Measuring the Business Value of IT Investments

IT Investment projects are defined as jobs with different sizes generally subdivided into sequence of activities, tasks with clear timelines and expectations, or complex IT efforts of interconnected activities performed by various teams to achieve well-defined objectives, budget, and schedule. IT investments are unsuccessful for many reasons but the primary explanations for these failures are the lack of commitment from the management, organizational problems, lack of strategic vision and execution capabilities, implementation problems, and lack of projects planning.

The research on IT project planning process can be subdivided into strategic and operational perspectives. Some research on IT project planning has explored the strategic aspects and the identification of projects that match with corporate objectives. Some other studies have focused on the analysis and selection of a project from several capital expenditures alternatives (or capital budgeting of IT investments).

Existing Valuation Frameworks

The traditional capital budget methods are based on the calculation of the cash flows input and outputs. Seven traditional budgeting models are used to evaluate capital projects: (a) payback method, (b) return on investment, (c) cost-benefit ratio, (d) profitability index, (e) net present value, (f) economic value added, and (g) internal rate of return.

The payback method measures the number of years required to reimburse the initial outlay of a project, by dividing the original investment by the annual net cash inflow. The return on investment (ROI) is found by dividing the net benefit by the total initial investment. The net benefit is calculated by considering the total benefits minus the total cost and the depreciation and divide by the useful life. The cost-benefit ratio method calculates the returns from a capital investment using the ratio between the total benefits and the total costs. The net present value (NPV) method is the amount of money an investment is worth, taking in account the costs, the earnings and the time value of money. The profitability index is calculated by dividing the present value of cash inflows by the initial cost of the investment. The internal rate of return (IRR) is the discount rate of return that an investment is expected to earn such as equate the present value of the project expected cash flows to the initial investment. Finally, the economic value added (EVA) approach refers to the measurement of the excess value created by managers showing a created or destroyed value of the enterprise in the analyzed period. Similar to other value-based methods (like the economic profit, cash or market value added, or cash flow ROI), EVA promotes the maximization of the economic value of a company by allocating its resources to their best use.

Traditional capital budget methods are limited to valuate IT projects because of (a) their inability to cope with risk, uncertainty, and flexibility, (b) they overlook the cost to train users, the learning curve to adapt to new technologies, and the socials subsystems costs and benefits of the IT projects, and (c) their inability to quantify intangible benefits such as improving knowledge, customer service, or decision making.

These shortcomings are especially clear with IT investments done under conditions of uncertainty in today global economy, which requires dynamic capabilities and strategic flexibility. The real option approach has been proposed as an alternative to the deterministic capital budget methodologies and the extension of the financial option theory to the options on real (non-financial) assets. The concept of real options was originally developed in the financial industry by Black, Scholes, and Merton in 1973. Myers (1984) pioneered the concept of real options by applying it to managing capital budget investments of an organization.

Prior research used real options valuation (ROV) theory for evaluating IT investments. For example, some scholars and practitioners used real options for evaluating an IT telecommunications infrastructure project. Others used a Black-Scholes approximation for valuating an IT project for the implementation of a point-of-sale banking service. Some others proposed a valuation framework for IT investments drawing upon the ROV theory and game theories.

Measuring the Performance of IT in Organizations

Even though the overall performance of the information systems (IS) function seems to be difficult to conceptualize and measure, two approaches can be distinguished in research into the IT business value: variance and process approaches. The former focuses on the relationship IT investments-organizational performance by taking into consideration financial measures such as lower costs, higher revenues, and improved market share. The latter analyses combine the returns of IT investments with process and organizational changes.

The process approach analyzes the impact of IT on an organization in terms of efficiency, effectiveness, and strategic IT alignment. IT efficiency is the IS function that highlights the relationship between IT expenditures (IS capabilities) into IT assets (or IS function outputs such as systems performance, information effectiveness, and services performance). IS capabilities are inputs such as hardware, software, human skills, and management processes that serves to translate IT expenditures into IT assets. Various metrics are used to assess IT efficiency: availability of systems and applications, number of help desk tickets, mean time between failure or license usage. These metrics comment on efficiency of systems, applications, and networks; unlike other performance variables that focus on engineering performance.

Business-IT Strategic Alignment

The metrics used to assess the efficiency of IT do not inform effectiveness. In fact, IT effectiveness is measured against the business goals and objectives. The impact of IT on organizations is moving from an efficiency production factor to the maximization of the business value of IT investments (or IT effectiveness). Enterprises use IT for two main reasons: (a) capturing information to support corporate processes, and (b) enabling business change. For these purposes, the contribution of IT must be both specific (by supporting defined business processes) and generic (by enabling undefined business change). Such measurement models are closed to capability models and different from performance models.

A reliable measurement of capability metrics is the key to align the corporate business and IT. Strategic alignment refers to the proper use of IT in the elaboration and implementation of corporate strategies and goals. Alignment is defined as the degree of fit between business and IT strategic orientations, and in particular how the integration can be achieved.

Business-IT strategic alignment grows in importance as organizations strive to link business and technology in light of the internationalization of their businesses. Our recent research study (see www.nkoyock.net) used a field survey design to examine (a) the role of knowledge management processes in the relationship between contextual factors and alignment in a multinational corporation (MNC), and (b) the role of IT projects in the relationship between alignment and the performance and effectiveness of an MNC.

The results of our research study (http://blog.nkoyock.net/?p=77) had at least four implications to leaders in MNCs: (a) the effects of top managers’ knowledge of IT on strategic business-IT alignment, (b) the importance of business-IT alignment to organizational performance and effectiveness, (c) the importance of internal context and nature of the organization to knowledge integration, and (d) the role of senior management in knowledge management and strategic management of IT.

A theoretical and practical perspective of business-IT strategic alignment in MNC was provided. Our study drew upon the strategic alignment model and the typology of MNCs to propose and test an IT strategic alignment model for MNCs (mSAM). The business-IT strategic alignment implementation model for MNCs (mSAIM) was the model for application proposed as the critical recommendation of our research study.

Please feel free to join the Business-IT Strategic Alignment community and share your experience using LinkedIn. You can also send me an invitation to connect to and download the five-stage process of business-IT strategic alignment (http://blog.nkoyock.net/?p=82) from the Slideshare presentations on my profile.

Reference:

Myers, S. (1984). Finance theory and financial Strategy. Interfaces, 14, 126-137.