Chapter 2 Why Evaluate IT Investment Management of Computer System Performance

2 Agenda Chapter 2 Objectives Students should be able: to mention the different approach to evaluation of technology investment. Why Evaluate IT Investment

3 Chapter 1 Summary Business Exist for one reason, optimizing shareholders wealth. IT projects are critical to accomplishing this. The selection of optimal IT projects are key to meeting this goal and allowing management to succeed. Large, diverse firms may have as many as IT projects going on at any one time and many more identified as needing funding. Selection of the optimal product is critical.

4 Chapter 1 Summary Ideally Benefits should be identified and quantified before an IT project is implemented and costs incurred in its development and/or deployment. The primary benefits are usually quickly identified. The secondary and tertiary benefits make the gross benefit more nebulous to quantify. Consistent approaches to valuation are critical to project selection.

5 Chapter 1 Summary The concept of IT Value is a combination of factors. Benefits are both tangible and intangible. Benefits are evolutionary. Cost benefit analysis remains a key tool for managerial decision making. Stakeholders must be recognized within the cost/ benefit analysis. Their information is critical. They are the ones who will receive the benefit and will pay the cost,

6 Chapter 2: Why Evaluate Information Technology Investments The need is based upon the efficient allocation of capital resources. IT Investment may equate to as much as 50% of a firms entire capital budget. IT investments do not appear over night. They require time and resources to roll out. The larger the firm, the more these types of investments can affect the corporations financial viability. To calculate value, several formulas are required. This is unavoidable.

7 The Evaluation of IT Investment IT Investment evaluations are driven by several factors. The price of IT services and solutions are usually the most expensive indirect capital investment made by any firm. A loaded Sun E6500, Workgroup Server can top $200K WITHOUT the application software. The return on an investment such as this should be substantial but is often not quantifiable. How would it be used? What efficiencies could be expected for the corporations benefit? When would they be realized? How much will be the return?

8 Approaches to IT Investment Evaluation There are several approaches to addressing IT investment evaluations. These are usually categorized as either: Predictive (or ex-ante) evaluations and, Predictive is used for pre-investment justification (includes Proposal supporting data). Post-implementation (or ex-post) evaluations. Post Implementation is used for confirmation, validation or repudiation of IT investment. These can be used neutrally or to defend ones position i.e. don’t assume that the evaluation will be consistent with your views.

9 Predictive Approaches to IT Investment Evaluation Predictive evaluations use predominately financially based estimates. These include single point/element or range estimates for costs and benefits. Return is calculated as a forecast for one or more of the following: NPV (Net Present Value) IRR (Internal Rate of Return) Payback Period ROI (Return on Investment),

10 Approaches to IT Investment Evaluation There are two approaches to IT investment evaluation. Predictive comes first, is used for justification and estimates as many variables as possible to determine the viability of the project. This usually takes the form of a cost benefit analysis. Post implementation involves reviewing actual cost and benefit data (after all cost and benefit data is identified) and compares this against the predictive estimates. This includes work in process evaluations often referred to as Earned Value calculations.

11 Approaches to IT Investment Evaluation Political issues and uses of these approaches aside, the performance of both types of evaluations can and should be done. Predictive is critical for justification. It is used not only for internal investment justification but in the bid and proposal process as well. This later element assumes that the firm is in the IT services business. Post Implementation evaluations should be done, if for no other reason, than to make the predictive process better and more accurate.

12 Approaches to IT Investment Evaluation A more accurate predictive process as the result of post implementation evaluations requires that the predictive process be subjected to error analysis. This requires each step of the predictive evaluation process to be reviewed and its assumptions validated. This should be done either by individuals or a team made up of different people other than those who did the predictive analysis initially. Anyone see political issues with this? Each of the underlying variables that were the basis of the assumptions that were made in the predictive evaluation should be reviewed in this process.

13 Types of Analytical Approaches Project Life Cycle Start Questions: What are the costs (purple)? What are the benefits (cream)? At what level of project success are they realized? Do benefits exceed costs and if so, when?

14 Predictive and Historical Analytical Methodologies Predictive (ex-ante) and historical (ex-post) methodologies refer to performing benefits and costs of a project. Predictive is, as it implies, a forward estimate with little or no firm, quantitative or empirical data on the current project. Actual cost data is missing.

15 Predictive and Historical Analytical Methodologies Ex-post analysis refers to using actual cost data from an existing project for the calculations as to the cost and benefit for that project. In both cases, the approach is to establish the costs of a project in the most quantitative means possible.

16 Predictive Methodologies Predictive or Ex-ante Methodologies are commonly used. These approach the quantification of benefits and costs using estimates or historical actuals from other projects. It requires that executive management make authorization decisions on those predictions.

17 Predictive Methodologies There are risks associated with this approach in some circumstances. These include items such as: The historical data was based on projects with dissimilar traits that can make many elemental difference and, The basis of estimates as to efficiencies achieved in the execution of the project are just plain wrong. Non-tangible benefits will be quantified incorrectly. These include gains in efficiency in indirect departments, etc.

18 Predictive Approaches to IT Investment Evaluation The conservative approach towards a predictive evaluation of an IT Project (Investment) is to aggressively document the estimated value of the project. By documenting your estimates that are used in the justification process, you are establishing a reference point that will be used to validate your process in the future. Depending on the organization, there could be career risk in this activity. Its part of your job but realize that it could come back an haunt you so make it as accurate as possible.

19 Ex-post Methodologies Post-implementation (or ex-post) evaluations projects use historical data from the existing project to determine if the project is viable. The main liability in this approach is that the money is already spent and the analysis can only tell you what you missed. This is important, if not critical, to prevent a repeat of mistakes. Remember, 30% of IT projects never reach fruitful conclusion 51% exceed budget by 189% and deliver only 74% functionality

20 Post-implementation Approaches to IT Investment Evaluation This analytical approach can be equally challenging because the analysts required to: quantify estimates that were developed in the earlier phases of the project as predictive estimates, determine if the deliverable product met the functionality promised in the estimating phase of the activity, look for other benefits or costs that were missed during initial estimating activity.

21 Post-implementation Approaches to IT Investment Evaluation In addition to the “newly discovered costs and benefits”, the Post- implementation process must be coupled with investment time lines. In most projects that I have worked, the time lines change as the project progresses. Military axiom: No plan survives intact, the first contact with the enemy.

22 Post-implementation Approaches to IT Investment Evaluation This makes the analyst job more challenging in that progress and schedules between estimates must be synchronized as well to acquire actual costs. Regardless of the position in relation to the investment, good accounting and financial practices require apples to apples comparisons. In addition to the quantifiable elements of IT investment evaluations, there is also a concept of formative and summative evaluations.

23 Formative and Summative Evaluation These attempt to assign value to costs and benefits of an IT project that are less quantitatively inclined. It addresses user satisfaction and stakeholder satisfaction. These elements are frequently part of the feed back loop process of IT Project Management. These are the approaches to project valuation.

24 Formative Evaluation Formative evaluation – Addresses program performance while program is in progress. Views an evaluation internally. Focuses on feed back iterative approaches. Relies on qualitative data Rebuilds and reworks Focuses on process and product development. May result in program changes in response to the needs of the owners and sponsors. Has the potential for significant scope creep.

25 Summative Evaluation Summative evaluation – assess the viability of the results of the program (the deliverable system) while in process and addresses: The impact of the system to the organization. The usability of the system to the user community. The effectiveness in it meeting its specifications and goals as well as overall performance.

26 Perspectives of Analytical Approaches Project Life Cycle Start Ex-Ante Ex-Post Formative Summative Each provides a different perspective on the same project. Each requires a different set of metrics to be collected.

27 Summary Ex-ante analysis requires predictive methodologies. These must be quantifiable where ever possible. Ex-post analysis can be accomplished with actual data, assuming that the needed data was collected Use caution on this collection approach.

28 Possible Test Questions What is an ex-ante evaluation? Predictive is used for pre-investment justification (includes Proposal supporting data). What is an ex-post evaluations? Post Implementation is used for confirmation, validation or repudiation of IT investment.

29 Individual Paper Due What are Ex-post and Ex-ante evaluations? Explain the approaches and concepts.