Download Management of Computer System Performance Chapter 3

Management of
Computer System
Performance
Chapter 3
Aspects of IT Investment Decision Process
Aspects of IT Investment
Decision Process
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Agenda
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Understanding Projects and alternatives.
Analytical approaches to Cost Benefit Analysis.
Objectives
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Students should be able: to explain the aspect
of IT investment decision process.
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Recap of Analytical
Approaches
Project Life Cycle
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Costs and 400,000
Benefits 300,000
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Time
Start
Project Life Cycle
Ex-Ante
Ex-Post
Formative
Summative
• Each provides a different perspective on the same project.
• Each requires a different set of metrics to be collected.
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Alternatives to the Base
Project
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Consider at least three alternative means of
achieving program objectives. Examples include:
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in-house development versus contractor development
in-house operation versus contractor operation
leasing equipment versus purchasing equipment
Include current operational procedures versus
new operational procedures.
Note the impact of each to the analysis.
Recognize the costs of:
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New or changed processes
Ancillary costs and benefit impacts.
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Analysis Methodologies
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Benefit-Cost Analysis (BCA) is a systematic,
quantitative method of assessing the life cycle
costs and benefits of competing alternative
approaches.
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This includes determining which one of the alternatives
is best for the corporation based on the information
available.
SOLUTION: If the benefit is greatest, and the
cost is acceptable as compared to the benefit
and to the corporation, then that alternative is
selected.
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Purpose of a Benefit Cost
Analysis
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The purpose of a Benefit Cost Analysis
(BCA) is to:
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support better decision-making to ensure that
resources are effectively allocated to support
the Corporation.
It should demonstrate that at least three
alternatives were considered, and
the chosen alternative is the most costeffective within the context of budgetary and
political considerations.
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BCA Characteristics
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BCA must include comprehensive estimates of
the projected benefits and costs for all
alternatives.
Benefits to which a dollar value cannot be
assigned (intangible benefits ) should be
included, or at least recognized, along with
tangible benefits and costs.
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Intangible benefits should be evaluated and assigned
relative numeric values for comparison purposes.
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BCA Characteristics
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For example of Intangible cost Valuation:
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maximum benefit could be assigned a value of 5,
average benefits a value of 3, and minimum benefits a
value of 1.
If this type of approach is used, it should be used
consistently across the estimating group.
Evaluating and comparing benefits that have both
dollar values and relative numeric values requires
extra effort, but it allows subjective judgment to be
a factor in the analysis.
BCA’s should be explicit about the underlying
assumptions used to arrive at estimates of future
benefits and costs.
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BCA Restrictions
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For in-process projects, Costs incurred in the
past (Sunk Costs) and savings or efficiencies
already achieved (Realized Benefits) should not
be considered in a BCA
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When a BCA is done on a project that is already
underway, there may be pressure to compare all costs
and benefits from the beginning of the project.
Use the Estimate to Complete or Future Benefit
evaluation model.
The question to be answered is whether or
not the benefits of proceeding justify the
costs associated with continuing the project.
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BCA Restrictions
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The classic example of this is a situation
where large amounts of money have been
spent designing a system that has not been
successfully implemented, and the project is
being re-evaluated.
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The fact that money has been spent is no
reason to continue spending.
BCAs focus on the future; and decisions have to
be based on the expected costs and benefits of
the proposed alternatives.
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BCA Restrictions
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Past experience is relevant only in
helping estimate the value of
future benefits and costs.
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This is often reflected in the Estimate
To Complete (ETC) costs of a project
which would be used to compare
against another new project.
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The Decision Making Criteria
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A Project should be initiated or continued
only if the projected benefits exceed the
projected costs.
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The only exception is if benefits are mandated
by law. An example of this are projects that
are associated with Health Insurance
Portability and Accountability Act (HIPAA)
compliance.
HIPPA requires specific information protection
and IT controls to be placed on patient data.
Much of this involves information protection.
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The Decision Making Criteria
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Benefit Cost Analysis - The standard
criterion for justifying an IT project is
that:
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the benefits exceed the costs over the
life cycle of the project.
or
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The competing alternative with the
greatest net benefit (benefits minus
costs) should be selected.
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The Decision Making Criteria
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When all benefits and costs cannot be assigned
monetary values, relative values for costs and
benefits should be used,
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and the alternative with the greatest net benefit
(benefit values minus cost values) should still
be selected.
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Make sure that the same scale and methodology is
used for each evaluation
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Analysis Methodologies
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Cost-Effectiveness Analysis (CEA) is a simplified
BCA, which can be done when either the benefits or
the costs are the same for all alternatives.
The analysis is greatly simplified because the best
alternative is either:
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the one with the most benefits (when the costs are the
same for all alternatives) or
the one with the lowest cost (when the benefits are the
same for all alternatives).
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The Decision Making Criteria
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Cost-Effectiveness Analysis - When
comparing alternatives with identical costs
and different benefits, the alternative with the
largest benefits should be selected.
When comparing alternatives with identical
benefits and different costs, the alternative
with the lowest costs should be selected.
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The Decision Making Criteria
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Benefit Cost Analysis - The standard
criterion for justifying an IT project is
that the benefits exceed the costs
over the life cycle of the project.
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The competing alternative with the
greatest net benefit (benefits minus costs)
should be selected.
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The Decision Making Criteria
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When all benefits and costs cannot be
assigned monetary values, relative values
for costs and benefits should be used,
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alternative with the greatest net benefit (benefit
values minus cost values) should still be
selected.
Make sure that the same scale and methodology
is used for each evaluation. Compare apples to
apples!
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The Decision Making Criteria
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Cost-Effectiveness Analysis - When comparing
alternatives with identical costs and different
benefits, the alternative with the largest benefits
should be selected.
When comparing alternatives with identical
benefits and different costs, the alternative with
the lowest costs should be selected.
Logical yes but in the heat of budget battles, logic
sometimes gets lost.
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Aspects of the Decision Making
Process
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The optimal IT investment evaluation criteria is
frequently the same as any other capital invest
criteria.
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Some fundamental aspects of the investment criteria may
differ from other capital investment project, such as
accelerated depreciation schedules, may vary.
Though different, the basic decision making process is
usually the most effectively utilized.
By applying the same criteria as that used for other capital
investment projects, a firm has the best chance to
recognize the risks, determine the best mitigation and then
select the optimum IT investments.
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Classes of the Decision Making
Process
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Classes of Projects subject to IT Investment
Decisions are as follows:
Must-Do Investments. These may be required
to meet legislated agendas but may not have any
direct benefit unto themselves.
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Though it is arguable that if you are required to institute
an IT investment, it would be incumbent upon the
organization to optimize the investment to improve
efficiency and by extension, profitability.
An Example of this is the HEALTH INSURANCE
PORTABILITY AND ACCOUNTABILITY ACT OF 1996
or HIPAA.
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Must-Do Investments –
the Decision Making Process
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HIPAA mandates many things including
certain levels of security in the operation of
IT systems that handle Patient data.
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The basic ROI for HIPAA compliance is very
limited in most cases.
The benefit of selling your firms services on the
basis that you have a “secure” system is an
oxymoron to your customers expectations.
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Must-Do Investments –
the Decision Making Process
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Your customers expect you to have a secure
system and besides, the law says you have
to have a secure system.
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Why are you different from your competitors?
Was your system unsafe previously, etc, etc?
If benefits are limited, alternatives should be
examined.
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Must-Do Investments –
the Decision Making Process
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A study by Arthur Andersen LLP and funded by
two healthcare industry firm found that ecommerce encompasses less than a third of the
industry's business that could be done
electronically.
It found that:
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e-commerce can cut work from processing errors by as
much as 52 percent.
that providers overpay suppliers by 2 percent to 7
percent for contracted medical supplies.
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Must-Do Investments –
the Decision Making Process
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For distributors, it could cut selling, general and
administrative expenses by 1 percent to 10 percent.
For manufacturers of medical and surgical products, it
could lighten the administrative load of sales
representatives by 25 percent to 49 percent.
These represent a significant savings potential.
Therefore, in making a decision on a legislated
requirement, such as HIPPA, perhaps making the IT
system optimized for all e-Commerce transactions is
the proper investment strategy.
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Classes of the Decision Making
Process
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After Must-do changes, Core Investment
decisions are the next class.
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The basis for core investments are similar to
those found in any capital investment.
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Maintenance costs increase,
Vendor support declines or no longer is available,
Newer systems provide greater capability thereby
promising a greater level of efficiency and costs
savings leading to increased profitability.
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Core Investments –
the Decision Making Process
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In IT, these changes are often driven by technology
itself.
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Accelerated development cycles in hardware provide
greater platform capability.
With this increased capacity, computing potential improves
so new software is created to meet the new systems
potential.
IT consumers (business and individuals) seek the greater
functionality fueling the entire cycle.
 It wasn’t too long ago that a spell checker was a separate
program bought as an add-in to a word processor.
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Core Investments –
the Decision Making Process
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In most cases, software vendors find that survival
constantly requires them to improve their
products.
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Competition will drive others within the industry to
delivery a similar product
Use of a product leads to requests for more functionality.
Improved products erode and eventually eliminate the
vast majority of the demand for the existing products.
Lack of demand leads to lack of a desire to support the
older product.
In the face of this, many vendors now stipulate
date where they will cease to support an older or
legacy system.
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Core Investments –
the Decision Making Process
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In the instances where support will be terminated,
new investment will almost always be required.
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Either in a new system or to support the product internally.
Often, the OEMs make it more cost effective to upgrade
than to keep the legacy system in tact.
There are really few viable alternatives.
Another characteristic is that the decision makers
are cognizant of the issues relating to the
investments.
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They know how the system is and the new system should
be used.
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Core Investments –
the Decision Making Process
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The costs and benefits are relatively easy to
quantify.
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Ex.: OEM support is ending in 6 months, to train
experts to replace their support on the old system will
cost x dollars per year +base labor. If we upgrade, it
will cost x dollars and the OEM will deal with the
support costs.
In all cases within the core investment category,
the costs are identifiable, though they may not be
calculated as part of the decision making
process.
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Core Investments –
the Decision Making Process
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Examples of Core IT Investments include:
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Supply Chain Management Systems
Web enabled Business to consumer sites,
Deploying an ERP/ERM system,
Upgrading basic database systems,
Upgrading Desktop systems
Upgrading the internal mail system.
Other examples are plentiful but these are
representative.
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Classes of the Decision Making
Process
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After Must-do and Core Investments, Prestige
Project decisions are the next class.
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These IT projects usually fall into categories that relate to
short term or interim activities. Examples include:
 Gateway’s support of the 2002 Winter Olympics.
 Victoria’s Secret on-line fashion show.
 Setting up an Employee Portal for “for sale items” by
employees.
These are on-offs designed to generate some
returns though those returns are usually estimated
and are not quantifiable at the project’s initiation.
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Prestige Projects –
the Decision Making Process
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In most cases, the characteristics of
Prestige Projects are:
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There are a large number of projects that may
be undertaken to meet the project’s goals.
Decision makers are driving the project.
The cost benefits characteristics are less than
clear,
The intangibles are usually vague but
intuitively, if the project is a success, the
benefits are felt to be significant.
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Classes of the Decision Making
Process
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After Must-do , Core Investments and Prestige
Projects, Research and Development are the final
class of projects.
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R&D IT projects may vary considerably. They will vary
from industry to industry.
These may fall into categories such as
Basic research or,
 developing a neural agent system for an AI application
Project specific research.
 developing a remote management system for a new CAM
product.
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Research and Development–
the Decision Making Process
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Characteristics of R&D IT projects include;
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Projects designed to improve or enhance a
firms competitive position.
Developing a solution to a company specific
problem (wastewater effluence monitoring,
CAM system management, etc.)
Considered by the firms to be an investment in
future income streams.
The relationship of these 4 different
classes are shown in the following matrix.
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The Decision Making Process
High
Risk of
Failure
Medium
Risk of
Failure
Low
Risk of
Failure
Prestige
Projects
R&D Projects
High Risk
Low Returns
Must-Do
Projects
Core Projects
Low Risk & Returns
Low
Returns
Very High Risk
Very High Returns
Medium Risk
Higher Returns
Medium
Returns
High
Returns
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Question?
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Homework
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Homework Financial methodologies
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