The Case for IT

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The Case for IT

• Chapter 4

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Announcements

• Quiz return after class
• Three people still need to form project team
• See me after class

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Todays Outline

• Economic Measures
• Justifying expenditure on IT
• As infrastructure cost
• As profit driver
• As proprietary advantage
• Three examples
• SABRE
• IBM
• MedCo
• Building a Business Case

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Important Financial Measures

• Return on Investment / Rate of Return
• Return on Equity
• Return on Assets
• Internal Rate of Return

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Return on Investment

• Also known as rate of return
• ratio of money gained/lost to investment amount
• Eg.
• Invest 1,000 at start,
• end with 1,075
• Return on investment 75/1000 7.5
• Often annualized ROI is used

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Return on Equity

• Return on net worth
• Measures the return to common stockholders
• ROE
• Net Income / Average stockholders equity
• (net income/sales) (sales/total assets)
  (total assets/avg stockholders equity)
• (known as DuPont Formula)

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Return on Assets

• ROA Net Income / Total Assets
• (Net Income / Sales) (Sales / Assets )

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Time Value of Money

• The present value of something its value in
  todays dollars
• Eg. Having 110 a year from now is equivalent to
  having 100 if the bank is giving 10 return

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Net Present Value

• Value of cash flows in todays dollars

Where t - the time of the cash flow n - the
total time of the project r - the discount
rate Ct - the net cash flow (the amount of cash)
at time t. C0 - the capital outlay at the
beginning of the investment time ( t 0 )
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Internal Rate of Return

• Annualized effective compounded return rate
• Discount rate that results in net present value
  of zero from series of cash flows

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Comparison with financial options

• Security option
• The right to buy a security at a fixed,
  predetermined price (called the exercise price)
  on or before a fixed date (called the maturity
  date)
• Eg. The right to buy (up to) ten Google Stock,
  one year from today for 450 each

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This weeks caseIT Doesnt matter
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Main Ideas

• Competitive Advantage from IT is possible, but
  challenging
• IT Doesnt matter responses

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Chapter 4 Making the Case for IT
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Table 4.1 IT Investment Categories
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Business Case for IT

• Investments in reusable, value-enabling
  infrastructure lower costs, improve asset
  efficiency and create strategic options for
  future growth
• Investments in value-creating IT applications
  drive profitable growth through further cost
  reductions and revenue generation
• Value-sustaining IT applications and
  infrastructure provide strategic differentiation
  and proprietary advantage

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SABRE

• 1957
• IBM and American Airlines team up to form SABRE,
  the Semi-Automatic Business Research Environment.
  It's based on SAGE, the Semi-Automatic Ground
  Environment -- the first major system to use
  interactive, real-time computing -- which IBM
  helped develop for the military.
• 1960
• The first Sabre reservation system is installed
  in Briarcliff Manor, N.Y., on two IBM 7090
  computers. It processes 84,000 telephone calls
  per day.
• 1964
• The Sabre system, and its nationwide network, is
  completed at a cost of 40 million and becomes
  the largest commercial real-time data-processing
  system in the world. It saves American Airlines
  30 on labor costs.

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SABRE

• 1972
• The Sabre system is upgraded to IBM S/360 and
  moved to a new consolidated computer center in
  Tulsa, Okla. It is used for all of American
  Airlines' data processing facilities.
• 1976
• The Sabre system is installed in a travel agency
  for the first time, triggering a wave of travel
  automation. By the end of the year, 130 locations
  have the system.
• 1984
• Sabre introduces BargainFinder, the industry's
  first automated low-fare search capability.
  Competitors sue American Airlines, saying its
  Sabre system unfairly gives its flights priority
  on the displays seen by travel agents. American
  agrees to discontinue any preferential treatment
  of its flights.

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SABRE

• 1985
• Sabre introduces easySabre, allowing consumers
  with PCs to tap into the Sabre system to make
  airline, hotel and car rental reservations.
• 1989
• On May 12, the ultrareliable Sabre system goes
  down for 12 hours. The cause a latent bug in
  disk-drive software that destroys file addresses.
  
• 1996
• Sabre launches Travelocity.com.
• 2000
• AMR Corp., the parent of American Airlines, spins
  off The Sabre Group as an independent company.
• 2001
• Sabre Holdings Corp. begins migrating its
  massive, 25-year-old mainframe system for
  air-travel shopping and pricing to HP NonStop
  servers and Linux servers.

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Table 4.2 Leveraging Infrastructure at IBM IT
Operations
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Table 4.3 IBM Enterprise Support Processes
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Arguments for IT

• New applications give competitive advantages
• Open standards, reliable infrastructure give rise
  to more innovation
• IT can give both operating efficiencies and
  business insight
• Reusable modules, shared middleware, common
  interfaces get around traditional pitfalls

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Role of infrastructure

• Examples of traditional infrastructure
• What value do they create?
• How do businesses account for them?

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Role of infrastructure

• IT infrastructure
• Specific IT operations (data center, network,
  call centers)
• Support for enterprise processes (procurement,
  ERP, finance, HR)
• Value creation
• Efficiency
• Speed to market
• Flexibility

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Proprietary Advantage

• More than just cost-cutting!
• Must change competitive positioning
• Successful entry into growing market or exit from
  shrinking one
• Achieving top position in attractive industry and
  sustaining it
• Attracting loyal investors
• Very few competitive advantages are sustainable!

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Table 4.4 Driving Profitable Growth at IBM
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Table 4.5 Creating Proprietary Advantage at IBM
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Differences of IT vs. other infrastructure costs
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Questions, Break, Presentation
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MedCo IT option

• Business plan to launch internet-enabled remote
  patient monitoring business
• Patients with pacemakers place device over
  pacemaker to collect data on rhythm, blood
  pressure, etc.
• Data sent from patients home by internet to
  physician, family, health care providers
• Cash flow expectations suggest
• 300 million investment over 5 years to develop
• Positive cash flow in 5 years
• 2 billion in revenues by year 10
• but there are risks
• See curve in fig 4.3(a)

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Figure 4.3(a) Three Cash flow scenarios for MedCo
Patient Monitoring Investments
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Alternative investment strategies

• MedCo A
• 2 years and 150 million spent developing
  databases, networks, call centers
• Next 18 months, proprietary remote monitoring
  business applications and user interface built
  for 25 million
• Final 18 months 125 million custom
  installations, networking patients etc.
• What if this leads to 600 million cash flow from
  year 13
• MedCo B
• Leverage existing IT infrastructure (databases,
  networks, call centers in 2 years for 25 million
• Minimizes custom integration, rollout time
• Proprietary advantage only lasts 3 years
• Cash flow approach 1.5billion

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Figure 4.3(b) MedCo A and MedCo B Patient
Monitoring Investments
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MedCo B options

• MedCo B can also use existing infrastructure for
  other income generating products
• Other diseases
• Charging family members for service
• These options are available because of initial
  investment
• They do not have to be exercised if the market
  changes
• Therefore give a lower risk

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Figure 4.3(c) MedCo B Leverages Infrastructure
and Exercises Options
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Figure 4.3(d) the Value of Leveraging
Infrastructure and Exercising Options
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Writing a Business Plan

• Two different scenarios
• A plan written for the purpose of attaining
  venture capital funds
• A plan for reorganizing the financial structure
  within a company
• Both require excellent writing, clear objectives
  and positive projections

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Business Plan Success

• Personal Introduction, visit
• Find out objectives of VC
• Tell story
• Negotiate
• Treat all interactions as part of proposal
• Executive summary is key
• Be careful with writing, formatting, packaging
• Maintain momentum
• Dont count cash till you have it
• Expect mostly no answers and move on!

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What Investors look for

• People/management that can get the job done
• Innovative technology that can be commercialized
• Large, rapidly expanding market
• Strategy to gain unfair advantage
• Attractive per price share

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Business Plan Components

• Executive Summary
• Customer Need and Business Opportunity
• Business Strategy and Key Milestones
• Marketing Plan
• Operations Plan
• Management and Key Personnel
• Financial Projections
• Appendices

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Business Plan Components

• Executive Summary
• Business opportunity, technology, product,
  market, management
• Proposed financing
• Amount
• Use of proceeds
• Five-year income summary and requirements
• Customer Need and Business Opportunity
• Product and technology description, uses
• Business Strategy and Key Milestones
• Cumulative cash need and head count at each
  milestone

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Business Plan Components

• Marketing Plan
• Customer need
• Market segmentation
• Channels of distribution
• Sales strategy and plans
• Five-year sales forecast
• Competition and positioning
• Operations Plan
• Engineering plan
• Manufacturing plan
• Facilities and administration plan

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Business Plan Components

• Management and Key Personnel
• Incentive compensation program
• Detailed resumes
• Organization
• Staffing plan and headcount projections
• Financial Projections
• Assumptions
• Five-year pro forma forecasts
• Income statement
• Balance sheet
• Cash flow statement
• Appendices
• (If needed)

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Reminder

• Project Team
• after class if you dont have team yet