Transcript Slide 1

Chapter 14
Assessing the Value of IT
Managing the Information
Technology Resource
Paula Goulding
ICT622
1
Chapter Outline






Importance of assessing IT value
Traditional financial measures to show value
Applying improved financial measure
Evaluating portfolio of IT investment projects
Activity-based management
Difference between showing value and measuring
value
 Leveraging assets of IT for competitive advantage
 How IT governance is shared responsibility
 How enterprise can benefit from processes
ICT622
2
Traditional Financial Approaches
 Return on Investment (ROI)
– Net Earnings from Operations ÷ Net Assets
– Used to asses value of IT investments
– Has limitations
 Residual Income
– Similar to measure of excess profit
– Operating Income ÷ Financial Opportunity Cost
of Investment base
ICT622
3
Traditional Financial Approaches
 Economic Value Added (EVA)
– Uses capital asset pricing model
– Identifies cost of capital for specific division or business
unit
– Removes distortions to investments decision by GAAP
– Expenditures should be capitalized and amortized
 Net Present Value (NPV)
– Firm chooses between alternative investment
opportunities to advance market value
– Evaluate projects based on measurable cash flows
ICT622
4
Real Options
 Decision to pursue investment project can be
deferred for period of time
 Opportunity to create IT investment at future time
 Mapping five characteristics of investment
opportunity
 Reduce uncertainty by deferring decision
 Interest income can be earned during deferral
period
 Ability to react to changing uncertain conditions
during deferral period by altering investment
decisions
ICT622
5
Mapping IT Investment Characteristics to
Financial Call Option Characteristics
Source: adapted from Luerhrman, T.A., Capital Projects as Real Options: An Introduction, Harvard Business School Teaching Note (1994).
ICT622
6
Decision Tree Analysis
 Capable of accounting for firm’s revisions of
strategies and operations under uncertainty
 Probabilities derived from past information
or future information that can be obtained
 Management chooses alternative that
maximizes risk-adjusted NPV
ICT622
7
Decision Tree Analysis vs. Real Option Analysis
Source: adapted from Luehrman, T.A., Capital Projects as Real Options: An Introduction, Harvard Business School Teaching Note (1994).
ICT622
8
Black-Scholes Model for European
Call Option
Vc = N(d1) PV (assets to be acquired) – N(d2)
(PV(expenditure)/efrt
ICT622
9
Real Option Valuation
of Individual Investment
 Traditional financial analysis of investment
projects has shortcomings
– Parker, Benson, Trainor
ICT622
10
Buss Framework for Individual Investment
 Investment projects ranked for 4 criteria:
–
–
–
–
financial benefits
intangible benefits
technical importance
fit with business objectives
 Each criterion comprised of relevant elements
 Each element scored for IT investment project and
total score derived
 Sum obtained across four criteria used to compare
IT investment against competing projects
ICT622
11
Oracle Corp. Decision Model
 Create committee of stakeholders affected by
IT investment
 Define intangible benefits of IT investment
 Define intangible risks associated with IT
investment
 Establish weights to relative importance of
tangible benefits
 Estimate on scale of zero to five the likelihood
of each benefit and risk observed
 Multiply likelihood estimate by weight
established for factor and add up products
ICT622
12
Real Options Analysis
 Build consensus among participants in IT
investment decisions
 They couple financial calculations with
intangible benefits and risks, aspects of
strategic concern
ICT622
13
“Tomato Garden” of IT Investment Project
Source: adapted from Luehrman, T.A., 1998b “Strategy as a Portfolio of Real Options,” Harvard Business Review, September-October (1998).
ICT622
14
Evaluating IT Investment Portfolio
 Ensure IT investment proposals are understood in
terms of expected business outcomes, efforts
needed to reach outcomes, and risks involved
 Ensure IT investments will advance value of firm
 Ensure risks associated with IT investments are in
line with acceptable risk profile
 Ensure IT investments are aligned with business
strategies
ICT622
15
Trigeorgis’ Framework
 Objective of value management refers to broad
measure of NPV
 Strategic NPV = Traditional NPV of expected cash
flows + Value of operating options from flexible
management + Investment interaction effects
 Strategic management of investments requires
management of collection of future investment
opportunities and options
 Appropriate control targets are necessary for
effective implementation of value-maximizing
approach
ICT622
16
3 Phases of Trigeorgis’ Framework
ICT622
17
Activity-Based Management Measures
 Activity-based costing
– Methodology that measures cost and
performance of activities, resources, and cost
objects
 Activity-based management
– Discipline that focuses on the management of
activities as the route to improving value
received by the customer and profit achieved by
providing this value
ICT622
18
TCO and TBO Concepts
 Total Cost of Ownership (TCO)
– Acquisition cost of materials is only portion of
true costs of a product or process
 Total Benefit of Ownership (TBO)
– Considers benefits of competing products or
processes instead of just focusing on individual
costs
ICT622
19
TCO Analysis Concerns Addressed
 Provide predictable costs and level budgets
 Determine which IT resources can be applied to
firm’s core mission
 How to determine current costs and services
 How to increase service levels at affordable cost
 How to track or recognize actual ongoing IT costs
 How to find cost-effective way of improving IT
expertise
 How to determine most effective implementation
strategy to improve effective/efficient delivery of IT
ICT622
20
Differentiating Features of
TVO Approach
 IT and business management must work
together
 Firm needs to move from pure cost center
perspective to one emphasizing value
creation
 Managers must evaluate and manage
collection or portfolio or projects
ICT622
21
Resources for More Methodologies
Applied information economics
–http://www.hubbardross.com
Balanced scorecard
–http://www.bscol.com
–http://www.aquent.com
Economic value added
–http://www.sternstewart.com
ICT622
22
Resources for More Methodologies
 Economic Value Sourced
– http://www.metagroup.com
 Portfolio management
– http://www.metricnet.com
– http://www.metagroup.com
 Real option valuation
– http://www.pwcglobal.com
ICT622
23
Value Management Framework Examples
ICT622
24
Application of Expanded Value
Management Framework
ICT622
25
Governance Is Shared Responsibility
 IT and business managers need to work
together
 Combined application of:
– Real options
– Value management
– Portfolio analysis as tools
– Metrics
– Indicators
ICT622
26
Enterprise Can Benefit from Processes
 IT work adds value to business
 Ongoing process that continues to evolve
and change
 All units must work toward same strategic
goals of firm
 Combination of financial measures,
nonfinancial measures, and partnerships
leveraging IT assets
 Encourage staff to embrace practices
ICT622
27