Download - Lecture 9 Notes
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IS/IT Policy and StrategyIS/IT Policy and StrategyCIS 590CIS 590
Spring 2005Spring 2005
Week 9 LectureWeek 9 Lecture
Dr. David GadishDr. David Gadish
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Week 8 Review
IT Business Communications (Ch-12) Measuring, Reporting, and Controlling (Ch-13)
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Week 9 Agenda
Assessing the Value of IT (Ch-14) Questions
4
Chapter 14Assessing the Value of IT
Managing the Information Technology Resource
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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
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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
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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
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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
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Mapping IT Investment Characteristics to Financial Call Option Characteristics
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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
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Decision Tree Analysis vs. Real Option Analysis
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Black-Scholes Model for European Call Option
Vc = N(d1) PV (assets to be acquired) – N(d2)(PV(expenditure)/efrt
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Real Option Valuation of Individual Investment Traditional financial analysis of investment
projects has shortcomings– Parker, Benson, Trainor
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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
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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
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Real Options Analysis
Build consensus among participants in IT investment decisions
They couple financial calculations with intangible benefits and risks, aspects of strategic concern
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“Tomato Garden” of IT Investment Project
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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
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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
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3 Phases of Trigeorgis’ Framework
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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
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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
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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
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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
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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
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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
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Value Management Framework Examples
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Application of Expanded Value Management Framework
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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
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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
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Next Week’s Agenda
Student Presentations
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In 2 Weeks
Final Exam