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Research conducted amongst companies in the Munster region provides a useful insight into the investment appraisal techniques in use in Irish companies, explains Ruth Vance.

In Ireland the business environment has changed and continues to change rapidly. In recent months the international credit crunch and the downturn in the economy has put increasing pressure on companies to re-examine their costs and justify every investment made. Rising IT costs are causing concern as organisations may lose significantly if they do not make the appropriate investment. Frequently hidden, IT investment costs are difficult to estimate and, benefits are hard to quantify and measure. Uncertainties and risks are often substantial. Considering the range of IT projects, a single, standardised capital budgeting approach may not serve the best interests of organisations. This article is based on empirical research conducted through a series of in-depth interviews with ten IT managers working in the Munster area. Their companies cover a wide spectrum from public sector to small indigenous firms and large multinational companies. Each of the interviews was semi-structured and took thirty to sixty minutes.

Current Methods Used While it is generally agreed that IT investments are beneficial to an organisation, evaluating and measuring the contribution of IT to the bottom line can be difficult. Many information technology investments have proven unsuccessful, exceeded budget, and even harmed companies. Organisations are eager to know how to use their limited resources effectively in order to gain a competitive advantage.

Consistently, financial methods such as Return on Investment, Net Present Value and Payback are used. The researched companies agreed financial methods form the foundation of any appraisal, with many of them using these methods for more than five years. The financial methods’ benefits are best summarised by a manager from an Irish-based multinational:

“They should be used because they offer an objective method of measuring the worthiness of the investment effort.”

However, very few firms use these traditional financial methods alone and recognise their inadequacy for evaluation of investments in research and development and technological innovations. A manager from the public sector thought that:

“Financial methods including Net Present Value, Internal Rate of Return, Payback, Accounting Rate of Return, and Ratios are more accurate in accounting terms but not in business terms.”

A significant number of firms follow a well-defined, quantitative evaluation approach for all IT projects. This research showed the most prevalent of these methods to be cost benefit analysis. This process involves applying values to the initial and ongoing expenses and the expected benefits. Many managers interviewed use cost benefit analysis once the investment reaches a certain threshold. Managers try to include such facets as relationship with clients, potential for expansion to other clients and publicity value, the option of doing nothing and what effect doing nothing will have on the business, improved quality, improved efficiency and improved customer relations. There has to be a business need for making any significant investment.

According to the managers, applying a value is achieved in several ways. One manager from a small indigenous firm said that intangibles would be taken into account by researching similar projects in the archive to see what, if any, benefits resulted. Another small indigenous manager prepares a value statement containing the hard, soft and strategic benefits. This is then translated into a business case. Managers from larger multinational firms apply value through customer satisfaction surveys and customer complaints and through key perform - ance indicators and verbal feedback.

Problems can be derived from the concept of value and the multidimensional facets of IT benefits and costs. This approach may lead to a significant but unnecessary expenditure of resources as attempts are made to apply a value to the benefits and costs of project implementation. One multinational IT manager stated:

“Quantifying the costs and benefits of an operational investment is typically more routine than that of a strategic investment.”

It was suggested that this may be caused by the increasing timeline and people input for a project and because the more strategic the investment the more intangible the costs and benefits. The costs identified by this research include hardware, software, project staff, other staff, consultancy, training, office overheads, travel, consumables, contingency, finance charges and running costs.

The benefits from IT investment identified by the surveyed managers are more diverse and thus more difficult to quantify. Two public sector managers identified a wide range of benefits which include: superior information, enhanced service to customers, competitive advantage, improved employee satisfaction and productivity, ISO accreditation, better market response, cost savings, increased resource utilisation and deferred future investment, quality of information, cost savings, feedback from industry, accreditation, work flow improvement, turnaround time, cost savings, employee satisfaction, improved IT skills.

A manager from the multinational sector thought the benefits were improved productivity, improved efficiency, improved customer relationships, increased quality, faster product developments, greater design flexibility, improved working conditions and improved decision making.

This diverse range of benefits has meant that IT departments are forced to resort to creative estimates to get needed project approval. Researchers report that many organisations are uncertain about how to measure the impact of outcomes of their IT investments. One manager said that:

“Quantifying is difficult as benefit is only potential and costs are absolute.”

All ten managers interviewed say subjective judgement and business acumen play a role in assigning a value to any benefit. Organisational strategy, shareholder value and the needs of clients are also taken into account when applying a weight to criteria in investment decisions. Consequently, IT management is led to select projects on intuition, experience and rule of thumb methods. The limited ability of managers to attend to al organisational problems simultaneously and remain rational thus can lead to sub-optimal IT investment decisions.

Roles in Investment Appraisal Information technology investments are very risky and difficult for managers to control. They are undertaken in rapidly changing environments in conjunction with dynamic organisational factors and can affect an organisation at its strategic core.

IT is too important to be left to IT professionals alone. The researched companies concur with Silk’s assessment.1 All consulted companies use appraisal systems which involve much more than just the IT manager alone. The IT manager from a Public Body stated that they use ‘a procurement team from multidisciplinary areas’.

Management accountants are often used to interpret and make sense of the data that needs to be reviewed for IT investment decisions. The companies who participated in this research use the resources of their management accountants and other accounting professionals in conjunction with their IT specialist. One multinational business uses what they term a Product and Portfolio Model Group. This group is made up of the accounting managers from different functions. Their role is to establish the business needs of each function and then tell the IT manager what the business requires.

Other companies were found to use ‘a service manager’ or ‘a client manager’, whose function it is to provide a similar role to the management accountant as discussed above. Three of the ten IT managers stated that the end user had role to play in the final decision on any IT investment. This is a recommended approach as performance improvements can be lost when end users reject the application. End-user support is best attained by achieving their contribution at all stages of the process, consisting of specification of system objectives, evaluation of investment criteria and pilot schemes. Establishing the information to support decisions Informed decisions require good communication and mechanisms to facilitate knowledge flows among decision makers. The companies in this research used various techniques to establish the information needs in the investment decision process.

Four companies use informal approaches. Their IT managers described their approach as ‘regular meetings’, ‘discussion among all staff’, ‘business functions telling IT what they need’, ‘the client manager asks what they need’. One IT manager stated that they interview business function managers to establish their requirements. A further manager said they get their information from their Management Accountant.

Computerised systems provide managers with too much information. Managers do not have the skills to interpret the information and make it useful in supporting their decision-making. The management accountant is used to analyze this information and make it meaningful.

Another company bases its IT investment decisions on industry trends. Using a follower strategy has the advantage of reduced costs. However, basing IT investment decisions on following the leader may not be optimal and will not give the organisation a competitive advantage from its IT.

Conclusion A reputation for getting poor value for money from information technology has been established. This reputation has been recognised by all of the companies interviewed and steps have been taken to try and improve the investment evaluation process and thus improve value for money. Most organisations have extended the evaluation process outside the IT department and have included end users and function managers in the final decision. There appears to be no ‘one method fits all’ but companies have been endeavouring to include both quantitative and qualitative analysis in their IT investment appraisals.

Notes 1 Silk, DH “Managing IS benefit for the 1990s,” Journal of Information technology, Vol. 5, pp185-193

Ruth Vance, MBS, is a Lecturer at Cork Institute of Technology.

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