Ch14
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This chapter discusses several topics related to evaluating IT investments and assessing productivity impacts, including: 1) The productivity paradox where measured IT investments do not always correlate with measured increases in outputs. 2) Approaches to evaluate IT investments including traditional cost-benefit analysis using NPV and ROI, as well as considering both tangible and intangible benefits. 3) Challenges in accurately assessing costs of IT investments given fixed costs and life cycle costs that accumulate over many years.
Ch14
- 1. Chapter 14 Information Technology Economics 1 Chapter 14
- 2. Moore’s Law 2 Chapter 14
- 3. Introduction Assuming the current rate of growth in computing power, organizations will have the opportunity to buy, for the same price, twice the processing power in 112 years, four times the power in 3 years, eight times the power in 412 years, and so forth. price-to-performance ratio will continue to decline exponentially. 3 Chapter 14
- 4. Productivity paradox The discrepancy between measures of investment in information technology and measures of output at the national level has been called the productivity paradox. 4 Chapter 14
- 5. Productivity Economists define productivity as outputs divided by inputs. Outputs are calculated by multiplying units produced (for example, number of automobiles)by their average value. The resulting figure needs to be adjusted for price inflation and also for any changes in quality (such as increased safety or better gas mileage). 5 Chapter 14
- 6. -cont… If inputs are measured simply as hours of work, the resulting ratio of outputs to inputs is labor productivity. If other inputs—investments and materials—are included, the ratio is known as multifactor productivity. 6 Chapter 14
- 7. Explaining the Productivity Paradox Explanations can be grouped into several categories: (1) problems with data or analyses hide productivity gains from IT, (2) gains from IT are offset by losses in other areas, and (3) IT productivity gains are offset by IT costs or losses. 7 Chapter 14
- 8. Does the Productivity Paradox Matter? The productivity-offsetting factors largely reflect problems with the administration of IT, rather than with the technologies themselves the critical issue is how it improves organization’s own productivity. 8 Chapter 14
- 9. Process approach to IT organizational investment and impact. 9 Chapter 14
- 10. -cont…. The relationships are basically indirect, via IT assets and IT impacts. The figure shows that the relationship between IT investment and performance are not direct; other factors exist in between. 10 Chapter 14
- 11. -cont… This is exactly why the productivity paradox exists, since these intermediary factors (in the middle of the figure) can moderate and influence the relationship. 11 Chapter 14
- 12. Value of Information - Evaluating One measurement of the benefit of an investment is the value of the information provided. The value of information is the difference between the net benefits (benefits adjusted for costs) of decisions made using information and the net benefits of decisions made without information. 12 Chapter 14
- 13. EVALUATING IT INVESTMENT: BENEFITS, COSTS, AND ISSUES One basic way to segregate IT investment is to distinguish between investment in infrastructure and investment in specific applications. 13 Chapter 14
- 14. IT Infrastructure IT infrastructure, provides the foundations for IT applications in the enterprise. Examples are a data center, networks, date warehouse, and knowledge base. Infrastructure investments are made for a long time, and the infrastructure is shared by many applications throughout the enterprise. 14 Chapter 14
- 15. IT Applications IT applications, are specific systems and programs for achieving certain objective for example, providing a payroll or taking a customer order. The number of IT applications is large. Applications can be in one functional department or they can be shared by several departments, which makes evaluation of their costs and benefits more complex. 15 Chapter 14
- 16. The Value of Information in Decision Making People in organizations use information to help them make decisions that are better than they would have been if they did not have the information. Value of information = Net benefits with information - Net benefits without information 16 Chapter 14
- 17. Evaluating IT Investment by Traditional Cost- Benefit Analysis USING NPV IN COST-BENEFIT ANALYSIS. Capital investment decisions can be analyzed by cost-benefit analyses, which compare the total value of the benefits with the associated costs. Organizations often use net present value (NPV) calculations for cost- benefit analyses. 17 Chapter 14
- 18. Return On Investment Another traditional tool for evaluating capital investments is return on investment (ROI), which measures the effectiveness of management in generating profits with its available assets. The ROI measure is a percentage, and the higher this percentage return, the better. It is calculated essentially by dividing net income attributable to a project by the average assets invested in the project 18 Chapter 14
- 19. Cost-Benefits Analyses - Evaluating 19 Chapter 14
- 20. “Costing” IT Investments - Evaluating Placing a dollar value on the cost of IT investments is not a simple task. One of the major issues is to allocate fixed costs among different IT projects. Fixed costs are those costs that remain the same in total regardless of change in the activity level. 20 Chapter 14
- 21. Another area of concern is the Life Cycle Cost; costs for keeping it running, dealing with bugs, and for improving and changing the system. Such costs can accumulate over many years, and sometimes they are not even anticipated when the investment is made. 21 Chapter 14
- 22. -cont… There are multiple kinds of values (tangible and intangible) improved efficiency improved customer relations the return of a capital investment measured in dollars or percentage many more … Probability of obtaining a return depends on probability of implementation success 22 Chapter 14
- 23. Opportunities & Revenues by IT Sales Transaction fees Subscription fees Advertising fees Affiliate fees Other revenue sources 23 Chapter 14
- 24. Reduction in transaction costs Transaction Costs: covers a wide range of costs that are associated with the distribution and/or exchange of products and services. Search costs Information costs Negotiation costs Decision costs Monitoring costs 24 Chapter 14
- 25. Intangible Benefits Sawhney’s Method of Handling Think broadly and softly. Supplement hard financial metrics with soft ones Pay your freight first. Think carefully about short-term benefits that can “pay the freight” for the initial investment in the project. Follow the unanticipated. Keep an open mind about where the payoff from IT and e-business projects may come from 25 Chapter 14
- 26. Business Case approach It is a written document that is used by managers to garner funding for one or more specific applications or projects. Emphasis is on the justification for a specific required investment. Bridges the gap between the initial plan and its execution. 26 Chapter 14
- 27. Specific Evaluation Methods (Continued) Chapter 14 27
- 28. Methods for evaluating IT Financial approach Multicriteria approach Ratio approach Portfolio approach 28 Chapter 14
- 29. “Costing” IT – Economic Strategies Chapter 14 29
- 30. Outsourcing 30 Chapter 14
- 31. IT Metric It is a specific, measurable standard against which actual performance is compared. 31 Chapter 14