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IS INVESTMENT Title: IS Investment Why Finance Matters?

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1 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

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 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…”

4 Why Finance Matters? Company’s 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

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

7 IS INVESTMENT The 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 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

9 IT/IS COSTS Hardware Software Installation Environmental
Running/Expense Maintenance Security Networking Training Wider Organisational Compliance/Regulatory

10 Example of an ITJustification Framework

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

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 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

14 Costs/Benefits Benefits: Intangible Costs: Ongoing
Synergy with other projects Expanded long-term opportunities Strategic positioning Job enrichment Recording of knowledge Costs: Ongoing Operating personnel Communication lines Hardware maintenance Software upgrades Office space and utilities Benefits: Quantifiable Improved decision speed Improved decision quality Automation of tasks Ability to perform new tasks Costs: One Time Software expert system purchase Software development Other software purchase Hardware platform lease or purchase

15 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

16 Modern Evaluation Tools/Techniques (Intangibles)
Information Economics Performance Metrics Benchmarking Return on Management Risk Analysis Opinion 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 (

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

20 Performance Measurement Example
PROCESS STRATEGIC GOAL CSF MEASUREMENT Software Procurement Reduce cost Negotiate Pricing Percent discount/user

21 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

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 budget Best-practice benchmarks emphasize how information system activities are actually performed rather than numeric measures of performance.

23 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).

24 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

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

26 Opinion Modelling Interviews Questionnaires
Direction of Perception methods Opinion Surveys

27 Modern IT Evaluation Costing Approaches
Total Cost of Ownership Chargeback

28 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).

29 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.

30 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.

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