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Financial Value Measures of IT

September 29, 2008

Multi-Attribute Analysis Value

The need for a broader measurement of the strategic and tactical value that IT can bring to the business has lead to the consideration of multi-dimensional IT valuation approaches that include other aspects of value in addition to the financial valuation. Three types:

1. Multi-criteria approaches have their roots in multi-attribute utility theory with various approaches to combining the scores from different dimensions. The end result usually takes a normalized score (between 0 and 1) and applies it as a multiplier to the ROI.
2. Strategy framework approaches explicitly define strategic objectives for the organization or business and establish key parameters for measuring success. Candidate IT investments are assessed against these success parameters.
3. Portfolio management approaches take strategy framework approaches a stage further by grouping IT investments into sets that share the same objectives. Under this approach, different portfolios can have different objectives.

Strategic Value

The concept of a “Minimum Attribute Analysis” (MAA) defined as “components of intrinsic marketable value” or units of software value creation. Candidate MAAs are identified through the cooperative efforts of the business and IT groups by considering the application domain, shareholders’ needs and constraints, and the current business context. Note that MAAs are probably not synonymous with tasks on the IT team’s project plan, although they should be close to the high-level requirements in the product backlog of an agile development team. To derive the value of MAAs, We ask some key questions:

  1. What type of value will this MAA return?

    1. Savings in resource costs?

    2. Increased sales revenue?

    3. Improved customer retention?

  2. Can the value of the MAA be expressed in monetary units (e.g., dollars)?

  3. If not, how can intangible benefits be justified or compared?

  4. What are the risk factors associated with this MAA?

  5. What cost and effort is required to develop this MAA?

  6. What is the anticipated timeline to generate the MAA and realize the associated benefits?

Note that the value of individual MAAs may be dependent on the delivery sequence. For example, online customer access to their bank statement is valuable only after up-to-date bank statements have been delivered online.

This theme of the business and IT working together to link value measurement to strategic focus is extended who assert the importance of business and IT executives working together to agree on practical courses of conduct to deliver value. Their idea is to ask what IT capabilities are required for the implementation of particular strategic initiatives. Importantly, they link these initiatives to the three high-level value disciplines first proposed by Treacy and Wiersema12 in six ways:

  1. Cost focus: Drawing on the value discipline of operational excellence

    1. Price products and services at lowest cost

    2. Drive economies of scale through shared best practices

  2. Value differentiation as perceived by customers: Drawing on the value discipline of customer intimacy

    1. Meet client expectations for quality at reasonable cost

    2. Make the customers’ product selection as easy as possible

    3. Provide all information needed to service any client from any service point

  3. Flexibility and agility: Drawing on the value discipline of product and service innovation

    1. Grow in cross-selling capabilities

    2. Develop new products and services rapidly

    3. Create capacity to manufacture in any location for a particular order

  4. Growth: How the base of the business will expand

    1. Expand aggressively into underdeveloped and emerging markets

    2. Carefully grow internationally to meet the needs of customers that are expanding their business

    3. Target growth through specific product and customer niches

  5. Human resources: Where people policies fit in

    1. Create an environment that maximizes intellectual productivity

    2. Maintain a high level of professional and technical expertise

    3. Identify and facilitate the movement of talented people

  6. Management orientation: Different aspects of business governance and decision making

    1. Maximize independence in local operations with a minimum of mandates

    2. Make management decisions close to the line

    3. Create a management culture of information sharing (to maintain or generate new business

Practically, a four-step approach for CIOs seeking to link the value of their IT group to the value goals of the business:

  1. Start with some measure of business value at as high a level of the enterprise as possible

  2. Look for strategic initiatives in place to improve that value

  3. Identify how IT can support and add value to those initiatives and programs

  4. Attach metrics to the specific IT investments and initiatives contributing to achievement of the business value

Method

Description

Information economics (IE)

IE provides a scoring mechanism taking into consideration ten variables: six business domains and four technical domains. Business domain includes enhanced ROI and risk and business alignment issues. Technical domain includes architecture alignment and technical risk factors.

Applied information economics (AIE)

Built around principles of measurement theory, decision theory, and actuarial sciences, AIE reduces each variable to a range of ROI outcomes with assigned probability. The impact of all risks is quantified in this way, along with intangible benefits. The result is a probability distribution for ROI, e.g., 75 percent chance of an ROI of 30 percent.

Total economic impact (TEI)

TEI calculates traditional costs and business benefits using financial methods, adds a quantitative measure of benefits related to future flexibility based on ROV or other techniques and then adjusts the probability distribution based on risk factors. The result is an ROI that has taken into account real options and risk.

Total value of opportunity (TVO)

TVO combines quantitative and qualitative measures. Costs are derived using a TCO approach. Metrics convert IT benefits into bottom-line business results in three main categories: demand management, supply management, and support services. The TVO methodology considers four other qualitative measures including risk, architecture alignment, business process impact, and strategic business alignment.

Table: Strategy Framework Approaches

Method

Description

Balanced scorecard (BSC)

The BSC has four layers: financial, customer, business process and learning, and growth (sometimes referred to as the “people” layer). Each layer has specific, company-unique strategic objectives with defined metrics that are linked to other objectives in other dimensions to reflect strategy. A strategy map is constructed by linking objectives to show cause and effect, i.e., “linkage.”

IT scorecard

The IT scorecard has four categories: user orientation (user satisfaction), operational excellence (efficiency in development and operations), business contribution (financial), and future orientation (approach to skill set development and innovation). Critical success factors identified in each are based on business strategy.

Table: Portfolio Management Techniques

Method

Description

Giga Information Group portfolio framework

This method categorizes projects on two axes: IT impact on operations (low to high) and IT impact on the business (low to high).

Quadrants: In terms of IT’s role (operational impact and business impact), projects are support, factory, strategic, or turnaround. Allocating IT projects to quadrants reflects IT’s role in the organization and strategy.

Ross and Beath investment quadrants

This method categorizes projects on two axes: technology scope (infrastructure or business applications) and strategic focus (short-term profitability or long-term growth).

Quadrants: Infrastructure projects are renewal (short-term profitability focused) or transformational (long-term growth focused). Business applications are process improvements (short-term profitability) or experiments (long-term growth).

MIT Center for Information Systems Research portfolio pyramid

In this technique, four defined asset classes focus on risk versus reward and IT projects’ varying profiles along these lines. Investment profiles are geared toward agility versus cost-driven strategies.

Rather than a quadrant-based approach, a pyramid is constructed with infrastructure investments at the base and supporting transactional projects (internal business process focused) at the next layer. Informational (management decision support) and strategic projects (external market-driven) form the pinnacle.


Table: Business Value Measures for IT

Technology Investment

Categories of IT Investment

Business Value Characteristics

Typical Business Value Outcomes

Key Business Value Measures

to gain competitive advantage or to position the company in the marketplace to increase market share or sales

Strategic

Competitive advantage

Competitive necessity

Market positioning

Innovative services

Increased sales

50 percent fail

Some spectacular successes

Two-to three-year lead time

Higher revenue per employee

Business unit financial

Revenue growth

Return on investment

Return on assets

Revenue per employee

for managing and controlling the organization at the business unit level (e.g., financial control, decision support, planning)

Informational

Better information

Better integration

Improved quality

Increased control

Shorter time to market

Superior quality

Premium pricing

Improved control

Business unit operational:

  • Time — new product to market

  • Sales — new products

  • Product/service quality

to process basic repetitive transactions of the company; focus is on high-volume transactions and cost reduction

Transactional

Increased throughput

Cost reduction

25 to 40 percent return

Higher ROI/ROA

Lower risk

Improved control

Business unit IT application:

  • Time — application implementation

  • Cost — application implementation

to construct foundation IT capability (e.g., PCs, servers, networks, maintenance, help desks)

Infrastructure

Standardization

Flexibility

Cost reduction

Utility-type reliability

Supports and facilitates change

Creates compatibility

Enterprisewide IT infrastructure:

  • Infrastructure availability

  • Cost per transaction

  • Cost per user

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