller would be in a position to pay substantially more for the rental of the rickshaw, and still retain a higher proportion of the earnings. The estimates are that he could pay up to $3, which is ten times the existing rate, while retaining $6, which is six times his current earnings. Thus both the fleet owner and the rickshaw puller would make more money than they do at present. Fleet owner Although the income of the fleet owner will go up three times as discussed in the previous section, there is a cost associated in the form of higher price to be paid for the improved version of the rickshaw. Since the rental received by the fleet owner would be ten times the present rates, it is assumed that the fleet owner would be in a position to pay up to $1,000 as purchase price per rickshaw. While this makes economic sense to the fleet owner, the resources available with them will have to be sufficient to provide the required capital. Manufacturer The manufacturer of the rickshaw will have to invest more in terms of material and manufacturing cost in order to produce the improved version. Exactly how much the new version will cost is not clear at this point. Moreover, three different models have been proposed, and the cost will depend on the model chosen. Looking at the cost structure explained above, it should be possible for the manufacturer to make and sell the best models. As against the existing price of between $100 and $250, the cost of the improved vehicles could be anything between $150 and $400, depending on the type of vehicle manufactured. Since the above analysis shows that the fleet owners should find it viable to pay a price up to $1,000, it should be possible to at least convert a portion of the existing fleet to the luxury category. Overall There are 30,000 to 90,000 rickshaw “wallahs” in Agra. Taking a figure of 60,000, each wallah would increase his earnings by $6 a day. The total increase per year for all wallahs will be 6 x 360 x 60,000 = $1,29,600,000. If this is taken as the social benefit from the project, an amount of $12,96,000,000 can be invested in the project if a return of 10% is expected. However, investing money alone may not be sufficient as cultural factors must also be considered in a project to ensure its success. (Kendra & Taplin, 2004, 35) Value Analysis The value accruing to various stakeholders could be much more than the benefits to the pullers, owners and manufacturers discussed above. Even these stakeholders will gain much more than merely improved earnings. Indirect value added by the project would include the following. Public opinion One of the major hurdles to implementing the project is the strong public opinion against continuation of the rickshaw system. The objection arises on three major counts, namely, the prevailing low image of the wallah and the perceived unreliability of service, the effect on the traffic (slowing the traffic down), and the exploitation of the rickshaw puller. For the project to succeed, these resistances will need to be overcome. The last objection should be substantially reduced with an improved version of the rickshaw. The speed of the rickshaw will improve and hence will not form a bottleneck in the traffic. The image of the wallah should also improve, along with the reliability of service that should result from better rickshaws. Environment The environmental issues would get sorted out by avoiding motorized vehicles and substituting them with the improved rickshaws. Although this is happening to some extent even now with the existing versions of rickshaws, they have generated resistance among the public, and this may result in abandoning them in future. Moreover, the new rickshaws can substitute motorized vehicles even in places where the latter are allowed, reducing pollution further. As House (1999) observes, “Environmental management is often hampered by a lack of consensus of what is desirable”. It is essential that public involvement is ensured. Public involvement can be informal. (House 1999, 125-126) This would help in diffusing much of the resistance in this case. Like other social benefits, it is difficult to estimate precisely the gains on account of these. However, even if a portion of the amount of money spent by the Archaeological Survey of India is saved, the resultant savings would be substantial. Generation of employment and improvement in living standards This is another value addition that can be expected from the project. The benefits to the individual rickshaw puller have already been discussed in an earlier section. In addition to the direct benefits to these stakeholders, there is bound to be further all round improvement because of the multiplier effect that the additional spending power in the hands of the direct beneficiaries will create. Health The improvement in the environment will reduce pollution and lead to improved health. The direct impact of this would be to reduce the medical costs. Better health will improve productivity and lead to better overall quality of life. Government and local bodies The main beneficiaries from the above improvements are the local and state governments, who have the primary responsibility to ensure a cleaner atmosphere, provide employment to people at reasonable wages, ensure the upkeep of the monuments and heritage site, and maintain the traffic and infrastructure in the city at acceptable levels. Although it is difficult to state how much the society will benefit, the direct savings in the amounts spent on various measures to ensure these objectives will add up to a substantial figure. The indirect benefits will be in addition to the direct cost savings. Non government Organizations NGOs will also derive value from the project since the project will contribute to many of the causes they work for. In fact the project is proposed as Public-Private partnership programme. However, Public Private Partnership is not straightforward, and a number of complex issues need to be addressed to make it a success. (Akintoye, Beck & Hardcastle, 2003, xix) Conclusion and recommendations As stated in the case, it is not clear whether this initiative can lead to commercial production of a superior vehicle, and if it does, whether the new vehicle will be used by ordinary people. There is also the danger that the new vehicles might lead to the ban of the existing vehicles, thereby putting the poor rickshaw pullers to great difficulty. Apart from the people of Agra, it is the governments concerned that will be the greatest beneficiaries. Many of the issues raised are also within the control of the same governments. For example, banning of the old version when the new one comes is in the hands of the government. Because of this, it makes sense for the governments to extend the maximum support for this initiative. If this is done, the project has a fair chance of success. With greater governmental involvement, the risks of failure will also be spread. The government should be able to absorb whatever risks exist in the project. It would also be worthwhile for the government to take this risk because the value added will be immense. In view of this, the concerned governments should be persuaded and convinced to extend their support fully to this project. In particular, the following actions can be taken. 1. Making the necessary capital available to the rickshaw pullers at low interest and easy repayment terms. 2. Some form of guarantee for the repayment of principal and interest so that the risk of the rickshaw pullers and fleet owners is reduced. 3. Phased implementation of the programme so that the risk at any point is greatly reduced. 4. Support for export of the improved rickshaws so that the costs could be recovered faster, apart from increasing opportunities for the local population in terms of employment, higher earnings, and better living standards. The total investment by the government for all these purposes would be a miniscule fraction of the amount that was calculated as the upper limit for investment in the project considering the benefits. References 1. Akintoye, A, Beck, M. and Hardcastle, C. (eds.) 2003. Public-Private partnerships: Managing Risks and Opportunities, Blackwell Publishing, Oxford. 2. Archaeological Survey of India 2009, Conservation and Preservation, viewed November 12, 2009 3. Arnold, G. 2002, Corporate Financial management, Pearson Education Limited, Essex, England. 4. Chadwick, L. 2002, Essential Finance and Accounting for Managers, Pearson Education Limited, Essex, England. 5. Gardiner, P.D. and Stewart, K. ‘Revisiting the Golden Triangle of Cost, Time and Quality: the role of NPV in Project Control’, International Journal of Project Management, Vol 18 (2000), pp 251-256 6. House, M. A. 1999, ‘Citizen Participation in Water management’, Water Science Technology, vol.40, no.10, 7. Kendra, K. and Taplin, L. J 2004, ‘Project Success: A Cultural Framework’, Project Management Journal, April 2004. 8. Venkataraman, R.R. and Pinto, J. K. 2008, Introduction to the Challenge of Cost and Value Management in Projects, John Wiley & Sons, Hoboken, NJ. Read More