HPI633 Assignment 6
Drgraham27
HPI633Chapter10.pptxChapter 10 Funding IT
Managing and Using Information Systems: A Strategic Approach
by Keri Pearlson & Carol Saunders
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Learning Objectives
Understand how IT costs are best allocated across an organization.
Describe the method that is most likely to be fair and accurate.
Define how companies determine what the real costs are for IT investments (TCO and Activity-based costing).
Identify which metrics (ROI, NPV, etc.) that should be used to evaluate IT investments.
Understand the uses and benefits of business cases.
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Real World Examples
The CIO of Avon Products Inc. relies heavily on hard-dollar metrics like NPV, and IRR to demonstrate business value in IT investments.
Although not the typical IT metrics they are what business understands.
Avon uses payback, NPV, IRR and risk analysis for every investment.
Business side of IT is similar to the business itself.
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FUNDING IT RESOURCES
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Funding IT Resources
Who pays for IT? Users, IT department, Corporate, etc.
There are three main funding methods:
Chargeback
Allocation
Corporate budget
The first two are done for management reasons, while the latter recovers costs using corporate coffers
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Chargeback
IT costs are recovered by charging individuals, departments, or business units
Rates for usage are calculated based on the actual cost to the IT group to run the system and billed out on a regular basis
They are popular because they are viewed as the most equitable way to recover IT costs
However, creating and managing a chargeback system is a costly endeavor
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Allocation
Recovers costs based on something other than usage, such as revenues, log-in accounts, or number of employees
Its primary advantage is that it is simpler to implement and apply
There are two major problems:
The 'free rider' problem
Deciding the basis for charging out the costs
True-up process is needed where total IT expenses are compared to total IT funds recovered from the business units.
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Corporate Budget
Here the costs fall to the corporate “bottom line”, rather than levying charges on specific users or business units
In this case there is no requirement to calculate prices of the IT systems and hence no financial concern raised monthly by the business managers
However, there are drawbacks, as shown in the next slide (Figure 10.1).
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| Funding Method | Description | Why do it? | Why not do it? |
| Chargeback | Charges are calculated based on actual usage | Fairest method for recovering costs since it is based on actual usage | Must collect details on usage; often expensive and difficult |
| Allocation | Expenditures are divided by non-usage basis | Less bookkeeping for IT; predictable monthly costs | IT department must defend allocation rates |
| Corporate Budget | Corporate allocates funds to IT in annual budget | No billing to the businesses. Good for encouraging use of new technologies. | Have to compete with all other budgeted items for funds |
Figure 10.1 Comparison of IT funding methods
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HOW MUCH DOES IT COST?
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Overview
The most basic method of determining costs is to add up all of the hardware, software, network, and people involved in IS.
Real cost is not as easy to determine.
Most companies continue to use the over-simplistic view of determining cost and never really know the real cost.
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Activity Based Costing
Activity Based Costing (ABC) counts the actual activities that go into making a specific product or delivering a specific service.
Activities are processes, functions, or tasks that occur over time and have recognized results. They consume assigned resources to produce products and services.
Activities are useful in costing because they are the common denominator between business process improvement and information improvement across departments
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Total Cost of Ownership
Total Cost of Ownership (TCO) is fast becoming the industry standard
It looks beyond initial capital investments to include costs associated with technical support, administration, and training.
This technique estimates annual costs per user for each potential infrastructure choice; these costs are then totaled.
Careful estimates of TCO provide the best investment numbers to compare with financial return numbers when analyzing the net returns on various IT options
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| Category | Infrastructure Component | Cost per end user of Option 1 | Cost per end user of Option 2 |
| Hardware | Desktops Servers Mobile platforms Printers Archival storage Technical support Administration Training Informal support Retirement Total Hardware Cost | ||
| Software | OS Office Suite Database Proprietary Technical support Administration Training Informal support Total Software Cost | ||
| Network | LAN WAN Dial-in lines/modems Technical support Administration Total Network Cost | ||
| Data | Removable media Onsite backup storage Offsite backup storage Total Data Cost |
Figure 10.2 TCO component evaluation.
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TCO Component Breakdown
TCO estimates should be computed per component and then divided among all users who access them (servers, printers, etc.)
For more complex situations.
Such as when only certain groups of users possess certain components, it is wise to segment the hardware analysis by platform
Soft costs, such as technical support, administration, and training are easier to estimate than they may first appear.
Informal support is harder to pin down
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| Category | Component | Responsible Party | Annual hours | Cost/ hour | Total cost |
| Technical support | Hardware phone support. | Call center | |||
| In-person hardware troubleshooting | IT operations | ||||
| Hardware hot swaps | IT operations | ||||
| Physical hardware repair | IT operations | ||||
| Total cost of technical support | |||||
| Administration | Hardware setup | System administrator | |||
| Hardware upgrades/ modifications | System administrator | ||||
| New hardware evaluation | IT operations | ||||
| Total cost of administration | |||||
| Training | New employee training | IT operations | |||
| Ongoing administrator training | Hardware vendor | ||||
| Total cost of training | |||||
| Total soft costs for hardware |
Figure 10.3 – Soft costs considerations
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TCO as a Management Tool
TCO also can help managers understand how infrastructure costs break down
It provides the fullest picture of where managers spend their IT dollars as TCO results can be evaluated over time against industry standards
Even without comparison data, the numbers that emerge from TCO studies assist in decisions about budgeting, resource allocation, and organizational structure
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BUILDING A BUSINESS CASE
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Business Case
Similar to a legal case.
A structured document where all relevant information needed to make a decision is laid out.
Way to establish IT priorities.
Determine which projects to invest in
Primary elements are listed in Figure 10.4
Critical to identify both costs and benefits.
Financial and non-financial.
Fig 10.5 shows how these benefits are identified.
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| Section or Component | Description |
| Executive Summary | One or two page description of the overall business case document. |
| Overview and Introduction | Includes a brief business background, the current business situation, a clear statement of the business problem or opportunity and a recommended solution at a high level |
| Assumptions and Rationale | Includes issues driving the proposal (could be operational, human resource, environmental, competitive, industry or market trends, financial or otherwise), |
| Program Summary | Includes high level and then detailed description of the project, well-defined scope, objectives, contacts, resource plan, key metrics (financial and otherwise), implementation plan (high level discussion and potential impacts) and key components to make this a success. |
| Financial Discussion and Analysis | Starts with financial summary. Then includes details such as projected costs/revenues/benefits, financial metrics, financial model, cash flow statement, and assumptions that went into creating financial statements. Total Cost of Ownership (TCO) calculations analysis would go in this section. |
| Benefits and Business Impacts | Starts with business impacts summary. Then includes details on all non-financial outcomes such as new business, transformation, innovations, competitive responses, organizational, supply chain, and human resource impacts. |
| Schedule and Milestones | Outlines the entire schedule for the project, highlights milestones and details expected metrics at each stage (what makes the go/no-go decision at each stage). If appropriate, this section can also include a marketing plan and schedule (sometimes this is a separate section). |
| Risk and Contingency Analysis | Includes details on risks, risk analysis and contingencies to manage those risks. Includes sensitivity analysis on the scenario(s) proposed and contingencies to manage anticipated consequences. Includes interdependencies and impact they will have on potential outcomes. |
| Conclusion and Recommendation | Reiterates primary recommendation and draws any necessary conclusions |
| Appendicies | Can include any back up materials that were not directly included in the body of the document such as detailed financial investment analysis, marketing materials, competitors literature, |
Figure 10.4 – Components of a Business Case
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| Type of Business Change | ||||
| Innovation (Do new things) | Improvement (Do things better) | Cessation (Stop Doing Things) | ||
| High ^ | | | degree of explicitness | | v Low | Financial Benefits | Financial value can be calculated by applying a cost/price or other valid financial formula to a quantifiable benefit | ||
| Quantifiable Benefits | There is sufficient evidence to forecast how much improvement/benefit should result from the changes. | |||
| Measurable Benefits | Although this aspect of performance is currently measured, or an approximate measure could be implemented, it is not possible to estimate how much performance will improve when changes are implemented. | |||
| Observable Benefits | By using agreed criteria, specific individuals or groups will use their experience or judgment to decide the extent the benefit will be realized. |
Figure 10.5 - Classification Framework for Benefits in a Business Case
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IT PORTFOLIO MANAGEMENT
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IT Portfolio Management
IT investments should be managed as any other investment would be managed by an organization.
IT Portfolio Management refers to the process of evaluating and approving IT investments as they relate to other current and potential IT investments.
Often involves picking the right mix of investments.
Goal is to invest in most valuable IT initiatives.
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Asset Classes IT Portfolio
According to Weill and Aral, there are four asset classes of IT investments:
Transactional systems – systems that streamline or cut costs on business operations.
Informational systems – any system that provides information used to control, manage, communicate, analyze or collaborate.
Strategic systems – any system used to gain competitive advantage in the marketplace.
Infrastructure systems – the base foundation or shared IT services used for multiple applications.
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Relative Investment Profile
Average firm allocates 54% to infrastructure each year and only 13% to transactional systems.
Service companies (such as food service) allocate:
26% to informational systems
18% to transactional systems
45% to infrastructure systems
11% to strategic systems
Figure 10.6 contains a sample of the cost-risk-benefit analysis.
Figure 10.7 summarizes a typical IT portfolio.
Table 10.8 summarizes the differences of strategies.
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Investment Costs
Purchase of new call center hardware and software: £250,000
Cost of implementation technical consultants: £120,000
Internal systems development costs (for configuration): £150,000
Infrastructure upgrade costs: £75,000
Business change costs: £270,000
Training costs: £80,000
Total: £945,000
Net increase in annual systems support and license costs: £80,000
Risk Analysis
Technical Risks: Complexity of the systems functionality
Number of system interfaces and systems being replaced
Financial Risks: Confidence in some investment costs—especially business change
Confidence in the evidence for some of the benefits
Business criticality of areas affected by the system
Organizational Risks: The extent of changes to call center processes and practice
Limited existing change management capability
Call center staff capability to promote more technical services
Customer willingness to share information for profiling purposes
Figure 10.6 – Sample cost-risk-benefit analysis
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Figure 10.7 Average Company’s IT Portfolio Profile
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Click to edit Master text styles
Second level
Third level
Fourth level
Fifth level
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| Infrastructure investments | Transactional investments | Informational investments | Strategic investments | |
| Average Firm | 54% | 13% | 20% | 13% |
| Cost Focus | 42% | 40% | 13% | 5% |
| Agility Focus | 58% | 11% | 14% | 17% |
Table 10.8 IT Investment strategies compared
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VALUING IT INVESTMENTS
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Valuing IT Investments
Soft benefits, such as the ability to make future decisions, make it difficult to measure the payback of IT investment
First, IT can be a significant part of the annual budget, thus under close scrutiny.
Second, the systems themselves are complex, and calculating the costs is an art, not a science.
Third, because many IT investments are for infrastructure, the payback period is much longer than other types of capital investments.
Fourth, many times the payback cannot be calculated because the investment is a necessity rather than a choice, and there is no tangible payback
Figure 10.6 show the valuation methods used.
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| Valuation Method | Description |
| Return on Investment (ROI) | ROI= (Estimated lifetime benefits- Estimated lifetime costs)/Estimated lifetime costs |
| Net Present Value (NPV) | Calculated by discounting the costs and benefits for each year of system’s lifetime using present value |
| Economic Value Added (EVA) | EVA = net operating profit after taxes |
| Payback Analysis | Time that will lapse before accrued benefits overtake accrued and continuing costs |
| Internal Rate of Return (IRR) | Return that the IT investment is compared to the corporate policy on rate of return |
| Weighted Scoring Methods | Costs and revenues/savings are weighted based on their strategic importance, etc |
| Prototyping | A scaled-down version of a system is tested for its costs and benefits |
| Game Theory or Role-playing | These approaches may surface behavioral changes or new tasks attributable to a new system |
| Simulation | A model is used to test the impact of a new system or series of tasks; low-cost method |
Figure 10.9 Valuation Methods
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MONITORING IT INVESTMENTS
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IT Investment Monitoring
“If you can’t measure it, you can’t manage it”.
Management needs to make sure that money spent on IT results in organizational benefit.
Must agree upon a set of metrics for monitoring IT investments.
Often financial in nature (ROI, NPV, etc.).
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The Balanced Scorecard
Focuses attention on the organization’s value drivers (which include financial performance)
Companies use it to assess the full impact of their corporate strategies on their customers and workforce, as well as their financial performance
This methodology allows managers to look at their business from four perspectives: customer, internal business, innovation/learning, and financial
Figure 10.7 shows the relationship of these perspectives.
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Figure 10.7 The Balanced Scorecard perspectives
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The Balanced Scorecard
Focuses attention on the organization’s value drivers.
Applying the categories of the balanced scorecard to IT might mean interpreting them more broadly than originally conceived
The questions asked when using this methodology are:
How do customers see us?
At what must we excel?
Can we continue to improve and create value?
How do we look to shareholders?
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| Dimension | Description | Example IT Measures |
| Customer Perspective | Measures that reflect factors that really matter to customers | User defined operational metrics |
| Internal Business Perspective | Measures of what the company must do internally to meet customer expectations. | IT process metrics, project completion rates, system operational performance metrics |
| Innovating and Learning Perspective | Measures of the company’s ability to innovate, improve and learn | IT R&D, New technology introduction success rate, training metrics |
| Financial Perspective | Measures to indicate contribution of activities to the bottom-line | IT project ROI, NPV, IRR, cost/benefit, TCO, ABC |
Figure 10.10 Balanced Scorecard Perspectives
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The IT Balanced Scorecard
A scorecard used within the IT department.
Helps senior IS managers understand their organization’s performance, and measure it in a way that supports its business strategy
The IT scorecard is linked to the corporate scorecard, by insuring that the measures used by IT are those that support the corporate goals
Helps senior managers understand their organization’s performance.
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IT Dashboards
IT dashboards summarize key metrics for senior managers in a way that provides quick identification of the status of the organization
Dashboards provide frequently-updated information on areas of interest within the IT department.
The data tends to focus on project status or operational systems status.
Problems can also be identified and handled without waiting for the monthly CIO meeting
Built on information contained in other apps.
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OPTIONS PRICING
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Options Pricing
Options pricing offers management the opportunity to take some future action in response to uncertainty about changes in the business and its environment.
It offers a risk-hedging strategy to minimize the negative impact of risk when uncertainty can be resolved by waiting to see what happens.
Fig 10.13 offers a simple example of how it works.
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Figure 10.13 NPV vs. Option Pricing View.
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Option Pricing View
They are especially applicable in the following situations:
When an investment can be deferred.
In helping managers strike a balance between waiting to obtain valuable information and forgoing revenues or strategic benefits from an implemented project.
For emerging investments.
For prototyping investments.
For technology-as-product investments.
Downside – sensitive to certain parameters.
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FOOD FOR THOUGHT: WHO PAYS FOR THE INTERNET?
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Who Pays for the Internet?
1.4 billion users on the Internet.
21.9% of the world’s population
Not one pays a “bill” to the Internet.
Service providers (telephone companies, etc.) provide access for a fee.
These fees alone do not “pay” for the Internet.
Several organizations are responsible for portions of the Internet.
Internet Society (ISOC)
Internet Engineering Task Force (IETF)
Internet Corporation for Assigned Names and Numbers (ICANN)
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So Who Pays?
US Government through the National Science Foundation subsidizes a portion.
Provide a backbone for science, engineering and education.
Academic institutions and corporations bear some of the cost by providing access.
Service providers pay for systems linked together over the backbone.
Users pay service providers, so they pay for the Internet.
So, everyone who uses the Internet pays for it.
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Summary
IT is funded using either chargeback, allocation, or corporate budget.
Chargeback is viewed as most equitable.
TCO is used to understand ALL costs associated with a technology.
Activity-based costing can be a meaningful measure of determining cost.
The portfolio of IT investments must be carefully evaluated and managed.
Balanced scorecards and IT dashboards are used to communicate the status and benefits of IT.
Business case is a tool used to support a decision or a proposal of a new investment
Options pricing offers a risk-hedging strategy.
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Transactional
13%
Infrastructure
54%
Informational
20%
Strategic
13%
Transactional 13% Infrastructure 54%
Informational 20%
Strategic 13%
The Net Present Value View
June, 2005
June, 2006
(0.5) ($350,000-$120,000)
(0.5) ($20,000 -$90,000)
The Option Pricing View
June, 2005
June, 2006
(0.5) ($350,000-$120,000)
(0.5) ($0)
The Net Present Value View
June, 2005
June, 2006
(0.5) ($350,000-$120,000)
(0.5) ($20,000 - $90,000)
The Option Pricing View
June, 2005
June, 2006
(0.5) ($350,000-$120,000)
(0.5) ($0)
