Value of IT by ewghwehws

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									Value of IT

The Economics of IT Investments
Moore’s Law
         Moore’s Law
                            Year of introduction                                   Transistors


   4004                              1971                                         2,250
   8008                              1972                                         2,500
   8080                              1974                                         5,000
   8086                              1978                                         29,000
   286                               1982                                         120,000
   386™ processor                    1985                                         275,000
   486™ DX processor                 1989                                         1,180,000
   Pentium® processor                1993                                         3,100,000
   Pentium II processor              1997                                         7,500,000
   Pentium III processor             1999                                         24,000,000
   Pentium 4 processor               2000                                         42,000,000




                                      Source: http://www.intel.com/research/silicon/mooreslaw.htm?iid=sr+moore&
Implications of Moore’s Law
   Price-to-Performance ratio is declining
    exponentially
       Existing functions will be done at lower costs
        (efficiency improvements)
       New uses for technology will emerge
         • Enhanced products and services
         • Make the technologically feasible economically
           viable
         • IT will be embedded in traditionally low-tech goods
       Provides competitive advantage to
        innovative companies
       Greater benefit to consumers
       Greater emphasis on intangible benefits
Intangible Benefits of IT

   Factors that are important but difficult to
    express in terms of monetary value
   Early days- easy to measure value
       Computers replaced manual jobs on a one-
        by-one basis
   Now… most manual tasks have been dealt
    with
       Additional advantages come through re-
        engineering business processes
       BPR produces intangibles – better response
        time, better quality… difficult to measure
Productivity Paradox

   Despite massive investments in IT in the
    1970s and 1980s, there is lack of evidence
    of a payoff.
       Services showed much less productivity
        gains than manufacturing
   Difficult to demonstrate that the IT
    investments are directly correlated to higher
    wages or outputs
   The discrepancy between measures of IT
    investments and output measures is called
    the productivity paradox.
Explaining the Paradox
   Data and Analysis problems
        Difficult to allocate costs to products in the service sector
        Analysis does not take into account time lags (it takes time to learn
         new software – productivity may decrease…)
   IT gains are offset by losses in other areas
        Reduce production staff (due to IT) but increase staffing in other
         areas
   IT gains are offset by IT losses
   Is there really a relationship between IT spending and profitability?
        Strassman says “no evidence”
        What if IT causes outputs to increase 25 percent but inputs
         increase 30 percent?
        Evaluations must include changes in inputs over entire lifecycle
         (including projects not implemented)
          •   Support costs
          •   Wasted time
          •   Software development problems
          •   Software maintenance (remember Y2K?)
          •   Incompatible systems and integration costs.
Evaluating IT
Consider some of the costs and benefits associated with
acquiring a new software system

Costs                        Benefits
One-Time                     Quantifiable
S/W purchase                 Improved decision speed
S/W Development              Improved decision quality
Other S/W purchase           Automation of tasks
Hardware purchase            Ability to perform new tasks
Communication equipment      Standardization of decisions
Office Space                 Shorter training time
Training and Documentation
                             Intangible
Recurrent                    Synergy with other projects
Operating personnel          Expanded long-term options
Communication lines          Strategic positioning
Hardware maintenance         Job enrichment
Software upgrades            Recording of knowledge
Office space and utilities
            IT Investment Types
Investment Purpose                  Comments
Infrastructure to support current   Possible future benefits; Difficult to identify
business                            contribution
Required for managerial control     Cost of doing business; no expected return

No other way to do job              Returns in terms of labor savings

Direct returns from IT              Returns can be identified and measured

Indirect returns from IT            Hard to identify; large potential returns

Competitive necessity               No expected return other than keeping market
                                    share
Strategic Application               Hard to identify; large potential returns; estimation
                                    possible only after implementation
Transformational IT                 Hard to identify; large potential returns;


                                                                  Source: Lucas, 1999
Value of IT Investments:
Keep in Mind
   Multiple kinds of values: ROI dollars is only
    one of them
   Different types of investments have different
    probabilities of providing returns
   Probability of return depends on probability
    of conversion (systems may not be be fully
    implement, over-budget, late..)
   Expected value of ROI is usually less than
    initially calculated

                       Source: Lucas, 1999
Traditional Evaluation
Methods
 Internal Rate of Return
 Net Present Value

 Payback period

 Cost-Benefit Ratio

 Total Cost of Ownership
       http://h18000.www1.hp.com/tco/snaps
        hottool.html (A downloadable TCO
        tool)
Gartner TCO Lifecycle
Model




            Source: http://h18000.www1.hp.com/tco/models.html
Assessing the intangibles
   IT can
       Speed up business processes
       Provide more accurate information
       Improve communication
   Difficult to measure
       How do you estimate the value of email
   Approaches
       Value Analysis
       Information Economics
       Management by Maxim
       Option Valuation
               Value Analysis
  Identify Value                      Establish Maximum                    Build prototype if
  (Intangible Benefits)               Cost Willing to Pay                  cost is acceptable



                                                                                                Evaluate prototype



                                                                                                Establish Cost of
                                                                                                Full-Scale System



  Enhance                             Build Full-Scale                     Identify Benefits
  functionality of                    System if necessary                  Needed to Justify
  functionality of full-                                                   Cost
  scale system




Central philosophy: Create a low cost version of system first. Allow user to
identify potential intangible benefits. Allow developer to better estimate final
cost.
Information Economics
   Focuses on key organizational objectives
   Uses a scoring methodology
   Process
      Identify all key performance issues
      Assign each a weight based on importance
      Every product being evaluated receives a score (0-
        100) on each factor
      Score multiplied by weight
      Overall highest total judged to be best product
   More complicated methodologies are available (see
    http://www.expertchoice.com)



                                        Back
Management by Maxim

   Used to help with infrastructure decisions
    for multi-unit, multi-divisional organizations
       Infrastructure typically takes up about 50% of
        an IT budget
       Creates synergies between units
   Different units may have different
    evaluations for infrastructure
   MbM brings corporate executives, IT
    executives, and business unit managers
    together for planning sessions to determine
    appropriate infrastructure investments.
MbM Process
   Consider Strategic Context
        Identify long-term goals, potential synergies where data sharing
         could help performance, degree of emphasis on inter-unit
         cooperation
   Articulate business maxims
        Short, well-defined goals in areas such as cost, quality, flexibility,
         growth, human resources
   Identify IT maxims
        Statements of IT strategies and goals required to support the
         business maxims
           • Business maxim: “price services at lowest cost”
           • IT maxim: use IT to reduce cost by eliminating duplicated efforts
   Clarify firm’s view of IT infrastructure
        None (independent operations)
        Utility (sharing done to reduce costs)
        Dependent (supports current strategies of business units)
        Enabling (supports long-term goals of business units)
   Specify infrastructure services
        Identify infrastructure services required to achieve business and IT
         maxims.
Option Valuation
   Similar to the idea of option valuation in the securities
    market.
   It is possible that the cost of an IT investment exceeds
    its tangible benefits.
   What if the project creates opportunities for other
    projects in the future (like the frequent flier program
    was the unexpected benefit of online airline
    reservation systems)?
       The IT investment has options value that needs to be
         added to the other benefits
       expected value of a IT investment is
         • Size of benefit x probability of its occurrence
         • Eg: 50% chance that investment would lead to $10m in
           new business ($5m benefit)
Balanced Scorecard
(can you tell if you’re winning if you don’t keep
score?)
   Developed in the 1990s
   Converts value drivers to series of metrics
       Customer service
       Innovation
       Operational efficiency
       Financial performance
   Companies record and analyze metrics to see if they
    are meeting strategic goals
   Cascades from top of organization downward
   Ultimately, each individual has a personal scorecard
    linked to overall corporate objectives.
IT Scorecard
   Allows for a greater alignment between business objectives
    and IT objectives
   “Customer” is now a client user within company
   Scorecard helps eliminate projects that make little
    contribution to strategic goal (useful in project prioritization)
   Example Metrics from FirstEnergy
        Developing “raving fans” – for IT, that means internal users
        Three metrics
          • Percentage of projects completed on time and on budget.
          • Percentage of projects released to the customer by the
            agreed-upon delivery date.
          • Client satisfaction as indicated by customer surveys
            completed at the end of a project.
        Project managers evaluated based on the metrics
Cost of failure
   Some statistics
      AMR Study (2003) of CRM projects
          • Project failure: 12 percent of CRM projects fail to go live.
          • System implementation: 47 percent of CRM projects go live,
            and the technology aspects of the project are considered a
            success, but business change and adoption fail.
          • Process and system adoption: 25 percent of CRM projects
            succeed in adoption and systems but still cannot quantify a
            specific quantified business benefit.
          • Performance improvement: 16 percent of projects deemed
            success and measurably influence business performance

        Robbins-Gioia Survey (2001) of ERP projects
          • 51% felt ERP implementation was unsuccessful
          • 46% felt organization did not understand how to use the
            system to improve business
What can be done?

   One, One Ten Rule?
       No project should take more than one
        year, cost more than one million
        dollars, and involve more than ten
        developers
   Carefully consider build vs. buy
    decisions (see the information
    economics slide)
Managerial Issues
   Constant growth and change in technology (Moore’s
    Law)
      Necessitates constant monitoring of technology
        changes
   Shift from tangible to intangible benefits
   IT not a sure thing
   Use chargeback
      No incentive to control IT costs unless charged; but
        system should not discourage experimentation with
        new technologies
   Risk
      IT projects tend to be risky. Evaluate that risk before
        committing to project
AXA discussion

 What spurred the need for the
  reevaluation of IT projects?
 Comment on what emerges about IT-
  Business alignment before Bateman.
 What were the primary obstacles to
  the plan?
 Do you see any negatives to the
  approach at AXA

								
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