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Measuring Returns on IT Investments: Some Tools and
TechniquesPublished : July 18, 2001 in Knowledge@Wharton
Laptop computers could make a sales force more productive, but
they also cost more thandesktop PCs. Should a company buy laptops
for its salespeople? Software programs suchas Lotus Notes, which
allow distributed teams to collaborate on projects, can be pricey
but they also have the potential to make a far-flung workforce more
efficient. Should afirm invest in such software? When is
information technology a good buy? How canmanagers know when an
investment in IT has paid off and when it has been an
expensivedud?
Answering these questions and, by implication, measuring the
value of IT investments can be a majorheadache for U.S.
corporations, executives and managers, who spent a collective $762
billion in 1999 onIT, according to the U.S. Commerce Department. So
large is IT spending that between 1995 and 1999, thecategory
accounted for fully one-third of all real economic growth and half
of all productivity growth.
What these numbers do not quantify, however, are the returns
from IT investments. Experts at Whartonand Intel, the worlds
largest chipmaker, say that such returns are difficult to measure
because they andsome of the costs cover a host of intangibles. The
intangibles include the time it takes for returns toemerge from an
investment in IT; strategic fit in the company; opportunity costs;
levels of innovationrequired; the value of connecting with
customers; and finally, the possibility of retaliation
fromcompetitors.
Accounting for these intangible factors is crucial in valuing IT
investments. "The greatest danger is theconcrete and measurable
driving thesignificantout of the analysis," says Eric K. Clemons, a
professorof operations and information management at Wharton. "When
considering an (e-commerce) strategy it isclear what the costs are;
the benefits are less clear." The combination of tangibles and
intangibles
suggests a pair of gaps managers must face as they evaluate IT
investments.
Filling the Gaps
The first gap could be called a "subjectivity gap," according to
Wharton dean Pat Harker, professor ofoperations and information
management. Calculating estimated costs when a company wants to
invest intechnology is a relatively straight-forward process.
Figuring out the benefits, however, can be difficult.Wise managers
will "know what they know and know what they dont know." Too often,
Harker says,executives get investment proposals that barely scale
the hurdle rate required for them to be approved.Savvy managers
know they can work the numbers so that an expected increase in
market share or salesjustjustmakes it over the wire, but this
suggests a corporate culture unwilling to acknowledge a need
forsubjective evaluation. And yet, such a subjective evaluation of
intangible benefits received from an IT
investment may dramatically affect the overall calculation.
The second gap can be called "revenue distance," notes Ravi
Aron, a professor of operations andinformation management. This
refers to the gap between the investment itself and the revenue
mechanismit supports. Aron suggests, for example, that building a
corporate extranet where buyers can examinewhether a company has a
product available in its inventory before placing an order has a
short revenuedistance because it directly affects sales revenues.
"Revenues come from the customer," Aron says. "Forsomething that
makes my existing linkage more efficient and couples me tighter
with the customer, therevenue distance is close to zero."
But consider this: Managers of a geographically dispersed team
may believe software such as Microsoft
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Whiteboard or Lotus Notes will lead to more productivity and
efficiency among team members bymaking it easier for them to share
data. "Does it bring the team members closer to the customer?"
Aronasks. "The revenue distance between this investment and the
revenue mechanism is substantial." Still,great revenue distance
does not disqualify an investment. It may demand subjective
analysis.
Some Techniques for Measuring the Gaps
How can managers and executives account for intangible value?
Experts suggest employing one or moreof these techniques:
Business Value Index:
Intel is piloting a method of quantifying the business value of
IT investments. Martin Curley,director of IT people, intellectual
capital and solutions for Intels IT group, says managers
assignvalues between one and four to intangible benefits on a
scorecard. "The assumption is that wehave already performed a
financial benefit analysis for the tangible benefits," Curley
points out.The exercise addresses the "subjectivity gap" that
Harker describes. The result is a tool executivescan use to gauge
one investment against another over time.
Scenario Planning:This method can help avoid what Aron calls
"managerial myopia" when addressing investmentsthat may not show
immediate financial returns. Scenario planning lays out a variety
of paths thatcan occur if the investment is made or if it isnotmade
and pushes decision-makers to definethe likelihood for each
scenario and make decisions accordingly.
Real Option Theory:
Imagine a game of seven-card stud poker. On each deal, the
player antes up to see his next card and his opponents. If he
doesnt like what he sees, he folds. The theory defines
technologyinvestments as "options" to be pursued. As opportunities
present themselves, managers can placesmall bets or investments on
a variety of IT projects and see how they play out. As onebecomes
more likely to yield gains, the "betting strategy" becomes more
clear. "Its not acommon practice yet," Curley says. "But it is
emerging and there will be early adopters."
Both real option theory and scenario planning are fertile ground
for business researchers and can behighly esoteric. Experts say
plenty of consultants stand ready to advise how to apply these
concepts.
"R&D Council":
Curley says Intel has pushed some of this evaluation to a
separate unit, devoting less than 5% ofits budget to that unit for
research. Managers bring the more "out-there" or innovative
proposalsto the council for evaluation.
Determining the value depends on corporate culture
Ultimately, business culture is critical. A CFO who demands hard
numbers to justify every investmentwill get what he asks for,
Harker says. But he may not be able to depend on what he gets.
"People areoften looking for a panacea, some magic computer
program," Harker says. "The answer is usually insidetheir
organization. They have to have a clear process for decision making
and a clear articulation of howwe account for certain costs and
benefits."
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