of IT Investment Evaluation
Study
1. Information economics: The focus is on the role of IT in determining the attitude and value of the information available to the decision-maker.
2. Economics of IT: The analysis of supply and demand of IT is done in traditional economic framework.
3. IT and organizational performance: The focus is on the strategic advantages like competitiveness and efficiency that an organization gains due to the use of IT.
4. Industrial organization: The framework of analysis is constituted of business behavior and its implementation.
Due to the nature of benefits from IT, case studies have been widely used as a methodology to study benefits from IT. Most of the case studies have indicated definite strategic and competitive benefits of IT investments and these benefits are broadly classified as follows [Wen & Sylla, 1999]:
1. Decrease effort and operating process performance
2. Facilitate management support
3. Gain competitive advantage
4. Provide a good framework for business restructuring and transformation
Inputs & Productivity:
The investment in IT can be measured in various ways and it totally depends on how we define our IT capital.
1. Computer capital
2. Information Processing Equipment (IPE) that includes communications equipment, scientific and engineering instruments, photocopiers and related equipment.
3. Software and related services are sometimes included in the IT capital.
4. Sometimes the investment information systems staff and workers who use computers also forms the part of IT investments.
Productivity is calculated as the level of output divided by a given level of resource input. Multifactor productivity, which is better measure of firm or industry’s productivity is calculated as the level of output for a given level of several inputs, typically labor, capital and materials. Here, “output” is defined as the number of units produced times their unit value, proxied by their “real” price. Determining the real price of a good or service requires the calculation of individual price “deflators” to eliminate the effects of inflation without ignoring quality changes.
Firm Performance:
Measurement of firm performance and establishing of relationship with IT factors has been a major theme of research in IT investment payoffs. Here the selection of appropriate measures of firm profitability or performance plays an important role. Some of the widely used measures of firm performance in evaluating IT are as follows:
1. Accounting measures: Methods like return on investment (ROI) are based on historical data and reflect past information. This data is not adjusted for risk and is distorted by temporary equilibrium effects.
2. Financial market based measures like share price, price earning ratio and Tobin’s q are good indicators of future performance . But the inclusion of share price brings in the abnormalities of stock market that should be corrected by replacing it with share value.
3. Measures based on organizational effectiveness of converting IT inputs to productive outputs, psychometric measures as well as measures of IT intensiveness using content analysis of published and archival data.
4. Customer satisfaction as measure of firm performance or measure of business value of IT is widely used in service sector. Initial stage of study constitutes of exploratory research to identify factors related to IT that provide customer satisfaction. The questionnaire based data collection and analysis through various quantitative techniques follows the exploratory and literature survey study .
5. Management rating and user satisfaction is similar to method 4. In this method soft data is derived from the survey of managers and the end users of information systems in the firm. Managers evaluate the performance of the IT systems while the information from the end users is used to evaluate the suitability of systems.
6. Combination of qualitative and quantitative factors: Here the traditional measures of firm performance like profits, sales, ROI etc. are used along with factors like IT usage, organizational performance and IT governance.
All the methods that use the qualitative measures pose a challenge to develop, test and validate appropriate measures of analysis.
Tools and Techniques:
A lot of models, which has been used in evaluating IT investment payoff, are drawn from the production theory (based primarily on the Cobb-Douglas function). A production function relates output to a given set of inputs at a given technology. While employing this construct to examine relationships between IT and output, capital and labor are disaggregated to IT and non-IT components.
The firm performance measures have been related with the IT expenditure factors using following methodologies.
1. Simple correlation between the factors
2. Ratio studies examine the association between a ratio representing IT input and a ratio of organizational output. Firms are classified into quartiles or groups based on firm performance, which is followed by, test of independence between the performance variable and the different IT inputs.
3. Canonical correlation analysis to estimate the relations between the data sets
4. Regression of IT attributes to predict one of the performance measures. Econometric analysis attempts to measure the contribution of IT to firm performance by controlling for other factors of productions such as non-computer capital, the cost of labor and other expenses. Dynamic modeling is used to capture the lag effect in the benefits from IT investments.
5. Data envelopment analysis (DEA) is used to determine the impact of IT on the efficiency of an organization. DEA is suited to analyze the efficiency with which inputs are transformed into outputs. The qualitative data on IT factors which are either imprecise and expressed as a range rather than a single factor or known only in terms of ordinal relations can be incorporated into a DEA analysis through modified IDEA models. IDEA model permits mixtures of imprecisely and exactly not-known data and transforms them into ordinary linear programming forms. It is very useful tool for IT investment, as a lot of IT factors are intangible and are captured through imprecise qualitative tools.
6. Efficiency Ratio models seeks to relate output efficiency to monetary inputs which can in turn be related to other organizational performance measures via regression analysis.
7. Business value linkage (BVL) distinguishes between intermediate and higher levels output impacts of IT. The impact of IT on organizational performance is complex in nature. The impact of IT on intermediate output is first identified which is followed by estimation of relationship between the direct intermediate output and the indirect higher-level economic outputs.
Collection of relevant data is major problem with quantitative research in this field, since data on factors related to IT are not widely available. If available, the validity of data is questioned on account of qualitative nature of the information, which makes direct measurement of the factors very difficult. A lot of measurement errors creep in due to incomplete understanding of the relevant factors coupled with unavailability of uniform methods for measuring these factors. Some other possible sources of problem in IT investment investigation are:
§ Lags due to learning and adjustment
§ Redistribution and dissipation of profits
§ Mismanagement of information and technology