Title: Measuring IT Investments and Returns
1Chapter 15
- Measuring IT Investments and Returns
2Introduction
- 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
3Accounting 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
4Objectives 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
5IT 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
6Recovering 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
7IT 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
8IT 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
9Goals 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
10Alternative 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
11Profit 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
12Advantages 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
13Cost 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
14Characteristics 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
15Additional 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
16Funding 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
17Cost 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
18Network 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
19Relationship 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
20Some 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
21Managers 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
22Special 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
23Measuring 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
24Measuring 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
25Summary
- 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