Lecture 9 Notes

© 2004-05, David Gadish, Ph.D. 1

IS/IT Policy and StrategyIS/IT Policy and StrategyCIS 590CIS 590

Spring 2005Spring 2005

Week 9 LectureWeek 9 Lecture

Dr. David GadishDr. David Gadish


Week 8 Review

IT Business Communications (Ch-12) Measuring, Reporting, and Controlling (Ch-13)


Week 9 Agenda

Assessing the Value of IT (Ch-14) Questions

4

Chapter 14Assessing the Value of IT

Managing the Information Technology Resource


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


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


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


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


Mapping IT Investment Characteristics to Financial Call Option Characteristics


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


Decision Tree Analysis vs. Real Option Analysis


Black-Scholes Model for European Call Option

Vc = N(d1) PV (assets to be acquired) – N(d2)(PV(expenditure)/efrt


Real Option Valuation of Individual Investment Traditional financial analysis of investment

projects has shortcomings– Parker, Benson, Trainor


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


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


Real Options Analysis

Build consensus among participants in IT investment decisions

They couple financial calculations with intangible benefits and risks, aspects of strategic concern


“Tomato Garden” of IT Investment Project


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


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


3 Phases of Trigeorgis’ Framework


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


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


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


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


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


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


Value Management Framework Examples


Application of Expanded Value Management Framework


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


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


Next Week’s Agenda

Student Presentations


In 2 Weeks

Final Exam

Lecture 9 Notes

Documents

Transcript of Lecture 9 Notes