Value lesson for b-school - Technology Transfer - Column

Software Magazine, March, 1993 by Peter Greis, Robert Materna

Business school students learn how to analyze the value of investments using formulas such as Net Present Value (NPV), Internal Rate of Return (IRR) and Return on Investment (ROI). Most corporate operating policies try to force fit these traditional techniques onto the evaluation of information technology (IT) return. The intent is to prove how the use of new technology will reduce costs.

None of these techniques are very effective at capturing the true business value of complex enterprise-wide systems, however. Emerging technologies, in particular require a new way of quantifying IT investments.

Today's progressive firms are using a variety of innovative techniques. These include measuring the cost of quality, analyzing work and option values, aligning IT and business objectives, following competitive advantage frameworks, and creating a research and development budget for IT.

Cost of Quality. A business can divide its resources into "value-added" and "cost-of-quality" activities. Companies should try to minimize cost-of-quality activities while focusing on the value-added aspects of business.

Key to justifying an IT investment is to show how the company can use technology to prevent or reduce the cost of poor quality. IT can play a key role in decreasing costs by improving the way firms manage their information.

Firms that have continuous process improvement programs, or are involved in business process reengineering, are excellent candidates for this approach. This method works well when processes are well defined and the amount of day-to-day work is fairly routine.

Work Value Analysis. This technique recognizes two facts: White collar workers routinely perform activities of differing intrinsic value; and one of the benefits of IT is the ability to restructure work patterns. Thus, an IT investment may not only increase efficiency, but also heighten effectiveness.

The work value analysis approach requires a thorough analysis of work patterns throughout the organization. Based on the analysis, managers prepare a work profile matrix to evaluate shifts in work value through the more effective use of IT and readjustment of the work force. Experience to date indicates that many firms can save at least 15% in payroll costs by applying work value concepts.

This technique is useful when estimating the benefits of IT in a white collar environment, where the amount and type of work varies.

Option Value Analysis. Proponents of this approach say a company can assign value to the different options that IT investments may create for the future. This approach also recognizes the negative consequences that may result from not investing.

Most managers find it difficult to determine the value of technology options. However, experts argue that the act of assigning a value to an option -- based on how it will most likely effect the firm's competitive position -- is a valuable exercise.

This approach works well when managers are dealing with situations that involve a high degree of uncertainty or where flexibility is important. It is also a good way to capture the true value of investments that cut across multiple function or business units.

Strategic Alignment with Business Objectives. Tying IT investments to business needs is becoming more important. Professor John Henderson, director of the Systems Research Center at Boston University's School of Management, is credited with developing the Strategic Alignment Model. Unlike traditional approaches where IT planning follows strategic business planning, this model requires concurrent processes.

Henderson's model recognizes that in most companies, business strategy drives the design of the organization, IT infrastructure and processes. It also examines how emerging technology can influence or enable new strategies, and explores how those affect the IT infrastructure. In addition, the model addresses the need to balance short-term demands with long-term investments to achieve better customer service. Finally, the model focuses on establishing a strategic fit for IT, with an emphasis on understanding the relationships among the firm's business and IT strategies, and the organizational infrastructure.

This technique is especially appropriate for managers who are struggling with how to align their IT strategies, architectures, products and services with the firm's business needs.

Competitive Advantage Frameworks. Over the year, the academic community has developed several competitive advantage frameworks. Each offers some perspective on how IT investments can help companies gain competitive advantage.

One approach, proposed by Professor Warren McFarlan of the Harvard Business School in Cambridge, Mass., suggests that firms consider the following questions:

* Can IT build barriers to entry? Typically this involves offering new services and features that keep customers "hooked." The harder it is for competitors to emulate the product or service, the higher the barrier to entry.