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Ebook Guide to Custom Software Solutions
Considerations: Calculating the Opportunity Cost of Existing Technology

How to Calculate the Opportunity Cost Associated with Keeping Your Existing Systems

Considerations- Calculating the Opportunity Cost of Existing Technology.pngOpportunity costs are ubiquitous within Small and Medium-sized Enterprises (SMEs), and also exist within the framework of larger businesses. Opportunity costs are independent of the size - or industry - of any given business, and consequently, exist simply due to the nature of making core business decisions that ultimately affect both the bottom line and top line of an enterprise. An opportunity cost, in the general sense, is a route which is given up when a decision is made, allowing a company to go in a different direction.

Based on such a decision, a company hypothetically forfeits all benefits associated with the route that is not taken. Put more succinctly, an opportunity cost is the advantage - or disadvantage - associated with a course of action (that is not taken) that is lost in order to gain another advantage that results from taking a different course of action. The concept of opportunity costs must be fully realized from both a general perspective, and from a financial perspective. That is, per the above,  it is also important for enterprises to recognize that, potentially, opportunity costs that are associated with every major department in an enterprise may be the largest cost that is incurred in the business. This is because opportunity costs don’t just represent abstract concepts, such as the loss of an opportunity, but intrinsically represents costs associated with every decision made by a company’s managers/executives that are linked to missed opportunities. Thus, opportunity costs are the potential costs (including savings) that are associated with missed opportunities due to taking one course of action over another.

Planning and implementing business strategies associated with marketing, and with establishing an enterprise’s hardware infrastructure, choosing the correct enterprise software for the company, establishing business contracts, merging and/or acquiring companies, etc. are all key business decisions that must be made to increase an enterprise’s growth, along with increasing its efficiency, productivity, and ultimately, its bottom line. When financial officers and key enterprise executives are at the intersection of making such key decisions, they must thoroughly analyze how much each decision will cost the company. The pivotal fact about opportunity costs is that the overall cost of purchasing/implementing such systems or carrying out certain business processes (as noted above) includes more than the system/process itself, but also includes the opportunity costs (the cost of missed opportunities) associated with not taking another action.

Such alternative actions/decisions may include purchasing a different enterprise software suite, or utilizing a different hardware system for a post-merger integration process, or implementing a different marketing application suite, etc. Such opportunity costs, thus, must be included in all financial assessments associated with key business decisions revolving around the use of IT systems and/or the conducting of key business processes. Such an assessment must use best practice financial projections that take into account the financial data and metrics associated with taking different courses of action.

Analyzing the exact opportunity costs associated with any enterprise’s existing Information Technology assets requires complex calculations and a thorough review of all IT cost centers, revenue generators, and profit centers in the company. In order to conduct such an analytical assessment, there are some factors that should be considered so that business strategists can understand how to identify all corporate IT elements that are related to an enterprise’s IT opportunity costs.

Considerations While Calculating Your Production Possibilities

Ultimately, corporate technology serves the purpose of optimizing an enterprise’s productivity and efficiency, which includes the efficient production of goods and services. An enterprise’s goals - and corporate products/services - must be aligned with the specific elements of the company’s IT assets. To ascertain the most effective IT solutions to fulfill such business goals - and to aid in the production of an enterprise’s goods/services - business strategists must determine which hardware and software systems work to increase efficiency, productivity, automation, and workflow feasibility. The process of choosing different hardware and software systems to aid an enterprise with business processes in the way described above requires a detailed calculation of all opportunity costs associated with choosing one IT production system over another IT system/solution.

What is a Production Possibilities Curve?

As noted before, determining the most financially feasible and cost-effective business decision or strategy requires a financial projection-system that can help a business strategist understand all of the possible opportunity costs associated with such key decisions. Related to such a system is a representation of all possible financial outcomes associated with different production systems or products, in order to serve as an aid for executives who need to determine which direction to take. One such system is the production possibilities curve, which reveals the production efficiency of an entity based on all possible variations of resource allocation. Within the realm of calculating opportunity costs, the PPC system can greatly aid a business in determining the opportunity costs (and essentially, all financial opportunities and variables associated with productivity/resource allocation) associated with a range of varying production systems, products, IT systems, or business strategies/decisions. 

Understanding How Technology & Your Business Relate to Productivity

Depending on the implementation of a hardware/software IT system, the elements of an enterprise’s IT infrastructure are often considered cost centers by certain executivesAccording to CIO Magazine’s 13th annual State of the CIO study, roughly 50 percent of the 722 CIOs that were surveyed stated that their role (associated with the corporate IT infrastructure) was viewed more as a cost center than as a profit center, which reveals the somewhat common view that corporate IT systems are not revenue generators. Even so, IT systems in enterprises exist to increase the feasibility of corporate workflows, and to increase efficiency, productivity, creativity, and the automation of business processes. An increase in productivity and efficiency (associated with business processes) will positively affect a company’s bottom line. Thus, though corporate technology systems typically affect the bottom line of a company in some way (if implemented correctly), it is also important for business executives to recognize that IT infrastructures - when geared towards fulfilling strategic, service/product-based processes and goals - often directly affect an enterprise’s top line and bottom line.

Consequentially, while IT systems are regarded as cost centers at times, corporate technology can be used as a revenue generator or profit center as well. In the modern ecosystem of technologically driven enterprises, IT systems are used less as tactical solutions for issues as they arise, and more for fulfilling the business strategies and goals of the enterprise that are set forth by business strategists and company executives.

That said, in order to calculate the opportunity costs of a company’s existing IT infrastructure (including both hardware and software elements), business IT strategists must first understand exactly how technology positively affects corporate productivity, and how each component of said infrastructure helps to meet an enterprise’s specific goals.

Technology Which Saves Time

Time and other resources are valuable and limited, and since time determines how many products/services can be produced, time is directly related to productivity. Systems, such as IT infrastructures, are often implemented in order to save time by helping to produce more products and/or services, which thus increases productivity. Additionally, some software systems, such as Customer Relationship Management (CRM) software and Enterprise Resource Planning (ERP) suites, help to save time by combining and integrating distinct business operations with other operational applications in one place, which helps personnel to carry out complex processes in a shorter amount of time. Another set of software systems, that typically help to save time and overhead, are automation systems, which perform tasks - that are often carried out by a human - in a shorter amount of time. Such automation systems allow skilled personnel to perform other duties, which ultimately makes an enterprise more productive.

Technology Which Performs a Task Unable to be Done By a Human

Though software systems are often used to automate tasks that are typically carried out by a human, certain financial and advanced calculation software systems can be used to carry out tasks that cannot be feasibly performed by a human. This includes certain data analytics/big data and business intelligence systems, advanced Artificial Intelligence systems, advanced accounting systems, etc. Such systems allow an enterprise to benefit from computing resources that can greatly increase the productivity and efficiency of the organization in a way that increased personnel/manpower could not.

Determining if Your Technology is Diminishing in Benefits

Determining the opportunity costs associated with keeping, altering, customizing or replacing an enterprise’s IT infrastructure requires taking into consideration whether each hardware and software solution is keeping pace with the needs, goals and vision of the organization. Such a determination includes utilizing an assessment that produces a future-projection of data revealing whether the IT solutions in place will be pertinent in the future.

Are You Experiencing a Slowing Down Over Time?

IT systems tend to lose relevance as newer systems are produced by industry-vendors as products or even custom built software solutions, and as the legacy systems themselves slow down, break down, or become irrelevant with relation to the growing needs and/or novel issues that an enterprise may face. Thus, it is important for business strategists to assess whether the IT systems, that make up an enterprise’s technology assets, will continue to work as expected. In absolute terms, this type of assessment must be used to deduce whether the IT solutions will meet the needs of the organization and continue to increase productivity. In relative terms, such an assessment must determine whether the existing IT systems will be as pertinent to the organization as newer applications, which may increase productivity on a larger scale.

Is Your Current Technology Keeping You From Using Other, New Technology?

IT systems that are old, obsolete, unsupported, and/or cannot be modified, customized, integrated or added to, etc. often impede the progress of an enterprise when their needs grow or they face new issues. Such obsolete IT systems - which often utilize obsolete architecture - are often synonymous with legacy systems, which may end up costing an organization more due to the need for increased maintenance and due to such systems utilizing old functionalities that may not help a company deal with modern issues. Such systems, thus, do not increase corporate productivity or efficiency, and may even negatively affect the enterprise’s bottom line.

Is the Cost of Maintenance and Upkeep Growing?

Per the above, IT systems that are no longer functioning as expected - or are obsolete - may require extra overhead in the form of routine maintenance and upkeep costs. Such systems, thus, do not increase the enterprise’s bottom line or top line, but instead, require extra time and effort to maintain them in order for such systems to keep running. Ultimately, an assessment of opportunity costs associated with such systems must include an analysis of all overhead associated with keeping the existing IT infrastructure (including the expenses for system upkeep and savings associated with IT system-related increases in productivity) versus the savings associated with utilizing a better system that does not require extensive maintenance and upkeep costs.

Are There Growing Concerns Regarding Up Time &  IT System Availability?

Corporate IT systems should be readily available for use by personnel and should work as expected when needed. However, at times, certain IT systems - which are typically old and require maintenance work - crash or cease to function. Such IT system issues may increase in frequency as systems become older. In such a situation, an assessment of the corporate IT infrastructure should include an analysis of the true benefits of the IT solutions in place versus the potential benefits of an IT infrastructure that works optimally and at full capacity without shortages or system crashes.

Determining if Your Existing Technology Will Be Less Competitive in the Future

Another key factor associated with calculating the opportunity costs of an enterprise’s IT infrastructure is whether existing technologies can solve issues (that enterprises face today) as well as future needs and issues. As multiple technological fields rapidly advance - including technologies associated with optimizing corporate productivity  - any assessment that looks at the opportunity costs of an enterprise’s current IT solutions must understand the landscape of future technologies that can potentially solve existing corporate problems in a better fashion. Such evolving technologies include those associated with data analytics/big data, artificial intelligence, the internet of things, cloud computing, business intelligence, blockchain technology, etc.

Any Technology Related to Data Analytics

Business analysts are said to have been replaced with data scientists, and while data analytics is an important advance in the ecosystem of modern corporate strategizing, Big Data - which is made possible by more powerful computing systems and Cloud computing systems - can help to shape the strategies and goals of an organization in a significant way. Related to Big Data is the analysis of raw business information to produce novel understandings of an enterprise’s most optimal strategies - Business Intelligence. Additionally, technologies associated with Artificial Intelligence - including neural networks, deep learning, machine learning, etc. - can help corporations understand data in a new way, which can lead to the production of new strategies that previously were out of reach and unseen by corporate executives.

The Introduction of the Internet of Things

The Internet of Things (IoT) is a modern networking system that links together a myriad of components (objects) that are linked via WiFi to each other or to the public Internet. The IoT phenomenon is significant in that an array of actuators and/or sensors can be coupled with WiFi systems in order to transform everyday objects into “smart” objects that can be linked to feedback mechanisms via cloud computing. Such “smart” objects can include an array of technologies, including smart cities, smart cars, smart glasses, smart clothes, etc. Virtually any existing technology could potentially be made to work better with the introduction of IoT actuators, sensors and WiFi systems.

Calculating the Cost of Replacing Existing Technology Includes Calculating the Cost of Not Replacing It

In line with above, both legacy systems and non-legacy IT systems may require replacing if a company’s executives determine that a more efficient system can be implemented with the advantage of reduced costs and overhead. The steps required to make such a determination requires the procurement of financial metrics and data that can reveal the opportunity costs associated with taking different courses of action, including not replacing the IT systems. Calculating opportunity costs requires some best practices, including the use of financial projection systems and assessments. Such assessments must take into account the effects that the existing IT infrastructure has on productivity and corporate efficiency, whether the IT systems can be seen as a future benefit to the organization, and whether the IT systems will be relevant IT solutions in the future, which must take into consideration the aspects of the modern age where technology is rapidly evolving and IT solutions are quickly changing over time.

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