Chapter 3 Aspects of IT Investment Decision Process Management of Computer System Performance

Chapter 3Aspects of IT Investment Decision

Process

Management of Computer System

Performance

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Agenda Understanding Projects and alternatives. Analytical approaches to Cost Benefit

Analysis. Objectives

Students should be able: to explain the aspect of IT investment decision process.

Aspects of IT Investment Decision Process

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Recap of Analytical Approaches

Project Life CycleStart

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.

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Alternatives to the Base Project

Consider at least three alternative means of achieving program objectives. Examples include: in-house development versus contractor development in-house operation versus contractor operation leasing equipment versus purchasing equipment

Include current operational procedures versus new operational procedures.

Note the impact of each to the analysis. Recognize the costs of: New or changed processes Ancillary costs and benefit impacts.

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Analysis Methodologies

Benefit-Cost Analysis (BCA) is a systematic, quantitative method of assessing the life cycle costs and benefits of competing alternative approaches. This includes determining which one of the alternatives

is best for the corporation based on the information available.

SOLUTION: If the benefit is greatest, and the cost is acceptable as compared to the benefit and to the corporation, then that alternative is selected.

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Purpose of a Benefit Cost Analysis

The purpose of a Benefit Cost Analysis (BCA) is to: support better decision-making to ensure that

resources are effectively allocated to support the Corporation.

It should demonstrate that at least three alternatives were considered, and

the chosen alternative is the most cost-effective within the context of budgetary and political considerations.

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BCA Characteristics

BCA must include comprehensive estimates of the projected benefits and costs for all alternatives.

Benefits to which a dollar value cannot be assigned (intangible benefits ) should be included, or at least recognized, along with tangible benefits and costs. Intangible benefits should be evaluated and assigned

relative numeric values for comparison purposes.

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BCA Characteristics

For example of Intangible cost Valuation: maximum benefit could be assigned a value of 5,

average benefits a value of 3, and minimum benefits a value of 1.

If this type of approach is used, it should be used consistently across the estimating group.

Evaluating and comparing benefits that have both dollar values and relative numeric values requires extra effort, but it allows subjective judgment to be a factor in the analysis.

BCA’s should be explicit about the underlying assumptions used to arrive at estimates of future benefits and costs.

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BCA Restrictions

For in-process projects, Costs incurred in the past (Sunk Costs) and savings or efficiencies already achieved (Realized Benefits) should not be considered in a BCA When a BCA is done on a project that is already

underway, there may be pressure to compare all costs and benefits from the beginning of the project.

Use the Estimate to Complete or Future Benefit evaluation model.

The question to be answered is whether or not the benefits of proceeding justify the costs associated with continuing the project.

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BCA Restrictions The classic example of this is a situation

where large amounts of money have been spent designing a system that has not been successfully implemented, and the project is being re-evaluated. The fact that money has been spent is no

reason to continue spending. BCAs focus on the future; and decisions have to

be based on the expected costs and benefits of the proposed alternatives.

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BCA Restrictions

Past experience is relevant only in helping estimate the value of future benefits and costs.

This is often reflected in the Estimate To Complete (ETC) costs of a project which would be used to compare against another new project.

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The Decision Making Criteria

A Project should be initiated or continued only if the projected benefits exceed the projected costs. The only exception is if benefits are mandated

by law. An example of this are projects that are associated with Health Insurance Portability and Accountability Act (HIPAA) compliance.

HIPPA requires specific information protection and IT controls to be placed on patient data. Much of this involves information protection.

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The Decision Making CriteriaBenefit Cost Analysis - The standard

criterion for justifying an IT project is that: the benefits exceed the costs over the

life cycle of the project. or

The competing alternative with the greatest net benefit (benefits minus costs) should be selected.

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When all benefits and costs cannot be assigned monetary values, relative values for costs and benefits should be used,

and the alternative with the greatest net benefit (benefit values minus cost values) should still be selected.

Make sure that the same scale and methodology is used for each evaluation

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Analysis Methodologies

Cost-Effectiveness Analysis (CEA) is a simplified BCA, which can be done when either the benefits or the costs are the same for all alternatives.

The analysis is greatly simplified because the best alternative is either: the one with the most benefits (when the costs are the

same for all alternatives) or the one with the lowest cost (when the benefits are the

same for all alternatives).

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Cost-Effectiveness Analysis - When comparing alternatives with identical costs and different benefits, the alternative with the largest benefits should be selected.

When comparing alternatives with identical benefits and different costs, the alternative with the lowest costs should be selected.

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Benefit Cost Analysis - The standard criterion for justifying an IT project is that the benefits exceed the costs over the life cycle of the project.

The competing alternative with the greatest net benefit (benefits minus costs) should be selected.

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When all benefits and costs cannot be assigned monetary values, relative values for costs and benefits should be used,

alternative with the greatest net benefit (benefit values minus cost values) should still be selected.

Make sure that the same scale and methodology is used for each evaluation. Compare apples to apples!

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Cost-Effectiveness Analysis - When comparing alternatives with identical costs and different benefits, the alternative with the largest benefits should be selected.

When comparing alternatives with identical benefits and different costs, the alternative with the lowest costs should be selected.

Logical yes but in the heat of budget battles, logic sometimes gets lost.

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Aspects of the Decision Making Process

The optimal IT investment evaluation criteria is frequently the same as any other capital invest criteria. Some fundamental aspects of the investment criteria may

differ from other capital investment project, such as accelerated depreciation schedules, may vary.

Though different, the basic decision making process is usually the most effectively utilized.

By applying the same criteria as that used for other capital investment projects, a firm has the best chance to recognize the risks, determine the best mitigation and then select the optimum IT investments.

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Classes of the Decision Making Process

Classes of Projects subject to IT Investment Decisions are as follows:

Must-Do Investments. These may be required to meet legislated agendas but may not have any direct benefit unto themselves. Though it is arguable that if you are required to institute

an IT investment, it would be incumbent upon the organization to optimize the investment to improve efficiency and by extension, profitability.

An Example of this is the HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 or HIPAA.

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Must-Do Investments – the Decision Making Process

HIPAA mandates many things including certain levels of security in the operation of IT systems that handle Patient data. The basic ROI for HIPAA compliance is very

limited in most cases. The benefit of selling your firms services on the

basis that you have a “secure” system is an oxymoron to your customers expectations.

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Your customers expect you to have a secure system and besides, the law says you have to have a secure system. Why are you different from your competitors? Was your system unsafe previously, etc, etc?

If benefits are limited, alternatives should be examined.

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A study by Arthur Andersen LLP and funded by two healthcare industry firm found that e-commerce encompasses less than a third of the industry's business that could be done electronically.

It found that: e-commerce can cut work from processing errors by as

much as 52 percent. that providers overpay suppliers by 2 percent to 7

percent for contracted medical supplies.

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For distributors, it could cut selling, general and administrative expenses by 1 percent to 10 percent.

For manufacturers of medical and surgical products, it could lighten the administrative load of sales representatives by 25 percent to 49 percent.

These represent a significant savings potential. Therefore, in making a decision on a legislated

requirement, such as HIPPA, perhaps making the IT system optimized for all e-Commerce transactions is the proper investment strategy.

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After Must-do changes, Core Investment decisions are the next class. The basis for core investments are similar to

those found in any capital investment. Maintenance costs increase, Vendor support declines or no longer is available, Newer systems provide greater capability thereby

promising a greater level of efficiency and costs savings leading to increased profitability.

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Core Investments – the Decision Making Process

In IT, these changes are often driven by technology itself. Accelerated development cycles in hardware provide

greater platform capability. With this increased capacity, computing potential improves

so new software is created to meet the new systems potential.

IT consumers (business and individuals) seek the greater functionality fueling the entire cycle. It wasn’t too long ago that a spell checker was a separate

program bought as an add-in to a word processor.

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Core Investments – the Decision Making Process In most cases, software vendors find that survival

constantly requires them to improve their products. Competition will drive others within the industry to delivery a

similar product Use of a product leads to requests for more functionality. Improved products erode and eventually eliminate the vast

majority of the demand for the existing products. Lack of demand leads to lack of a desire to support the older

product. In the face of this, many vendors now stipulate date

where they will cease to support an older or legacy system.

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In the instances where support will be terminated, new investment will almost always be required. Either in a new system or to support the product internally.

Often, the OEMs make it more cost effective to upgrade than to keep the legacy system in tact.

There are really few viable alternatives. Another characteristic is that the decision makers

are cognizant of the issues relating to the investments. They know how the system is and the new system should

be used.

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The costs and benefits are relatively easy to quantify. Ex.: OEM support is ending in 6 months, to train

experts to replace their support on the old system will cost x dollars per year +base labor. If we upgrade, it will cost x dollars and the OEM will deal with the support costs.

In all cases within the core investment category, the costs are identifiable, though they may not be calculated as part of the decision making process.

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Examples of Core IT Investments include: Supply Chain Management Systems Web enabled Business to consumer sites, Deploying an ERP/ERM system, Upgrading basic database systems, Upgrading Desktop systems Upgrading the internal mail system.

Other examples are plentiful but these are representative.

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After Must-do and Core Investments, Prestige Project decisions are the next class. These IT projects usually fall into categories that relate to

short term or interim activities. Examples include: Gateway’s support of the 2002 Winter Olympics. Victoria’s Secret on-line fashion show. Setting up an Employee Portal for “for sale items” by

employees. These are on-offs designed to generate some

returns though those returns are usually estimated and are not quantifiable at the project’s initiation.

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Prestige Projects – the Decision Making Process

In most cases, the characteristics of Prestige Projects are: There are a large number of projects that may

be undertaken to meet the project’s goals. Decision makers are driving the project. The cost benefits characteristics are less than

clear, The intangibles are usually vague but

intuitively, if the project is a success, the benefits are felt to be significant.

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After Must-do , Core Investments and Prestige Projects, Research and Development are the final class of projects. R&D IT projects may vary considerably. They will vary

from industry to industry. These may fall into categories such as Basic research or,

developing a neural agent system for an AI application Project specific research.

developing a remote management system for a new CAM product.

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Research and Development– the Decision Making Process

Characteristics of R&D IT projects include; Projects designed to improve or enhance a

firms competitive position. Developing a solution to a company specific

problem (wastewater effluence monitoring, CAM system management, etc.)

Considered by the firms to be an investment in future income streams.

The relationship of these 4 different classes are shown in the following matrix.

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The Decision Making Process

Prestige Projects

R&D Projects

Must-Do Projects

Core Projects

HighRisk of Failure

MediumRisk of Failure

LowRisk of Failure

Low Returns

Medium Returns

HighReturns

High Risk

Low Returns

Very High Risk

Very High Returns

Low Risk & Returns

Medium Risk

Higher Returns

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Question?

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Homework

Homework Financial methodologies

Documents

Chapter 3 Aspects of IT Investment Decision Process Management of Computer System Performance