Transcript Managing Systems Integration Projects/Project Management

Understanding the Business
Value of IS
(supplement to Ch. 14)
Kat Schwaig
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Investing in Systems
 Investment in Systems May be Due to
– Need for strong infrastructure to provide
strategic life to the firm
– Survival
– Government Regulations
– Ongoing operations
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Decision Process of Investing in
Information Systems
 Level I Business Decision (Go/No Go)
– Status Quo or Manual Solution vs. Build and or
Buy (Buy #1 or Buy #2 or Buy #3)
– cost-benefit analysis & risk analysis
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Level 1 Business Decision
 (Go/No Go)
– Cost-benefit analysis = comparison of expected
costs to expected benefits to determine if a
computerized solution--irrespective of
build/buy or particular vendor decisions--makes
sense. Spreadsheets are often used as
computerized tools for this analysis!!!
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Costs & Benefits
 Costs
– Hardware
– Telecommunications
– Software
– Services
– Personnel
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Costs & Benefits
 Benefits
– Tangible (i.e. cost savings):
• increased productivity; lower operational costs;
reduced work force; lower computer expenses;
lower clerical & professional costs; reduced rate of
growth in expenses; reduced facility costs
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Cost & Benefits
 Benefits
– Intangible
• improved asset utilization; improved resource
control; improved organizational planning;
increased organizational flexibility; more timely
information; more information; increased
organizational learning; legal requirements attained;
enhanced employee goodwill; increased job
satisfaction; improved decision making; improved
operations; higher client satisfaction; better
corporate image
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Level I Business Decision
 (Go/NoGo)
– Risk Analysis - analysis of the uncertainties in
going ahead or not going ahead with a change
• Risks included general factors such as the level of
experience of the IS dept. in this type of system, the
fit with the organizational culture, & the stability of
the technology to deliver as required.
• They also include specific factors such as those in
the level II business decisions
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Level II Business Decision
 Build/Buy
– If a software investment is involved,
then…comparative software cost-benefit
analysis
• compare the financials on a decision to insource
versus a decision to outsource
• “Buy” estimates, which may be assembled by
systems integration managers from vendor
responses to an RFI (request for information), are
highly preliminary
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Level II Business Decision
 Build/Buy
– Financial argument
• The argument is whether a choice to build or buy
results in a greater production cost advantage. This
is the “economies of scale” issue in the outsourcing
decision
– Non-Financial argument
• The argument is whether a choice to build or buy
makes sense in the light of the other major questions
related to outsourcing, (core competency, expertise)
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Level II Business Decision
 Build/Buy
– “Build” risks refer to the uncertainty that the in-house
project will be completed to the user’s satisfaction and
that the estimated timelines and costs are reasonably
accurate
– “Buy” risks in this situation refer to the uncertainties
that the vendor software is real (not vaporware), that it
will perform as advertised, that the vendor will not go
out of business during the period that the software is in
use, etc..
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Level I & II Business Decision
 Go/No Go and Build/Buy
– In situations when an already existing system is
being replaced, benefits include the expenses
that will be avoided by scrapping the old
system plus the additional benefits realized by
integrating a wholly new system.
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Managing the Business Decision
to Invest in Information Systems
 Analytical Tools Commonly Used
– Payback Method
– Accounting Rate of Return
– Cost-benefit Ratio
– Net Present Value (NPV)
– Profitability Index
– Internal Rate of Return
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Capital Budgeting Models
 Why do firm’s invest in capital projects?
– Expand production to meet demand
– Modernize production equipment to reduce cost
– Noneconomic reasons
• Install pollution control equipment
• Convert to human resource database to meet
government regulations
• Satisfy public demands
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Cash Flows
 All capital budgeting models rely on measures of cash
flows into and out of firms
 Outflows
– Immediate outflows: cost due to purchase of
equipment, labor, etc
– Additional outflows: maintenance, updates
 Inflows
– Increased sales of more products
– Reduction in cost of production and operations
 Difference between cash outflows and inflows is used for
calculating financial worth of an investment.
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Payback Method
 A measure of the time required to payback
the initial investment on a project
Payback
=
1st Year investment
Annual net cash flows
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Accounting Rate of Return
 Calculation of the rate of return from an
investment by adjusting cash inflows
produced by the investment for
depreciation. Approximates the accounting
income earned by the investment.
ROI =
Net Benefit
Total Initial Investment
where
Total Benefits - Total Cost - Depreciation
Net Benefit =
Useful Life
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Cost-Benefit Ratio
 A method for calculating the returns from a
capital expenditure. Ex. A cost/benefit
ratio of 1.42 indicates that benefits are 1.42
times greater than cost.
Cost -Benefit =
Total Benefits
Total Costs
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Net Present Value (NPV)
 Amount of money an investment is worth,
taking into account its cost, earnings and the
time value of money
– compare the cost of the investment (cash outflow in
year 0) with net cash inflows. Any dollars received in
the future must be discounted by some appropriate %
rate (prevailing interest rate or cost of capital)
NPV = PV of expected cash flows - Initial Investment Cost
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Profitability Index
 Used to compare the profitability of
alternative investments
PV of Cash Inflows
Profitability Index
=
Investment
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Internal Rate of Return
 Rate of return or profit an investment is
expected to earn; the discount (interest) rate
that will equate to PV of the project’s future
cash flows to the initial cost of the project.
– i.e. that rate which will result in PV - 1st year
investment = 0
– variation of NPV
– considers the time value of money
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Limitations of Financial Models
 Used to
– A) Justify new systems, B)explain old systems
post hoc, C) develop quantitative support for a
political position
 Financial models Assume:
– All relevant alternatives have been examined
– Costs and benefits are known
– Costs and benefits can be expressed in a
common metric ($)
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Limitation of Financial Models as Applied to
Information Systems
 May not express the risks and uncertainty of their cost and benefit
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estimates
Cost and Benefits do not occur in the same time frame
Inflation may affect costs and benefits differently
Technology can change during the course of the project causing
estimates to vary greatly
Intangible benefits are difficult to quantify
Financial models have an application bias: transaction and clerical
systems that displace labor and save space always produce more
measurable tangible benefits than MIS, DSS, GDSS
Models are usually dealing with PPE with life up to 25 years. IS much
shorter and require significant investment to redesign. Payback must
be shorter; rates of return higher
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Level III Business Decision
 Buy #1 vs. Buy #2 vs. Buy 3 (S.I. alternatives)
– RFP process or small $ investment data gathering
• see lecture on RFPs and small $ investment decisions
– Comparative S.I. alternatives (detailed) analysis
• thorough analysis of systems integration proposals and
responses to RFPs ( see lectures on RFPs)
– risk analysis
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Level III Business Decision (S.I.
Alternatives)
 Buy#1 vs. Buy #2 vs. Buy #3 - Risk
Analysis
– similar to that of business level II except that
the vendor’s bids are more precise
– to include risk factors in the overall assessment,
a single index value for all risks taken together
should be created
– this risk index value can then be considered in a
scoring model
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Level III Business Decision
 The result?
– Vendor bids rejected and some accepted.
– What was an inquiry project is now a systems
project.
– preparation of contract
– negotiation of contract
– signing/awarding of contract
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