The Money side of IT

It is important to evaluate IT investments in terms of their business benefits. However, very often these benefits themselves are not quantifiable and at times decisions are made more on hunch than on business linkage. It is also important to note that IT investments not only entail start-up investment but have recurring costs in terms of maintenance, resources and upgrades. Organisations need to understand the value impact of such investments. There also needs to be a quantification of return on IT investments.

IT managers must evaluate projects based on costs, savings, strategic benefits and risks in order to determine the most advantageous initiatives for the enterprise. Boards want to know which projects will contribute how much to the strategic and tactical business goals.
There are various methods for evaluating IT projects. It is important to determine the appropriate method for a given project as the deliverables of each project will vary. While some can be quantified straight away, others may have more notional or indirect benefits. Let us take the example of investment in an ERP project. The benefits will have to be quantified in terms of the following:

1. Eliminating non value adding activities
2. Online information, MIS and decision making
3. Reduction in manpower and related resource costs
4. Reliability and better compliances
5. Intelligent data mining and subsequent impact in cost reduction and improvement in productivity
6. Cycle time reduction
7. Internal controls

This example is illustrative. For some project, there can be more tangible or intangible benefits, so each IT project needs careful evaluation and use of one of the following methods.

1. Return on investments: The method is easy to calculate and interpret. It measures the tangible benefits received over the amount of investments made in the project. However, it ignores the risk and time value of money.

2. Payback period: It measures the time a project takes to recover the cost of investment made. The evaluation method is easy to use and provides a time frame but does not determine value.

3. Internal rate of return: the evaluation method measures the cash returns (in %) generated by the project considering the time value of money. It is easy to interpret but complex to calculate. The method ignores risk involved in the project and may generate multiple outcomes.

4. Net present value / discounted cash flow: The method takes into account the discounted cash flows based on an assumed rate of interest. It measures whether a project generates positive or negative net cash flows (net of cash outflow/ inflow) within a defined time period. The method is complex to calculate and is subjective to the assumed rate of Interest. In case of projects with different durations it is not conclusive in determining the priority of projects. However, it takes into account the risk involved in the project.

5. Economic value added: The method measures the value generated by a project in comparison to the cost. It takes into account the opportunity value of money and is in line with shareholders value.

It is important for organisations to understand the value and impact of technology investments as well what those investments imply for effective management. While it is generally agreed that IT conveys value to the business, there are a number of factors that firms must carefully consider when deciding how best to procure and utilise IT resources. Organisations must fully understand the impact of IT capital on business performance and the correlation with shareholders return-on-investment decisions. Organisations must stay ahead of rapid developments in technology and align their technology investments to business needs.

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