MEASURES OF THE BUSINESS VALUE OF IT MODUL 4. SESSION Matakuliah: M0624/Information Technology Valuation Tahun : 2008

Bina Nusantara INTRODUCTION IN ANY BUSINESS A “DASHBOARD” OF VITAL PERFORMANCE INDICATORS IS NEEDED TO GAUGE HOW THE COMPANY IS FARING. SUCH A DASHBOARD, CONSISTING OF THE APPROPRIATE MEASURES TO INDICATE STRENGTHS AND WEAK- NESSES, PROVIDES TO A GUIDE FOR MANAGE- MENT AND FORMS THE CORE OF PLANNING AND CONTROL. A DASHBOARD ALLOWS MANAGEMENT TO VALUA- TE THE CONTRIBUTION OF SEVERAL FACTORS THAT IMPACT THE OVERALL PERFORMANCE OF THE ORGANIZATION.

Bina Nusantara INTRODUCTION TO VALUATE IT, A DASHBOARD OF RELEVANT PERFORMANCE INDICATORS FOR IT MUST BE DEVELOPED. THE BTRIPLEE FRAMEWORK OFFERS THE STRUCTURE OF THE DASHBOARD AND IDENTIFIES THE DISTINCT BUT INTERDEPENDENT LEVELS OF BUSINESS VALUE OF IT, EFFECTIVENESS OF IT, AND EFFECTIVENESS AND EFFICIENCY OF IT SUPPLY.

Bina Nusantara INTRODUCTION MEASURING THE BUSINESS VALUE OF IT IS CONCERNED WITH THE RELATIONSHIP BETWEEN THE COSTS OF IT AND ITS CONTRIBUTION TO THE IMPROVEMENT OF: A.FINANCIAL PERFORMANCE: SUCH AS PROFITABI- LITY, PRODUCTIVITY, EARNINGS, ETC B.BUSINESS PERFORMANCE: SUCH AS COMPETI- TIVENESS, NEW PRODUCT SALES, PRODUCT DEVELOPMENT LEAD TIMES, ETC C.STRATEGIC PERFORMANCE, MEASURED BY INDICATORS THAT MATCH SPECIFIC MANAGEMENT OBJECTIVES (MANAGEMENT’S CRITICAL SUCCESS FACTORS)

Bina Nusantara IT Costs Operations Mainte nance Develop ment $1.00 Operations Mainte nance Redevelop ment of existing functionality Development of new functionality Year 1Year 2Year 3 Year 5 Year 4 Fixed costs Variable costs $0.40 $0.20 Annual Growth of Operations Costs Annual Growth of Maintenance Costs Figure 4.1: Costs Dynamic of IT

Bina Nusantara DYNAMICS OF IT COST TO MANAGE AND MEASURE THE VALUE OF IT, ATTENTION SHOULD BE GIVEN TO THE COST SIDE OF YTHE COST-VALUE EQUATION. THESE PATTERN SUGGEST THAT EVERY DOLLAR SPENT ON IT DEVELOPMENT AUTOMATICALLY GENERATES FOLLOW-ON COSTS FOR IT MAINTENANCE AND IT OPERATIONS. ACCORDING TO KEEN (EARLY ‘90): EACH DOLLAR OF NEW DEVELOPMENT GENERATES 20 CENTS OF MAINTENANCE AND 40 CENTS OF OPERATIONS IN EACH SUBSEQUENT YAER.

Bina Nusantara DYNAMICS OF IT COST ORGANIZATIONS HAVE OPTIONS FOR DEALING WITH THE DYNAMICS OF IT COST. THIS IS IMPORTANT TO UNDERSTAND BOTH AT THE TIME OF PLANNING FOR IT (EX-ANTE) TO DETERMINE WHAT TO DO AND AT THE TIME OF VALUATING IT AFTERWARDS (EX-POST) TO PLACE IT COSTS IN THE CONTEXT OF PAST DECISIONS.

Bina Nusantara Year 1Year 2Year 3Year 4Year 5 Developmen t 10.0 Maintenance & operations 30.0 Cut development costs, overall IT budget remains the same Keep development costs at the same level Grow development costs by 10% per year IT Costs ($) Figure 4.2: Options to Deal with Costs Dynamics of IT

Bina Nusantara DYNAMICS OF IT COST 3 SCENARIOS FOLLOW, AS INDICATED IN FIG 4.2 CUT DEVELOPMENT COSTS: IF THE OVERALL IT BUDGET IS TO REMAIN THE SAME OVER THE PERIOD OF 5 YEARS, DEVELOPMENT COSTS MUST BE CUT BY A CUMULATIVE 93% OVER THE PERIOD, ONLY 7% OF THE ORIGINAL DEVELOPMENT BUDGET WILL REMAIN. KEEP DEVELOPMENT COSTS AT THE SAME LEVEL, THE COMPOUNDED IT BUDGET GROWS 15% PER YEAR OVER 5 YEARS AS A RESULT

Bina Nusantara DYNAMICS OF IT COST GROW DEVELOPMENT COSTS: GROWTH OF DEVELOPMENT COSTS OF 10% PER YEAR RESULT IN A COMPOUNDED GROWTH OF THE IT BUDGET OF 18% PER YEAR.

Bina Nusantara DYNAMICS OF IT COST 3 FACTORS SHOULD BE CONSIDERED WHEN EVALUATING THE STATISTICTS: 1.IT ANNUAL BUDGET ESTIMATES THAT HIDEN COST EQUAL 30-50% OF KNOWN SPENDING. 2. TECHNOLOGY HAS BECOME CHEAPER, WHILE MANY IT SUPPLY ORGANIZATIONS HAVE INCREASED THEIR EFFICIENCY LEVELS, ESPECIALLY IN THE COMPUTER OPERATIONS AREA, BY COMBINING DATA CENTERS AND BY OUTSOURCING PARTS OF THEIR DATA CENTER ACTIVITIES.

Bina Nusantara DYNAMICS OF IT COST 3.E-BUSINESS IS DRAMATICALLY CHANGING THE WAY BUSINESS OPERATE AND THE NECESSARY INVESTMENT TO MAKE THIS HAPPEN IS NOT SMALL.

Bina Nusantara % 6,0% 3,0% 1,5% 12,0% S/360 Mainframe PC – Client/ Server Web- internet North America Western Europe Asia/Pacific (Dev. Economies) Figure 4.3: Annual Rate of IT Budget Growth

Bina Nusantara DYNAMICS OF IT COST GENERALLY, IT COSTS ARE CATEGORIZED INTO THE ACTIVITIES OF: 1.DEVELOPMENT OF NEW IT CAPABILITIES 2.MAINTENANCE OF EXISTING IT CAPABILITIES 3.OPERATING IT CAPABILITIES (OPERATIONS) 4.END-USER COMPUTING SUPPORT 5.PLANNING AND ADMINISTRATION OF IT AND IT ACTIVITIES

Bina Nusantara Activity Development / Major enhancements Maintenance / minor enhancements Production / Operations End user computing/ Help desk Planning, administration, other Figure 4.4: IT Spending by Activity (%)

Bina Nusantara Resource Hardware Software Personnel Outside services Datacom and other Figure 4.5: IT spending by Resource (%)

Bina Nusantara MEASURES OF FINANCIAL PERFORMANCES THROUGH IT SOME MEASUREMENTS: 1.ROM (RETURN ON MANAGEMENT): FINANCIAL RESULTS OF THE BUSINESS MINUS THOSE ITEMS THAT OUTSIDE THE CONTROL OF MANAGEMENT. 2.ROA (RETURN ON ASSET) 3.ROE (RETURN ON EQUITY) 4.ROI (RETURN ON INVESTMENT)

Bina Nusantara MEASURES OF FINANCIAL PERFORMANCES THROUGH IT IT INVESTMENT: IT BUDGET AS % OF REVENUE VALUE OF AN ORGANIZATION’S IT EQUIPMENT AS % OF REVENUE % OF IT BUDGET SPENT ON IT STAFF % OF IT BUDGET SPENT ON TRAINING OF IT STAFF NUMBER OF PERSONAL COMPUTERS AND TERMINALS AS % OF TOTAL EMPLOYEES

Bina Nusantara MEASURES OF FINANCIAL PERFORMANCES THROUGH IT STRATEGIC AND ECONOMIC PERFORMANCE: 1.ROI 2.ROS (RETURN ON SALES) 3.REVENUE GROWTH 4.SALES BY TOTAL ASSETS 5.SALES BY EMPLOYEE

Bina Nusantara Value of IT equipment as % of revenue % of IT budget spent on IT staff training No. of PCs and terminals as % of total employees Return on Assets Sales by Total Assets Sales by Employee Return on Sales Return on Investment Figure 4.6: Relationships between IT Investment Radios and Financial Performance Ratios

Bina Nusantara MEASURES OF BUSINESS PERFORMANCES THROUGH IT BUSINESS PERFORMANCE IS ACHIEVED THROUGH BUSINESS ACTIVITIES, GROUPED TOGETHER IN BUSINESS PROCESSES, AND THROUGH THE ORGANIZATIONS AND ALLOCATION OF RESOURCES OF THESE BUSINESS PROCESSES. APPLIED OF THE BALANCED SCORECARD CONCEPT

Bina Nusantara MEASURES OF BUSINESS PERFORMANCES THROUGH IT 4 BASIC QUESTIONS FROM MANY PERSPECTIVES: HOW DO CUSTOMERS SEE US? (CUSTOMERS PERSPECTIVE) WHAT MUST WE EXCEL AT? (INTERNAL PERSPECTIVE) CAN WE CONTINUE TO IMPROVE AND ADD VALUE? (INNOVATION AND LEARNING PERSPECTIVE) HOW DO WE LOOK TO SHAREHOLDERS? (FINANCIAL PERSPECTIVE)

Bina Nusantara GoalMeasures GoalMeasures GoalMeasures GoalMeasures Financial Perspective Customer PerspectiveInternal Perspective Innovation Perspective Figure 4.7: The Balanced Scorecard

Bina Nusantara MEASURES OF BUSINESS PERFORMANCES THROUGH IT THE ADVANTAGES OF USING BALANCED SCORECARD TO RELATE IT COSTS TO BUSINESS PERFORMANCE INDICATORS: A.THE SCORECARD BRINGS TOGETHER MANY OF THE SEEMINGLY DISPARATE ELEMENTS OF A COMPANY’S POSSIBLE COMPETITIVE INITIATIVES: BECOMING CUSTOMER ORIENTED, SHORTENING RESPONSE TIME, IMPROVING QUALITY, EMPHASIZING TEAM WORK, REDUCING NEW LAUNCH TIMES, MANAGING ORGANIZATIONAL LEARNING, ETC

Bina Nusantara MEASURES OF BUSINESS PERFORMANCES THROUGH IT B.THE SCORECARD GUARDS AGAINST SUBOPTIMIZATION BY FORCING SENIOR MANAGERS TO CONSIDER ALL THE OPERATIONAL MEASURES TOGETHER. C. IT COST ARE DIRECTLY LINKED TO THE BUSINESS PERFORMANCE INDICATORS WITH WICH MANAGEMENT IS ALREADY FAMILIAR.

Bina Nusantara Performance indicator IT Costs ($m) Revenues ($m) Operating costs ($m) Number of passengers ($m) Number of freq. flyers ($m) IT costs as % revenue IT costs as % operating costs IT costs per passenger IT costs per frequent flyer Revenue per passenger Operating costs per passenger Trend (%) Year 1Year 2Year 3Year Financial Perspective Internal Perspective Customer Perspective Innovation Perspective Relating IT costs to the: Figure 4.8: Relating Costs to the Balanced Scoreboard of an Airline

Bina Nusantara MEASURES OF BUSINESS PERFORMANCES THROUGH IT FROM FIG 4.8: GROWING REVENUES REPRESENTS THE FINANCIAL PERSPECTIVE OPERATING COSTS REPRESENTS THE INTERNAL PERSPECTIVE; THEY INCREASE BUT AT A LOWER RATE THAN REVENUES, SHOWING INTERNAL EXCELLENCE GROWING NUMBER OF PASSENGER REPRESENTS THE CUSTOMER PERSPECTIVE, ASSUMING THAT THE GROWTH RESULTS FROM CUSTOMER SATISFACTION

Bina Nusantara MEASURES OF BUSINESS PERFORMANCES THROUGH IT EXPANDING NUMBER OF MEMBERS OF A NEW PRODUCTS, THE SO-CALLED FREQUENT FLYER PROGRAM, REPRESENT THE INNOVATION AND LEARNING PERSPECTIVE. MEASURES OF FINANCIAL PERFORMANCES THROUGH IT

Bina Nusantara MEASURES OF STRATEGIC PERFORMANCES THROUGH IT THE 3 RD DIMENSION OF BUSINESS OF IT DEALS WITH THE QUESTIONS TO WHAT EXTENT IT COSTS ARE DISTRIBUTED OVER THE LIMITED, BUT MOST IMPORTANT, AREA CSF IN WHICH RESULTS ARE EXPECTED TO GENERATE STRATEGIC SUCCESS. 1 ST ORGANIZATIONAL OBJECTIVES ARE DETER- MINED. THESE ARE HIGHLY COMPANY SPESIFIC, AND DIFFER BECAUSE OF THE STRUCTURE OF THE PARTICULAR INDUSTRY, THE COMPANY’S COMPETITIVE STRATEGY, ITS INDUSTRY POSITION AND GEOGRAPHIC LOCATION AND MANY OTHER EXTERNAL AND INTERNAL FACTORS.

Bina Nusantara MEASURES OF FINANCIAL PERFORMANCES THROUGH IT 2 ND CSF ARE DETERMINED AND RANKED. LIMITING SEARCH FOR CSF TO 1 OR MORE OF 4 PERSPECTIVE: PRIORITY PRODUCTS OR SERVICES, PRIORITY PROCESSES, PRIORITY BUSINESS PROCESSES, AND PRIORITY JOB FAMILIES. 3 RD THE LEVEL OF ANNUAL IT COSTS ARE DETERMINED FOR EACH OF THE CSF.

Bina Nusantara Maintenance & Operation Mandatory Development IT Infrastructure & Research Business Improvement Rejuvenate Product portfolio Develop Eastern European Market Payroll Business Redesign New IT DevelopmentGoing Concern IT Classes of IT General Ledger Critical to business Success No critical to business Success IT Costs Figure 4.9: IT Costs by Critical Success Factor

Bina Nusantara MEASURES OF FINANCIAL PERFORMANCES THROUGH IT 3 CLASSES OF IT COSTS: A.IT COST TO MAINTAIN THE ORGANIZATION’S STATUS QUO, CALLED GOING CONCERN COSTS: THE COSTS OF IT MAINTENANCE AND IT OPERATIONS ADDED TOGETHER. B.IT INFRASTRUCTURED AND IT RESEARCH COSTS, THAT ARE GENERALLY CORPORATE WIDE INVESTMENTS IN A “CORE COMPETENCE” OF THE ORGANIZATIONS, ENABLING OTHER IT INVESTMENTS TO CREATE DIRECT VALUE. C.DEVELOPMENT COSTS OF NEW IT APPLICATIONS.

Bina Nusantara CONCLUSION THE KEY TO DETERMINING THE BUSINESS VALUE OF IT IS TO APPLY AN AGGREGATED APPROACH TO CORRELATE IT COSTS WITH THE PERFORMANCE OF THE ORGANIZATIONS. IMPROVED PERFORMANCE IS EXPRESSED AS IMPROVED FINANCIAL PERFORMANCE, IMPROVED BUSINESS PERFORMANCE AND REALIZED STRATEGIC GOALS.

Bina Nusantara CONCLUSION IT IS RECOMMENDED: A. 1 ST DETERMINED THE DYNAMICS OF IT COSTS OF A PARTICULAR ORGANIZATION BY MEASURING OVERALL IT COSTS AS A % OF REVENUE, ANNUAL GROWTH OF IT COSTS, IT COSTS BY RESOURCE (PERSONNEL AND TECHNOLOGY), AND IT COSTS BY ACTIVITY (DEVELOPMENT, MAINTENANCE AND OPERATION). THEY PROVIDE AN INSIGHT IN IT COST PATTERNS AND MAY REVEAL ABNORMALITIES IN TRENDS.

Bina Nusantara CONCLUSION B. 2 ND TO DETERMINE THE VALUE OF IT MEASURED BY IMPROVED ECONOMIC PERFORMANCE OF PARTICULAR ORGANIZATION, IT COST MUST BE RELATED WITH FINANCIAL PERFORMANCE MEASURES. C. 3 RD TO VALUATE THE CONTRIBUTION OF IT TO IMPROVE BUSINESS PERFORMANCE IT IS RECOMMENDED TO RELATE IT COSTS WITH MULTIPLE BUSINESS MEASURES FOR DIFFERENT CATEGORIES OF BUSINESS PERFORMANCE TO REFLECT THE DIFFERENT ACTIVITIES AND OBJAECTIVES OF THE BUSINESS IN A BALANCED WAY.

Bina Nusantara CONCLUSION A REFINEMENT OF THE APPROACH OF VALUATING IT IN TERMS OF BUSINESS PERFORMANCE IS TO MEASURE THE CONTRIBUTION OF IT IN REALIZING STRATEGIC GOALS.

Bina Nusantara THE END OF SESSION