Presentation on theme: "IS INVESTMENT Title: IS Investment Why Finance Matters?"— Presentation transcript:
1 IS INVESTMENT Title: IS Investment Why Finance Matters? Productivity and the Productivity ParadoxIS InvestmentEvaluation Tools/TechniquesTraditional (tangibles)Modern (intangibles)Modern (tangibles)Cases
2 “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
3 Why IT Gets no Respect (Forbes et al., 2005) COMPANIES ARE MAKING THE SAME MISTAKES OVER AND OVER AGAINA full 1/3 of the IT money was essentially wastedMore than one half of projects either fail or experience major cost overrunsOnly 10% were on time and on budgetMore than 1/3 of the attempts to implement major software packages fail71% cannot say whether IT is delivering value for money(VFM)38% say IT is “… only moderately well in alignment with business objectives…”
4 Why Finance Matters? Company’s need real assets Some assets are tangible – plant, machinery etc.Some assets are intangible – expertise, trademarks, patentsAll need to be paid for!Two major financial questionsHow 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
5 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.
6 Case: IT versus Profitability Quaker Oats80%Coca-ColaReturn on EquityPhilip Morris40%PepsicoH.J. HeinzTysonFoodsDoleFoodSuperValu0%$100$1,000$10,000$100,000IT Spending per EmployeeInformation Economics, Paul Strassman
7 IS INVESTMENTThe head of IT in AT&T (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 can’t measure it, you can’t manage it “
8 A number of measurement problem areas have been identified: Inappropriate measuresBudgeting practices concealing full costUndersanding human and organisational costsUnderstanding knock-on costsOverstating costsNeglecting ‘intangible’ benefitsNot fully investigating riskFailure to devote evaluation time and effort to major capital assets and failure to take into account time-scales for likely benefits2 Approaches – Justification and Evaluation
11 EVALUATION TOOLS/TECHNIQUES The traditional approach to evaluating IT investment concentrated on the tangibles and was focused on financial techniquesHowever, 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
12 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
13 Tangible Tools Tangible Tool Purpose Ratio Return on Investment Evaluate a no of projectsannual net incomeproject investmentNet Present ValueUse discount rate based on cost of capital to establish present value of projectNPV =Present Value of BenefitPresent Value of InvestmentInternal Rate of ReturnBase on NPVUses interest rate to cause npv to equal 0Discount rate at whichCash receipts = cash expenditureDiscounted Cash FlowConsiders time-dependant nature of money valuePayback PeriodAmount of time for cash inflows to equal project investmentPayback(in time) = InvestmentAverage Annual Benefit
14 Costs/Benefits Benefits: Intangible Costs: Ongoing Synergy with other projectsExpanded long-term opportunitiesStrategic positioningJob enrichmentRecording of knowledgeCosts: OngoingOperating personnel Communication linesHardware maintenanceSoftware upgradesOffice space and utilitiesBenefits: QuantifiableImproved decision speedImproved decision qualityAutomation of tasksAbility to perform new tasksCosts: One TimeSoftware expert system purchaseSoftware developmentOther software purchaseHardware platform lease or purchase
15 Evaluation: Automation Investments An area where it is necessary to define and measure IT benefits and costs.Car Assembly, robotsWarehousing, bar-codingWine ProductionCapital investment decision. Such decisions can be analyzed by a cost-benefit analysisCar Example with RobotsBenefits labour cost savings over usable life of the robotsCosts are the capital investment andthe operating and maintenance costs
16 Modern Evaluation Tools/Techniques (Intangibles) Information EconomicsPerformance MetricsBenchmarkingReturn on ManagementRisk AnalysisOpinion Modelling*see notes for more details
17 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).
18 Information Economics Return on Investment (ROI) =Traditional cost-benefit analysis (CBA)+ Value Linking+ Value Acceleration+ Value Restructuring+ Innovation Evaluation
19 Information Economics – Value Assessment Factors Business DomainStrategic Match +Competitive Advantage +Management Information +Competitive Response +Organisational/Project Risk -IT DomainStrategic IS Architecture +Definitional Uncertainty -Technical Uncertainty -IS Infrastructure Risk -
20 Performance Measurement Example PROCESSSTRATEGIC GOALCSFMEASUREMENTSoftware ProcurementReduce costNegotiate PricingPercent discount/user
21 Some Current IT Performance Metric Examples DevelopmentNo. of modifications to software packageNo. of changes to design% development costRatio of contractors to employeesData CenterNo of users requesting access to toolsNo. of errors reportedNo. of user queries storedNo. of Service outagesNetworkNetwork response timeMean time to repair (MTTR)Network availability percentCost per LAN port
22 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 budgetBest-practice benchmarks emphasize how information system activities are actually performed rather than numeric measures of performance.
23 Benchmarking ToolCostmark 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).
24 Return on ManagementA measure of performance based on the added value to an organisation provided by managementReturn-on-Management = Management Value-addedManagement Costs
25 Risk Analysis Game Theory Simulation/modelling Techniques Sensitivity Analysis/Structured ScenariosProbability of AttainmentBayesian Analysis
26 Opinion Modelling Interviews Questionnaires Direction of Perception methodsOpinion Surveys
27 Modern IT Evaluation Costing Approaches Total Cost of OwnershipChargeback
28 Evaluating IT - TCOAn 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).
29 IT Accounting SystemsIdeally 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.
30 ChargebackChargeback 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.