Title: IS Investment

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IS INVESTMENT

• Title IS Investment
• Why Finance Matters?
• Productivity and the Productivity Paradox
• IS Investment
• Evaluation Tools/Techniques
• Traditional (tangibles)
• Modern (intangibles)
• Modern (tangibles)
• Cases

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• The past forty years has seen dramatic advances
  in the technology of information processing and
  its widespread adoption bears testimony to the
  advent of the information society. However,
  the economic implications of this transition
  remain to some degree obscure, since there is
  little evidence that the new technology has led
  to clear improvements in productive efficiency.
• Geoffrey M. Brooke

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Why IT Gets no Respect(Forbes et al., 2005)

• COMPANIES ARE MAKING THE SAME MISTAKES OVER AND
  OVER AGAIN
• A full 1/3 of the IT money was essentially wasted
• More than one half of projects either fail or
  experience major cost overruns
• Only 10 were on time and on budget
• More than 1/3 of the attempts to implement major
  software packages fail
• 71 cannot say whether IT is delivering value for
  money(VFM)
• 38 say IT is only moderately well in
  alignment with business objectives

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Why Finance Matters?

• Companys need real assets
• Some assets are tangible plant, machinery etc.
• Some assets are intangible expertise,
  trademarks, patents
• All need to be paid for!
• Two major financial questions
• How much should we invest and what specific
  assets should we invest in?
• How to raise cash for the investment loans,
  shares etc.
• Our focus is on the first question IS
  investment decisions

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Productivity Paradox !

• Over the last 50 years, organizations have
  invested trillions of dollars in information
  technology.
• Total worldwide annual spending on IT in 2005 was
  three trillion dollars,
• Yet it is very hard to demonstrate that IT
  investments really have increased outputs or
  wages or profitability.
• The discrepancy between measures of investment in
  information technology and measures of output at
  the national level is described as the
  Productivity Paradox.

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Case IT versus Profitability

Quaker Oats
80
Coca-Cola
Return on Equity
Philip Morris
40
H.J. Heinz
Pepsico
Tyson Foods
Dole Food
SuperValu
0
100
1,000
10,000
100,000
IT Spending per Employee
Information Economics, Paul Strassman
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IS INVESTMENT

• The head of IT in ATT (2003) stated that
• the area of measurement is the biggest single
  failure of information systems while it is the
  single biggest issue in front of our board of
  directors
• Peter Drucker
• If you cant measure it, you cant manage it

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A number of measurement problem areas have been
identified

• Inappropriate measures
• Budgeting practices concealing full cost
• Undersanding human and organisational costs
• Understanding knock-on costs
• Overstating costs
• Neglecting intangible benefits
• Not fully investigating risk
• Failure to devote evaluation time and effort to
  major capital assets and failure to take into
  account time-scales for likely benefits
• 2 Approaches Justification and Evaluation

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IT/IS COSTS

• Hardware
• Software
• Installation
• Environmental
• Running/Expense
• Maintenance

• Security
• Networking
• Training
• Wider Organisational
• Compliance/Regulatory

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Example of an ITJustification Framework
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EVALUATION TOOLS/TECHNIQUES

• The traditional approach to evaluating IT
  investment concentrated on the tangibles and was
  focused on financial techniques
• However, information, which, is at the core of
  most intangible assets has become a valuable
  commodity, which requires measure in order to
  enable a company to gain a true reflection of the
  value of their investments and the subsequent
  derived outcomes

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Traditional IS Evaluation Tools/Techniques
(Tangibles)

• Cost Benefit Analysis (CBA)
• Return on Investment (ROI)
• Internal Rate of Return (IRR)
• Net Present Value (NPV)
• Discounted CashFlow (DCF)
• Payback Period
• See notes for more details

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Tangible Tools
Tangible Tool Purpose Ratio
Return on Investment Evaluate a no of projects annual net income project investment
Net Present Value Use discount rate based on cost of capital to establish present value of project NPV Present Value of Benefit Present Value of Investment
Internal Rate of Return Base on NPV Uses interest rate to cause npv to equal 0 Discount rate at which Cash receipts cash expenditure
Discounted Cash Flow Considers time-dependant nature of money value
Payback Period Amount of time for cash inflows to equal project investment Payback(in time) Investment Average Annual Benefit
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Costs/Benefits
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Evaluation Automation Investments

• An area where it is necessary to define and
  measure IT benefits and costs.
• Car Assembly, robots
• Warehousing, bar-coding
• Wine Production
• Capital investment decision. Such decisions can
  be analyzed by a cost-benefit analysis
• Car Example with Robots
• Benefits labour cost savings over usable life of
  the robots

Costs are the capital investment and the
operating and maintenance costs
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Modern Evaluation Tools/Techniques (Intangibles)

• Information Economics
• Performance Metrics
• Benchmarking
• Return on Management
• Risk Analysis
• Opinion Modelling
• see notes for more details

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Information Economics

• Information Economics is another method of
  evaluating IT that focuses on key organizational
  objectives.
• It incorporates the technique of scoring
  methodologies, which are used in many evaluation
  situations.
• Scoring methodology is used by analysts to first
  identify all the key performance issues and
  assign a weight to each one.

• Organizational objectives are used to determine
  which factors to include, and what weights to
  assign in the scoring methodology.
• This approach can incorporate both tangible and
  intangible benefits.
• This flexible approach can be carried out by
  software packages such as Expert Choice
  (expertchoice.com).

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Information Economics

• Return on Investment (ROI)
• Traditional cost-benefit analysis (CBA)
• Value Linking
• Value Acceleration
• Value Restructuring
• Innovation Evaluation

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Information Economics Value Assessment Factors

• Business Domain
• Strategic Match
• Competitive Advantage
• Management Information
• Competitive Response
• Organisational/Project Risk -
• IT Domain
• Strategic IS Architecture
• Definitional Uncertainty -
• Technical Uncertainty -
• IS Infrastructure Risk -

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Performance Measurement Example
PROCESS STRATEGIC GOAL CSF MEASUREMENT
Software Procurement Reduce cost Negotiate Pricing Percent discount/user
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Some Current IT Performance Metric Examples

• Development
• No. of modifications to software package
• No. of changes to design
• development cost
• Ratio of contractors to employees
• Data Center
• No of users requesting access to tools
• No. of errors reported
• No. of user queries stored
• No. of Service outages
• Network
• Network response time
• Mean time to repair (MTTR)
• Network availability percent
• Cost per LAN port

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Evaluating IT - Benchmarking

• One approach to evaluating infrastructure is to
  focus on objective measures of performance known
  as benchmarks.
• Benchmarks come in two forms
• Metric benchmarks provide numeric measures of
  performance.
• IT expenses as percent of total revenues.
• Percent of downtime (when the computer is not
  available).
• CPU usage (as percent of total capacity).
• Percentage of IS projects completed on-time and
  within budget
• Best-practice benchmarks emphasize how
  information system activities are actually
  performed rather than numeric measures of
  performance.

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Benchmarking Tool

• Costmark is a benchmarking tool to assist in
  managing SAP R/3-related environments.
• It provides a snapshot of various costs related
  to personnel, hardware, software licenses,
  maintenance, help-desk functions, and
  telecommunications.
• Some examples of reports generated by Costmark
• Distribution of cost of operations across
  different user groups.
• Total cost of operations across different user
  groups and across different departments.
• Comparison of various costs with average costs
  obtained across all SAP-R/3 installations (i.e.,
  industry average).

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Return on Management

• A measure of performance based on the added value
  to an organisation provided by management
• Return-on-Management Management Value-added
• Management Costs

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Risk Analysis

• Game Theory
• Simulation/modelling Techniques
• Sensitivity Analysis/Structured Scenarios
• Probability of Attainment
• Bayesian Analysis

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Opinion Modelling

• Interviews
• Questionnaires
• Direction of Perception methods
• Opinion Surveys

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Modern IT Evaluation Costing Approaches

• Total Cost of Ownership
• Chargeback

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Evaluating IT - TCO

• An interesting approach for evaluating the value
  of IT is the total cost of ownership (TCO).
• TCO is a formula for calculating the cost of
  owning and operating a PC.
• The cost includes hardware, technical support,
  maintenance, software upgrades, and help-desk and
  peer support.
• By identifying such costs, organizations get more
  accurate cost-benefit analyses and also reduce
  the TCO.
• It is possible to reduce TCO of workstations in
  networked environments by as much as 26 percent
  by adopting best practices in workstation
  management (Kirwin et al., 1997).

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IT Accounting Systems

• Ideally IT accounting systems will effectively
  deal with two issues
• Provide an accurate measure of total IT costs for
  management control purposes.
• Charge users for shared (usually infrastructure)
  IT investments and services in a manner that
  contributes to the achievement of organization
  goals.

• These are two very challenging goals for any
  accounting system.
• The complexities and rapid pace of change make
  them even more difficult to achieve in the
  context of IT.
• In the early days of computing it was much easier
  to identify costs. Nowadays a large proportion of
  the costs are in hidden, indirect costs that
  are often overlooked.

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Chargeback

• Chargeback is an alternative IT accounting method
  which distributes all costs of IT to users as
  accurately as possible, based on actual costs and
  usage levels.
• Although accurate allocation sounds desirable in
  principle, it can create problems in practice.The
  most accurate measures of use may reflect
  technological factors that are totally
  incomprehensible to the user.

• Behavior-oriented chargeback is another IT
  accounting alternative. The primary objective of
  this system is influencing users behavior.
• It is possible to encourage (or discourage) usage
  of certain IT resources by assigning lower (or
  higher) costs. Although more difficult to
  develop, it recognizes the importance of IT to
  the success of the organization.