© , David Gadish, Ph.D.1 IS/IT Policy and Strategy CIS 590 Spring 2005 Week 9 Lecture Dr. David Gadish

© , David Gadish, Ph.D.2 Week 8 Review  IT Business Communications (Ch-12)  Measuring, Reporting, and Controlling (Ch-13)

© , David Gadish, Ph.D.3 Week 9 Agenda  Assessing the Value of IT (Ch-14)  Questions

4 Chapter 14 Assessing the Value of IT Managing the Information Technology Resource

© , David Gadish, Ph.D.5 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

© , David Gadish, Ph.D.6 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

© , David Gadish, Ph.D.7 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

© , David Gadish, Ph.D.8 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

© , David Gadish, Ph.D.9 Mapping IT Investment Characteristics to Financial Call Option Characteristics

© , David Gadish, Ph.D.10 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

© , David Gadish, Ph.D.11 Decision Tree Analysis vs. Real Option Analysis

© , David Gadish, Ph.D.12 Black-Scholes Model for European Call Option V c = N(d 1 ) PV (assets to be acquired) – N(d 2 ) (PV(expenditure)/e f rt

© , David Gadish, Ph.D.13 Real Option Valuation of Individual Investment  Traditional financial analysis of investment projects has shortcomings –Parker, Benson, Trainor

© , David Gadish, Ph.D.14 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

© , David Gadish, Ph.D.15 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

© , David Gadish, Ph.D.16 Real Options Analysis  Build consensus among participants in IT investment decisions  They couple financial calculations with intangible benefits and risks, aspects of strategic concern

© , David Gadish, Ph.D.17 “Tomato Garden” of IT Investment Project

© , David Gadish, Ph.D.18 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

© , David Gadish, Ph.D.19 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

© , David Gadish, Ph.D.20 3 Phases of Trigeorgis’ Framework

© , David Gadish, Ph.D.21 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

© , David Gadish, Ph.D.22 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

© , David Gadish, Ph.D.23 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

© , David Gadish, Ph.D.24 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

© , David Gadish, Ph.D.25 Resources for More Methodologies  Applied information economics –  Balanced scorecard – –  Economic value added –

© , David Gadish, Ph.D.26 Resources for More Methodologies  Economic Value Sourced –  Portfolio management – –  Real option valuation –

© , David Gadish, Ph.D.27 Value Management Framework Examples

© , David Gadish, Ph.D.28 Application of Expanded Value Management Framework

© , David Gadish, Ph.D.29 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

© , David Gadish, Ph.D.30 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

© , David Gadish, Ph.D.31 Next Week’s Agenda  Student Presentations

© , David Gadish, Ph.D.32 In 2 Weeks  Final Exam