BUSINESS DRIVEN TECHNOLOGY Plug-In T7 Valuing Technology

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-2 LEARNING OUTCOMES 1.Summarize the three areas an organization can use to assess the financial health of an information technology project 2.Describe the different financial metrics an organization can use to determine the value of an information technology project 3.Explain customer metrics and their importance to an organization 4.Describe the different types of comparative metrics an organization can use to determine the efficiency and effectiveness of its information technology resources

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-3 Introduction Strategic resources – include those assets available after an organization has cautiously spend what it must to keep its existing business operating at its current level Most organizations routinely analyze efficiency and effectiveness metrics to measure the performance of IT projects This plug-in takes a step beyond simple efficiency and effectiveness metrics by covering a number of tools commonly used in IT investment decisions including financial, customers, and comparative metrics

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-4 Metrics – Measuring IT Value Metrics provide feedback to the firm, quickly confirming success or immediately identifying corrective actions needed such as changes in processes, strategy, or product offering Specifying concrete goals with precise measurements can help senior managers clarify their strategic priorities and set clear direction, strategies, and goals throughout the organization

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-5 Metrics – Measuring IT Value Financial metrics, customer metrics, and comparative metrics best capture a firm’s performance

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-6 Financial Metrics Financial metrics – assess the financial performance of a company Typical financial metrics include: – Revenue growth – Gross margin – Operating income – Earnings per share – Cash flow

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-7 CAPITAL BUDGETING Many IT projects fall under the category of capital budgeting and capital expenditures – Capital budgeting – the process of planning for purchases of assets whose returns are expected to continue beyond one year – Capital expenditure – a cash outlay that is expected to generate a flow of future cash benefits lasting longer than one year The organization must perform capital rationing on its prospective IT projects – Capital rationing – the process of limiting the number of capital expenditure projects because of insufficient funds to finance all projects

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-8 PROJECT CLASSIFICATIONS Organizations commonly undertake three types of IT projects: 1. Independent projects – projects whose acceptance or rejection does not directly eliminate other projects from consideration 2. Mutually exclusive projects – projects whose acceptance precludes the acceptance of one or more alternative proposals 3. Contingent projects – projects whose acceptance is dependent on the adoption of one or more other projects

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved. 7-9 THE FIVE COMMON FINANCIAL METRICS The five common financial metrics include: 1.Net present value (NPV) 2.Internal rate of return (IRR) 3.Return on investment (ROI) 4.Payback period (PB) 5.Total cost of ownership (TCO)

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved NET PRESENT VALUE (NPV) Present value – the value of cash to be received in the future expressed in today’s dollars Net present value (NPV) – of a capital expenditure project is the present value of the stream of net (operating) cash flows from the project minus the project’s net investment

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - NPV A project should be accepted if its NPV is greater than or equal to zero and rejected if its NPV is less than zero

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - NPV Project A would be rejected and Project B would be accepted

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - NPV Project X and Z would be rejected and Project Y would be accepted

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved INTERNAL REATE OF RETURN (IRR) Internal rate of return (IRR) – the rate at which the NPV of an investment equals zero Essentially, the IRR is the interest rate, when applied to the cost and benefits of a project, which discounts the cash flows to zero

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - IRR The IRR is often compared against the hurdle rate – the minimum ROI percentage a project must meet to be considered for management approval – A project with an IRR in excess of the hurdle rate is worth pursuing – A project whose IRR is greater than or equal to the firm’s cost of capital should be accepted – A project whose IRR is less than the firm’s cost of capital should be rejected

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved RETURN ON INVESTMENT (ROI) Return on investment (ROI) – indicates the earning power of a project and is measured by dividing the benefits of a project by the investment In analyzing projects, the risk factor should be included in the evaluation – For example, a high ROI for “risky projects” may not be as good as a lower ROI for “safe projects”

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved RETURN ON INVESTMENT (ROI) ROI = Increased revenues or cost savings Investment $100,000 = 2.5 times or 250% ROI $40,000

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - ROI When the expected ROI is greater than or equal to the required return, an organization will find the investment attractive Placing an ROI on a technology project is difficult – For example, how do you place an ROI on a fire extinguisher? How do you place an ROI on a firewall or antivirus software?

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved PAYBACK PERIOD (PB) Payback period (PB) – the period of time required for the cumulative cash inflows from a project to equal the initial cash outlay Payback Period = Net Investment Annual Net Cash Inflows $100,000 = 4 years payback $25,000

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - PB The PB method should not be used to determine acceptance or rejection of an investment project for two reasons: 1.The PB method does not take into account the time value of money and gives equal weight to all cash inflows. 2.The PB method also ignores all cash flows occurring after the payback period

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved TOTAL COST OF OWNERSHIP (TCO) Total cost of ownership (TCO) – consists of the costs, direct and indirect, incurred throughout the life cycle of an asset, including acquisition, deployment, operation, support, and retirement Essentially, TCO attempts to properly state the costs of an IT investment In 1980, Gartner determine that a single PC cost an enterprise nearly $10,000 per year as a result of additional software, hardware, and maintenance

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Decision Rule - TCO Organization typically hire consultants and vendors to assist in the task of determining TCO for different IT areas Essentially, there are no hard rules for TCO calculations and they are typically analyzed on a project-by-project basis

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved ASSESSING THE VALUE OF IT NPV and IRR are primarily used for large projects where the time value of money is a big factor ROI is most valuable when used to decide between different projects or competing priorities PB is applied to projects of short duration TCO is used on projects of varying sizes because it provides a framework for good financial analysis of IT

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Customer Metrics Customer metrics – assess the management of customer relationships by the organization and typically focus on: – Market share – Customer acquisition – Customer satisfaction – Customer profitability

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved WEB TRAFFIC ANALYSIS Most companies measure the traffic on a Web site as the primary determinant of the Web site’s success However, a large amount of Web site traffic does not necessarily equate to large sales Many organizations with high Web site traffic volumes have low sales

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved WEB TRAFFIC ANALYSIS Web site traffic analysis can include: – Cookie – a small file deposited on a hard drive by a Web site containing information about customers and their Web activities – Click-through – a count of the number of people who visit one site and click on an advertisement that takes them to the site of the advertiser – Banner ad – a small ad on one Web site that advertises the products and services of another business, usually another dot-com business – Interactivity – visitor interactions with the target ad

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Behavioral Metrics Click-stream data - a virtual trail that a Web user leaves behind while using the Internet Click-stream data can revel: – Number of pageviews – Pattern of Web sites visited – Length of stay on a Web site – Date and time visited – Number of customers with shopping carts – Number of abandoned shopping carts

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Behavioral Metrics Visitor Web site metrics

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Behavioral Metrics Exposure, visit, and hit Web Site Metrics

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved Comparative Metrics Comparative metrics – assess how the organization is performing compared to other organizations, industries, and markets

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved IT SPENDING BY ACTIVITY AND RESOURCE IT spending by activity and resource allows management to easily compare spending among departments and even compare other organizations’ spending against its own

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved IT SPENDING AS A PERCENTAGE OF REVENUE Looking at IT spending as a percentage of revenue is one indicator that the company is or is not spending the right amount on information technology.

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved IT BUDGET ALLOCATED PER EMPLOYEE Dividing the IT budget by the number of employees generates the IT budget allocated per employee If the business is currently satisfied with the quality of service from the IT department then it can determine the amount per employee that the business is paying for this service

McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc. All rights reserved THE VALUE OF THE HELP DESK Determining the value of the help desk is typically easy since most organizations track detailed trouble tickets – Each trouble ticket typically tracks the department origin, time to complete, and IT employee assigned