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TOWARDS AN APPROACH TO MEASURE AND JUSTIFY INVESTMENTS IN A TECHNOLOGY INFRASTRUCTURE
Presentation OverviewPresentation Overview
Background Definition of an IT infrastructure 2-phased approach to measure and justify
infrastructure investments • assessing the cost and value of IT infrastructure• justifying additional expenditures
Conclusion
BackgroundBackground Development and support of IT infrastructure:
• Key responsibility of IS function in the 1990s (Rockart, 1992)• 1 of 10 critical tasks for IT managers (Niederman et al, 1991)
Technical and managerial challenges
• technical technical -->> functionality, efficiency, maintainability (Davenport & Linder, 1994; Weill et al., 1993)
• managerialmanagerial -->> identifying / measuring benefits and justifying additional expenditures (McKay & Brockway, 1989; Weill, 1992)
BackgroundBackground
Infrastructure expenditures = 46% of total IT expenditures (Weill et al, 1995)
However, there is a lack of guidelines on how to measure and justify these expenditures
Focus of this paper:
• How to assess the business value of the firm’s installed infrastructure resources?
• How to justify additional investments in an IT infrastructure?
ITIT Infrastructure Defined Infrastructure Defined
Integrated set of technical components coupled with human capabilities to form a shared foundation for supporting internal & external business activities of an organization.
It impacts organizational performance indirectly by enabling applications that provide business value
ASSESSING COST AND VALUEASSESSING COST AND VALUE
Payoff assessment of IT assets:– How well are we doing today?– Who well are we positioned to compete?
Question 1– Requires understanding of the current investments in
different infrastructure components and sources of value Question 2
– depends on the level of current investments and the role of ITI
Justifying additional ITI Justifying additional ITI investmentsinvestments
Characteristics of ITI investments:• large initial expenditures• payoff uncertainty; risk• intangible benefits to many stakeholders over a long
period of time
Many approaches to ITI investment justification are possible • form capital budgeting to “gut feel”
Approaches are contingent upon ITI role
Justifying additional ITI Justifying additional ITI investmentsinvestments
“UTILITY” infrastructure
• resources aimed at providing cost savings via economies of scale
• net present value approach (Weston & Brigham, 1985)
– reasonable estimates of inflows/outflows of money and discounted rate
Justifying additional ITI Justifying additional ITI investmentsinvestments
“DEPENDENT” infrastructure
• resources aimed at enabling the current strategy of the firm
• cost-benefit analysis methodology (Toraskar & Joglekar, 1993)
– identifying tangible as well as intangible costs/ benefits
Justifying additional ITI Justifying additional ITI investmentsinvestments
“ENABLING” infrastructure
• resources aimed at providing flexibility to quickly respond to changing business needs
• future benefits are much harder to define ahead of time
• “real option” approach (Kambil et al., 1993)
Net Present Value MethodNet Present Value Method
Traditional capital investment technique• net cash flows, discount rate (I.e. project’s cost of
capital), initial cost, project’s expected life
Using NPV to justify ITI investments• deriving present value of the net cash flows associated
with the investments (I.e. cost savings from economies of scale)
• discounting cash flows at the cost of capital• subtracting cost of ITI resources from the resulting
amount
Net Present Value MethodNet Present Value Method
Pros/ Cons of NPVPros/ Cons of NPV• quantitative and mostly accurate estimates of the
investment’s value
• applicable only if inflows and outflows of money and the discount rate could be reasonably estimated
• What about expenditures with a negative ROI that play a critical role in the long-term competitive stance of the organization?
Cost-Benefit Analysis MethodCost-Benefit Analysis Method
Applied to public investment decisions in flood control and national defense areas (I.e. complex, uncertain)
Five phases:
• Identification of benefits• Measurement of tangible benefits and description of
intangible benefits• Explicit valuation of both types of benefits• Final assessment of ITI investment alternatives
Cost-Benefit Analysis MethodCost-Benefit Analysis Method
Pros / Cons of CBAPros / Cons of CBA
• measures both types of benefits• but too much emphasis on quantification of
intangibles• bias towards investments with a short-term payoff• lack of consideration for risky and uncertain
strategic investments
““Real Option” method Real Option” method
Valuing the “option” to invest in future ITI that would in turn, provide value in the long run (Kambil et al, 1993)
5-step process:
• derive traditional NPV estimate for the project (I.e. investment in ICASE environment)
• estimate project cost (I.e. initial infrastructure investment + cost to expand the project a year from now)
• define an option
• estimate the option value
• make the investment decision
““Real Option” methodReal Option” method
Pros/ Cons ROMPros/ Cons ROM
• systematic approach to estimate and quantify the value of uncertain future projects made possible by initial ITI investments
• complex method
• relies on robust estimates of expected cash flows and the cost of exercising the “real option”
ConclusionConclusion
ITI investments are large, uncertain and risky
Thus, it is difficult to tie such investments directly to organizational performance
The application of the proposed payoff assessment approach• the first step towards addressing the managerial
challenge of measuring and justifying ITI investments
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