Measuring IT Investments and Returns

1
Chapter 15

• Measuring IT Investments and Returns

2
Introduction

• With increasing competition, cost pressures, and
  outsourcing opportunities, organizations
  increasingly focus on Return on Investment (ROI)
• Firms need an objective financial measure for
  understanding costs of IT as well as the benefits
• IT accounting is difficult, but, given the
  strategic nature of this expenditure, necessary
  for sound decision making

3
Accounting for IT Resources

• Accounting is the process of collecting,
  analyzing, and reporting financial information
  about an organization
• Financial Accounting information available to
  outside organizations (banks, stockholders,
  government)
• Follows carefully crafted rules results in a
  balance sheet and an income statement
• Managerial Accounting information useful
  internally in support of the management process
• Firms establish own rules and tailor to internal
  processes

4
Objectives of Resource Accountability

• The objectives help measure the progress of the
  firms operational and tactical plans
• They form a basis for management control
• Control is the process in which employees act in
  accordance with the firms policies and plans
• Effective control must be preceded by policy
  setting and planning
• Budgetary control is the process of relating
  actual to planned expenses

5
IT Accounting Establishes

• Continuity between planning and implementation
• A mechanism for measuring implementation progress
• A basis for management control actions
• Linkage of IT actions to the firms goals
• Communication of plans and accomplishments
• A basis for performance appraisal information
• Financial benchmarks

6
Recovering Costs from Client Organizations

• IT cost accounting and cost recovery provides a
  basis for clarifying the costs and benefits of IT
  services
• Helps to reveal the important role IT plays
  within the firm
• Strengthens communication between IT and client
  organizations
• Helps to objectify organizational alignments

7
IT Cost Recovery Benefits

• 1. Helps clarify costs/benefits of IT services
• 2. Highlights ITs role within and contribution
  to the firm
• 3. Strengthens communication between IT and user
  organizations
• 4. Permits IT to operate as a business within a
  business
• 5. Increases employees sensitivity to IT costs
  and benefits
• 6. Spotlights potential unnecessary expenses
• 7. Encourages effective use of resources
• 8. Improves IT cost effectiveness
• 9. Enables IT benchmarking
• 10. Provides a financial basis for evaluating
  outsourcing

8
IT Cost Recovery Disadvantages

• Administrative overhead
• Some managers prefer to keep their operations
  opaque
• Cost sensitivity is not an issue for IT
• Organization is not concerned with expenses
• Not in the organizations culture

9
Goals of Chargeback Systems

• 1. Be easily administered
• 2. Be easily understood by customers
• 3. Distribute costs equitably
• 4. Promote effective use of IT resources
• 5. Provide incentives to change behavior

10
Alternative Accounting Methodologies

• Two major alternatives exist for handling IT cost
  recovery
• Profit center approach
• Cost center approach
• Both distribute IT costs to users but vary in the
  impact and incentives placed on the IT
  organization

11
Profit Centers

• IT operates as a business within a business
• By charging customers for services, the IT
  organization recovers its costs and expenses
• The organization can generate a profit or incur a
  loss
• IT managers must be business managers

12
Advantages of IT Profit Centers

• 1. Easy to understand and explain
• 2. Promote business management
• 3. Provide benchmarks and comparisons
• 4. Establish financial rigor
• 5. Enable outside sale of services

13
Cost Centers

• Each client organization budgets its anticipated
  IT services during the corporate budgeting and
  planning cycle
• The sum of the budgets is ITs cost support
• This approach encourages interaction between IT
  and clients during the planning stages

14
Characteristics of the Cost-Center Method

• 1. Promotes intensely interactive planning and
  budgeting
• 2. Establishes prices in advance of known support
• 3. Forces IT and client managers to handle
  variances
• 4. Exposes the planning process to manipulation
• 5. May lead to conflict (which may be beneficial)
• 6. Forces decision making
• 7. Reinforces the SLA and capacity-planning
  processes

15
Additional Cost-Recovery Considerations

• No single scheme for recovering costs works for
  every type of service
• Managers must tailor the chosen cost recovery
  method to take advantage of and optimize for the
  specific service characteristics

16
Funding Application Development and Maintenance

• These functions are well suited to customized or
  unique cost-accounting or cost-recovery
  approaches
• Commonly funded as a long-term contract for
  support
• Has inherent flexibility
• Accounts for work in a general way
• Projects accounted for in this manner create
  incentives for thorough planning and disciplined
  phase-review processes

17
Cost Recovery in Production Operations

• Attempt to recover cost by charging for resources
  used in the production of useful output
• Pages printed, memory used, CPU cycles consumed
• Difficult to develop the charging algorithms
• Pricing creates incentives and can affect users
  consumption of resources
• Less cost for overnight or weekend CPU cycles

18
Network Accounting and Cost Recovery

• Network accounting is difficult because the
  interactions between applications, processors,
  and storage make it difficult for clients to
  understand the incentives
• Corporate network managers must understand
  operational costs and expenses, and the effect
  expenses have on service levels
• This knowledge can be used to help optimize
  applications and their network demands to
  decrease costs for clients and the firm

19
Relationship of Accounting to Client Behavior

• The goal of user-chargeback processes is to
  encourage and promote cost-effective use of IT
  services
• Cost-recovery actions can create powerful
  financial incentives that modify behavior
• Motivations present in accounting and chargeback
  mechanisms can help improve the firms performance

20
Some Additional Considerations

• The purpose of the managerial accounting system
  is to serve managers, not to devise highly
  precise accounting processes
• If the system controls, communicates, motivates,
  and helps measure and plan as management desires,
  then additional accuracy and precision in the
  accounting processes may not be justified
• Sacrificing accuracy can reduce administrative
  overhead

21
Managers Expectations of Accounting Systems

• Cost-recovery systems should be designed for
  clients
• Clients expect fair distribution of IT costs and
  consistency
• Frequent or unusually large price changes upset
  plans and diminish confidence in the IT
  organizations ability
• IT managers expect these systems to help them
  understand how IT is spending resources to
  advance the firms goals

22
Special Considerations for E-Business Systems

• E-business strategies originate from and are
  justified at the firms highest levels and are
  strategic in nature they are less amenable to
  ROI calculations at lower levels in the firm
• what matters most is that costs are identified,
  controlled, and justified in some manner
• who does the work or who owns the assets is far
  less important

23
Measuring IT Investment Returns

• For many IT projects like those leading to
  improved quality or customer service strict ROI
  calculations frequently show a negative or low
  return
• Due to the nature of the calculation not able to
  capture the business dynamics resulting from the
  investment
• Hendersons Option Model may provide an
  alternative assessment

24
Measuring E-Business Investment Returns

• ROI is a simple tool, but it may be too
  simplistic in the context of e-business
  projects.
• Measures investment returns to the firm but fails
  to account for possible returns to customers and
  suppliers
• Fails to measure improved responsiveness or
  increased collaborator satisfaction
• B2B or B2C e-commerce

25
Summary

• IT resources are widely dispersed, making
  accounting processes difficult
• Accounting for IT resources helps managers with
  planning, controlling, communicating, and
  assessing performance
• Chargeback methods are very important to IT
  managers
• IT accounting systems are not an end in and of
  themselves but a means