IT Economics

Trends ICT What trends are apparent in the IT field? Computational power Costs Enables more extensive applications of information technology Moore’s law Number of transistors of an integrated circuit would double every year while cost remaining same Later revised to 18 months

Moore’s Law

Moore’s law What are the different ways of interpreting this, pertaining to organizations? Companies can buy double the power in one and half years for the same cost Price-to-performance ratio continues to decline exponentially Will this trend continue? With silicon chips? Other technologies?

Economic Meaning of Growth of Computing Power Efficiency Organizations will perform same computations at decreasing costs over time Effectiveness Creative organizations will find new ways of doing things with IT Apply IT to tasks that are currently computationally feasible but not economically. New or enhanced products and services Benefits to consumers

What Economics of IT All About? Evaluating the costs, benefits and other economic aspects of IT Productivity

IT costs that reduce productivity Support Costs Wasted time Software development problems Software maintenance Incompatible systems and workarounds 7

Why IT Justification Needed Pressure from the top management IT is not necessarily the solution to all problems IT too has now to compete for funding To force aligning with the business strategy Potential stock market increases once an IT in vestment is announced A study reveals a 32% increase To assess an IT investment after completion and periodically thereafter To pay bonuses to those who involved in the project

When is it not needed to justify When the value of the investment is relatively small for the organization When the relevant data is not available, inaccurate or too volatile When the IT project is mandated However, some qualitative analysis would be good to have to explain the logic of the project

Investment Categories Invest in infrastructure data center, networks, data warehouse, an IT security system, and a corporate knowledge base Made to exist for a long time Shared by many applications Invest in Applications Specific systems and programs for achieving certain objectives Providing a payroll or taking a customer’s order

IT Justification Areas

IT Justification Process Lay an appropriate foundation for analysis, and then conduct your ROI. Conduct a good research on metrics (including internal and external metrics) and validate them. Justify, clarify, and document the costs and benefits assumptions. Document and verify all figures used in the calculation. Make figures as realistic as possible and include risk analysis. Do not leave out strategic benefits, including long-term ones. Is the project really bolstering the company’s competitive and strategic advantage? Be careful not to underestimate costs and overestimate benefits (a tendency of many technology lovers). Commit all partners, including vendors and top management.

Intangible Benefits Difficult to justify Social subsystem issues Ex. many people would agree that e-mail improves communications, but it is not at all clear how to measure the value of this improvement. Social subsystem issues One class of intangible benefits Comfort to employees, impact on the environment, changes in the power distribution in an organization, green IT, and invasion of the privacy of employees and customers.

Costing of Investments Placing a monetary value on IT costs is very difficult Issues: Fixed costs are not easy to calculate Shared among multiple systems Ex. infrastructure cost, cost of IT services, and IT management cost. IT manager’s salary will not change by adding a new system Cost of a system doesn’t end after installation Some costs are not even anticipated Y2K

Transaction Costs Costs that are associated with the distribution (sale) and/or exchange of products and services What are different types of transaction costs? Search cost: cost of locating buyers and sellers Information cost: learn about the product, basis for pricing, etc./learn the needs of the buyer, legitimate and financial conditions, etc. Negotiation cost: costs of meetings, communications, information exchange, etc. Decision costs: cost of making a decision whether to buy from/sell to a particular seller/buyer Monitoring cost: costs of ensuring whether the transaction happens as agreed What is the impact of IT on transaction costs?

Revenue Models Additional revenues that may generate due to an IT investment Sales: additional sales revenue from online transactions Transaction fees: commissions received for transactions Subscription fees: fees that the customers pay to subscribe to a service Advertising fees: fees to display advertisements Affiliate fee: fees for referring to other’s websites Other: fees for playing games or watching competitions

Impact of Risk IT can mitigate risk as well as introduce risk Reduce risks to firms by providing timely information Reduce risks to customers Delays, incorrect choices, quality concerns Introduce risk Financial transactions Security and privacy of information

Evaluating an IT Investment Traditional methods to determine ROI NPV Converts future values of benefits to their present-value equivalent. When does NPV works well? When costs and returns are well defined (tangible) IRR Interest rate that makes NPV of future cash in-flows zero. Higher the value, better Accepted if greater than cost of capital or minimum acceptable rate set Payback period point at which the yearly benefits of a project equal the costs.

IT Justification: Sample Cost Benefit Projection

Advanced Methods for IT justification Traditional Methods are not good to evaluate IT investments There are many justification methods categorized into four approaches Financial approach: consider only impacts that can be monetary valued Multi-criteria approach: consider both financial impacts and non- financial impacts that cannot be (or cannot easily be) expressed in monetary terms. Ratio approach: use several ratios (e.g., IT expenditures vs. total turnover) to assist in IT investment evaluation Portfolio approach: apply portfolios (or grids) to plot several investment proposals against decision-making criteria

Common Methods Business case method Commonly used in large IT projects A written document to garner funds for an IT project Helps to clarify how the organization will use its resources in the best way to accomplish the IT strategy. Software support for preparation is available

Common Methods Total Cost of Ownership A formula for calculating the cost of owning, operating and controlling an IT system over its life cycle Acquisition cost: hardware and software Operations cost: maintenance, training, operations, evaluation, technical support, installation, downtime, auditing, virus damage, and power consumption Control cost: standardization, security, and central services

Common Methods Benchmarking Assesses the investments in infrastructure Assessment of infrastructure is difficult Comparison of measures of performance or of an organization’s expenditures with the averages for the industry, or comparisons with values of the most efficient performers in the industry If performance is below standard, corrective action is indicated.

Other Methods Using third party support Activity-based costing SAP business case builder, IDC (idc.com) Activity-based costing Identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each Expected Value Analysis Expected value (EV) of future benefits Value of the benefit multiplied by the probability of the benefit occurring

IT Metrics A specific, measurable standard against which actual performance is compared Where does metrics help? Communicate the strategy to the workforce through performance targets Increase accountability when metrics are linked to performance-appraisal programs Align the objectives of individuals, departments, and divisions to the enterprise’s strategic objectives Evaluate the performance of IT systems, including Web-based systems Assess the health of companies Define the value proposition of business models

IT Metrics: Examples Revenue growth Cost reduction Cost avoidance How much increase in revenue in the past 12 months Cost reduction How much sales and promotion costs were reduced Cost avoidance What costs were avoided Customer fulfillment How much of lead time reduced Customer service What is the level of customer satisfaction achieved Customer communication How fast is communication via emails

Key Performance Indicators (KPI) Quantitative expression of critically important metrics Key performance factors frequently measure factors that directly deals with performance Ex. Sales, revenue, profit, etc. Frequently, one metric can have several KPIs

Balanced Scorecard A method of evaluating the overall health of organizations and projects (including IT projects) by looking at metrics in four areas Finance, customer satisfaction, learning and growth for employees, and internal business processes Each of the four areas can be defined by organizational goals and corresponding measurable metrics

Economic Aspects of Web-based Systems Increased overheads and marketing costs

Economic Impact of E-Commerce on Non-digital products

Reach Vs. Richness The trade-off between the number of customers a company can reach (called reach) and the amount of interactions and information services it can provide to them (richness)

Chargebacks IT is not a free service Need to control usage and avoid waste Costs should not go to an overheads account Chargeback method helps allocating costs as accurately as possible to users Enables incentives for controlling usage Can also generate issues Sharing fixed costs, technological terms incomprehensible to users, etc.