for Tangible Benefits
IT Investments Page
# Net Present value (NPV): It is the discounted value of expected net payoffs and is the standard criteria for deciding whether a programme can be justified on economic principles. It is calculated by assigning values to payoffs and costs, discounting future payoffs and costs using an appropriate discount rate, and subtracting the sum total of discounted costs from the sum total of the discounted payoffs. The disadvantages of NPA as applied in IT sector are as follows.
1. May not measure the intangible benefits of information systems correctly.
2. Its main application is in project investment basically in a manufacturing environment. May therefore not be suitable to an information system setting.
3. The value of information in the future is difficult to determine and the discount rate that should be applied.
4. If the system produces more information, it is not sure if the value of the system has automatically increased.
# Discounted Cash Flow (DCF) and payback period methods are other two widely used methods. DCF calculations base their discount rate on a interest rate regard as appropriate by the financial, managers of the organization, while the payback period method does not requires an IT assumption of fixed interest rates. It only requires an IT project to repay its investment over a prescribed period.
2. Cost Benefit Analysis (CBA): CBA tries to overcome the problem of ROI by finding some surrogate measure for intangible costs or benefits, which can be expressed, in monitory terms.
This approach attempts to deal with two problem namely:
# The difficulty of quantifying the value of benefits that do not directly accrue to the investor in the project.
# The difficulty of identifying the benefits or costs, which do not have an obvious market value or price.
Cost benefit analysis is much more a methodology than a theory. It involves a comparative examination of the costs and benefits of the project. CBA can be characterized as a decision problem in which the outcome attributes take the form of a cost measure C, and r benefit measures B1,B2,….,Br. These benefits’ measures may be in different units of measurement. Some means of condensing the benefits into a single monitory measure is needed. It is necessary to construct a set of conversion factors to accomplish this. Time discounting in situations where there is t future time periods over which a stream of costs and r streams of benefits occur.
CBA is applied to the evaluation of information system became established practice with transactions in processing dominated information services activities. In that type of environment, the benefits of largely took the form of enhanced efficiency. These cost savings were relatively straightforward to quantify. However, in a modern context, computer based information systems are more effectiveness based. The problem of using CBA is how to measure benefits associated with IS. Most of the benefits of IS investments are intangible, difficult to measure, and difficult to relate to profit results. Assuming the continued use of capital budgeting techniques like CBA, the problem is that information technology will tend to be under funded.
The costs and benefits of project lie along a spectrum of ‘quantifiability’,
1. Intangibles: The effects involving non-economic values that are not susceptible to measurement.
2. Incommensurables: Can be readily measured, but not in money terms.
3. Market goods: Good or services exchanged through market and hence possessing a market price that is a direct measure of market value.
A significant problem facing the analyst is how far to go in converting apparent incommensurables into monitory terms. The conversion process is itself based on use of shadow prices for the incommensurables. Shadow prices are non-market monetary values imputed to a good or service. These in turn are used to monetise associated incommensurable effects. The construction of shadow prices requires a methodology, and is not a costless activity.
Appropriate adjustments to the traditional use of CBA must be made when it is employed to evaluate a modern IT investment. Current market share, selling price, costs may be poor choice. The appropriate comparator may well be a situation of declining cash flows, market share, and profit margins based on a foregone strategic opportunity that may be undertaken by a competitor.
An alternative method based on similar principles, which is widely used to compare alternate IT investment, is Benefit Cost ratio (BCR) method. It measures the economic desirability of an investment by dividing the present value of its payoffs (cash inflows) by the present value of the costs (outflows). The alternative with the highest BCR is the most cost effective because it returns the most payoffs per Rupee spent.
3. Return on Management (ROM): It is argued that IT serves primarily to help the management do its job. The impact of information technology on the business unit performance can be measured through value-added due to direct labor. The advantage of the ROM methods is that they concentrate on the contributions of IT on the management process. The disadvantage is that the residual assigned as the value added by the management cannot be directly attributed to the management process.