Literature Related To Information Technology Investment Finance Essay
Gone are the days when investment in Information system or technology (IST) was considered as the cost centre of the organisation rather than profit generating investments. It took a considerable amount of time for these companies to realise the returns and potential benefits of investing in IST. Different research report indicates that in spite of the recent economic downturn, the companies are investing heavily in the IST (Gartner, 2010). The report indicates the budget amount allocated for the investment is quite high in fortune 500 companies. There are no definite terms to classify the IT investment. They can range from hardware, software, and virtualisation. The impact of IST in organisation has led it to be considered as the capital asset just like any other investment made by the organisation with expectation of generating profit. But the question remains why companies invest in Information technology or system and why these trends have been increasing in spite of global economic meltdown. The IST investment is based on six class of value which are return on investment, strategic match, competitive advantage, managerial information support, competitive response and strategic IS architecture (Wilcox, 1994).
With Globalisation the companies are enjoying a benefit of access to market but at the same time it poses a threat in terms of competition and fight for different resources. Managing information has become even more important compared to the previous days where business used to operate within limited boundaries. In such situation, company existence without IST cannot be imagined. Leveraging information and knowledge has become key success factor for the sustainable advantage for the firms all around the world. This makes company to invest more in IST with an aim to generated more profit and reduce operating costs. It is not only the existing technologies but the emerging information highway will change the every organisation operates. (Bysinger and Knight, 1996).
Investment in Information technology can be broadly classified into two categories. Updating of existing technologies or implementing a new technology (Irani, 99). It is very important for information manager to classify the investment because nowadays technology dictates on how the business organisation runs it operation. Just like other investment there is always a risk of failure attached to it. According to the standing group Chaos report 2004, 37 % or projects are failure while 28% are abandoned without even completion of projects. Thus the investing requires attentions from all the level of the organisation i.e. strategic, management and operational level. The chaos report of 2010 predicts that the rate of failure is increasing. Thus it become very significant that how to invest in IST is always a critical question for information managers because based on the research carried out by pricewaterhousecooper 2000, they listed key issues of Investing in IST are
The record of controlling and measuring IST investment has not been impressive which implies managers have found it very difficult to justify the cost surrounding purchase, development and use of IT
There is difficulties in measuring benefits and cost which implies in spite of knowing the benefits of the IST, managers have difficulty in quantifying those benefits and measure its scale
There is a positive correlation between the firms IST strategy and success of IST investment which implies the strategic level must be very clear on the business objectives of investing in IST.
Framework for literature review:
Following framework has been adapted to carry out the critical review of literature: The study begins with analysing the current scenario of IST investment to justify the importance of study. The factors i.e. internal and external factors affecting the IST investment are analysed through SWOT and PESTLE analysis technique. This is to give the idea on what are the factors managers or decision makers have to scan at the planning phase of decision. Once the general factors are identified, the study aims to identify what are the potential or existing risk factors affecting investment decision. The risk factors are based on the analysis of internal
S W O T analysis
Internal factors affecting the IST Investment
Analysis of Investment decision process and framework
ROI analysis of Investment decisions
Risk factors – current and potential
External factors affecting the IST investment
P E S T L E Analysis
Figure: Model of Literature review
and external factor analysis. The risks are evaluated based on the different level of organisation and nature of decision. The research Then it moves to the most important aspect of this research which is analysing return on investment of IT. It is important as justifying the IT investment has been always a challenge for the mangers and decision makers. This section examines on how IT helps to improve the productivity of the firm based on the research carried out by different researchers. Further this section examines the different methodologies practiced in different industry and organisation with a brief analysis of these methodologies. The aim is understand the generally used techniques and why. The most important part is to examine the limitation of such methodologies and how manager can make the best use of the available methods. This research aims to understand the overall decision making process and different phase involved in it. The above approach is followed because researcher believes it will help to understand the overall nature and process of decision making of IST investment and how these investments has been treated differently to other types of investment. This study also aims to examine how organisation can justify the huge sum invested in their technology or system.
2.2 Trends of IST investment:
This section examines on how the pattern of investment has changed from the early 90s to what are the future technologies which will be attractive for a company investment. The analysis is done based on the report published by different research organisation.
The analysis is based on the findings of the OECD (Organisation for economic co-operation and development) recent report on technology investment. The investment has been measured in terms of percentage of revenue of the countries and published in the report of 2010.
Source: OECD Factbook 2010: Economic, Environmental and Social Statistics - ISBN 92-64-08356-1 - © OECD 2010
The table indicates how the trend of investing in IT has been in the past and present. The investment in IT has been measured based on four categories which computer hardware, computer software, computer services and communications. From the implementation of IT in organisation which is the year 1980, the trend of investment has been increasing dramatically till the year 2000. From 1995 to 2000, the investment in UK has increased by 7 percentages. From the year 2001 the increasing trend has been stabilised and more declining figures are observed. This can be attributed to the uncertainty involved with IT investment as the technologies were changing at the fast pace and with use of internet was more commonly adopted which made the previous technologies were obsolete or required updating. The US remains highest investor.
According to the recent research carried out by Ernst and Young in 2010 among the 123 CIO (Chief Information Officer), 97% CIOs indicated budget allocation for new IT initiatives and 62% of the respondents indicated that their investment could be in range 5-100 million (USD).The major research finding is most of the respondents want to reduce the IT costs but it necessarily doesn’t translate in reduction of IT investment. The concern is to decrease the operational cost of IT investment and security concern of IT investment. The respondents are mainly from large enterprise which has invested heavily in IST in past and more willing to review their spending now. But they are also willing to invest in new technologies such as Green IT, Cloud computing (Gartner, 2010), PDA, Virtualisation and Consolidating. But all the CIO indicates that they have to invest in new technologies to achieve the operational efficiency, leverage their existing IT and gain a competitive advantage to their competitors.
2.3 Factors Affecting IT/IS investment Decision:
Similar to organisation, Information system or technology dependent upon the factors which influences the planning, analysing and implementing phase. This is often referred as decision making environment. Decisions are made based on the analysis of historic data or information and they collect this information from all the factors prevailing in environment. The managers use all these data to make decisions (Saunder and Jones, 1990). The environment is classified into two type’s i.e. internal and external environment.
2.3.1 Internal Factors:
Internal environment represents the factor which directly affects the performance of organisation or the core issues of the business. The core issue refers to customer, supplier, company and competitors. In case of implementing any information system or technology, there are various factors needs to be considered such as size of the company, available human and financial resources etc.Beside these , the management must find out the support of top level management and involvement of the strategic and operational level staffs in decision making process. These factors are within the reach of managers to be controlled where analysis of various inputs can be futuristic figures such impact of IST on suppliers, customers, competitors and finally overall company mission. The degree of impact of these factors on investment decision depends upon the type and nature of investment. Thus the factors which can be controlled are directly affected by the investment are known as internal factors.
2.3.2 External Factors:
There are certain factors which are beyond reach of the managers and changes in which doesn’t only have the impact on individual company but at the industry at large or may be the global business environment. Such factors are referred as external factors. The external factors are mainly categorised as Political, Economical, Social, Technological and legal. The recent global economic crisis has adverse impact on all class of business and as a result of which the priorities have changes for the business organisations. The change in VAT or tax structure of the government can make some business more profitable but can be very dangerous when one is competing in global arena. Thus these factors are referred as external factors.
SOCIAL LEGAL TECHNOLOGICAL
Human resource Business Factors
Stakeholders Competitor Factors
(Porters five forces model
Figure: Decision Making Factors
The above figure shows the overall environment where the business operates and identifies the factors which play a vital role in the IST investment decision. The outer triangle represents external factors which are required to be scanned for making decision. The analysis of external factors can be done by the PESTLE analysis model. The Factors in the mid triangle represents the internal factors required to be considered making investment decisions.
2.3.3: Model for Factors affecting Investment decision: SWOT Analysis
As PESTLE (Political, Economical, Social, Technological and Legal) analysis are done to measure the impacts of external factors of environment. But decisions are affected by internal factors and .Both of these external and internal factors have their degree of impact to the decision and affect in both positive and negative way. Thus for analysis of both external and internal environment and measure its impact SWOT where S=Strength, W=Weakness, O=Opportunities and T=Threats. Analysis is carried out by the managers to evaluate the pros and cons of Investing on particular IST.
The concept of SWOT analysis is proposed by various scholars in the field of business management and extensively used by managers to identify the factors affecting various decision making process. The SWOT analysis is used for this research as its major aim is to identify the factors which can affect the decision or IST investments. It analyse the situation in two fold perspective which are external and internal analysis. Internal analysis deals with the strength and weakness while external appraisal deals with the threats and opportunities posses by the environment (Kotler,1988). The aim is to develop a strategic vision based on the strengths and weakness which can exploit the available opportunities and overcome weakness of organisation.
All these four components are explained in following way:
Figure : SWOT Matrix (Source: Hay & Castilla,2006)
Strengths: Strengths deals with the strong point of the organisation which can in any form. This examines what are the resources which are strong enough and can be used to meet the target objective of the investment decisions.
Weakness: Weakness identifies the weak point of the organisation which can probably cause the negative effect on the outcomes and stand in between achieving the target objectives
Opportunities: The environment posses’ different opportunities associated with the decisions and can be exploited by the organisation to enhance its performance and achieve its objective
Threats: Threat deals with the devastating situation which can paralyze the whole company and leave it crippled
2.4 Risk Factors of IST Investment Decisions:
Managers recognize that IT investment decisions are one of the most riskier decision to made as decision occurs frequently, costly, significantly affect the firms performance, affect decision maker careers, and requires the assimilation and use of accounting information.(Rose and Norman,2004). Considering the risk associated and its adverse effects on overall organisation it is essential that management or decision makers identify the entire factor which posses risk to the investment decisions. While analysing return on any investment, it is essential that risk factors associated with it are considered. The best method to start the investment decision process is to start with identifying the risk factors associated with IST investment. The ROI analysis considers the risk as major component for analysis. Creswell (2004) has identified the following risk factors associated with the IST investment decisions.
Political and Policy Factors
Exposure to failure
Divided authority over decision
Annual budget allocation and policy of clearance
Highly regulated guidelines and level of decision making process
Lack of top management support
Misalignments of internal goals
Alignment of strategic objective of company
Business Process Factors
Impact of existing process
Allocation of Human and Financial resources
Rapid and continuous change in technology
Interacting with parallel system
Scale and Complexity
Table: Risk factors associated with IST investment (Adapted from Creswell, 2004)
While making risk analysis the managers and the concerned stakeholders are required to analyse following questions
What are the potential risks associated with projects?
How these risk factors will affect the planning phase of investment?
How these factors will have affect on the return on investment in both tangible and non-tangible aspect?
How these factors have affect on achieving target objectives?
The reason why risk factors are keen area of interest for managers while making investment decision is due to it riskier nature than compare to other investment. This increase in risk is due in part to the fact that technology components are comparatively fragile, easily sabotaged by employees and usually decentralised which leads to increased difficulties in IT design, development, management and protection (Schneiderjans and Hamaker, 2004). The authors have classified the risk factors in two broader classes which are
The physical risks are those associated with the hardware and software’s quality such as functionality, efficiency, compatibility, security etc. This identifies the vulnerability of computer hardware and software to data theft and data security laps.
The managerial risk are the one which is mainly associated with failure to achieve anticipated benefits from IT/IS investment which might be in terms of cost reduction, operational efficiency of failure to complete the project on time. There are so many cases where the investment doesn’t complete on time which leads to cost overrun or has to be abandoned in the later phase due to the lack of implementation strategy especially due to resistance from end users. This research focuses more on the managerial risk factors because it is very crucial for managers to identify these factors and take into accounts before making decisions.
The another major risk factors which are referees as the systematic risk or unseen and unfamiliar risk to the managers which have similar impact on the overall industry or nation. There are often cases where the technology invested becomes obsolete by the time implementation is started at the end user level which is due the fact paced changes and development in technology (Clemens and Webber,1990). The current scenario of economic recession can have the global impact on the firms where major projects have been discontinued instead of high investments. The electronic identity card project has been currently discarded by the new government under the budget spending cuts which was heavily invested in the tenure of previous government. These systematic risk factors are very difficult to identify as they don’t have any definite source but efficient and timely management decision can help to minimise the effect of the systematic risk factors.
From above analysis it can be concluded that identifying risk factors are crucial before making investment decisions because these are associated with probability of any incidence occurring in future. The case studies or ERP implementation suggest that in spite of heavy investment from the organisation on revamping a whole business process, due to the lack of training and development program at end user level, the software is unable to provide expected results. These factors posses’ opportunity as well as limitation to investment decision which can be minimised by implementing the best methodologies. Another factor is the type of organisation we are discussing about because the factors affecting the public company and private firm can be entirely different. In terms of policy and procedures, the private firms are more flexible compare to the public firms while resource limitations can be major threat to the private firms which can be easily available at public firms. Thus managers need to make a detailed study of the objectives of IST investment, the factors i.e. environmental factors and identify the best fit methodology to analyse investment decisions.
2.5 Return on Investment (ROI) analysis of IST Investment decisions:
Return on Investment on IST has been always a great area of interest for researchers from the earlier days mainly due to the different results are observed throughout the history of investment. In compare to other investment the return on IST investment has been a great subject of debate as said by Nobel-prize winning economist Robert Solow who wrote “We see the computer age everywhere except the productivity statistics” (Dehning and Richardson, 2002). This was great question mark on the return on IST investment which early literature states that there is no significant relationship between the investment and return famously known as Productivity paradox (Brynjolfsson, 1993) that analysed the research to analyse return on investment in Information system or technology.
2.5.1: The Productivity Paradox:
The financial returns on the investment in information technology is one major area of research in IS with a debate on methodologies of quantifying these non-tangible return in accounting approach. In early 1990s the researchers found the productivity paradox with IST investment which showed that zero or negative return on investment. The first level of productivity paradox was based on economy but it must be kept in mind that productivity are affected by various factors and cannot be blamed if the amount invested in technology are not part of it mainly because the share of investment in IT was quite minimal. The second level of productivity paradox which as at the company level and major concerns for IS researchers stated that “There was no correlation whatsoever between the expenditures on Information technology and any known measures of profitability”. But as the time passed and the impact of Information technology became more visible the research results started showing that there is positive relationship between the IT investment and return (Dewan and Min, 1997). Thus the questions changed from are there a pay-off to when and how there is a pay-off. To validate these adjustments Bryanjolfsson carried out a research in 1998 by analysing the various literatures available in the field of IST investment. He categorized the research into manufacturing and service sector. The conclusion drawn from the research was there was always a positive relationship between the investment and return but the major factor was how these research were carried out and how the variable were treated in order to justify the investment. The researcher found four major reasons for this productivity paradox which are mismeasurement of outputs and Inputs, lags due to learning and adjustments, redistribution and dissipation of profits and mismanagement of information and technology (Bryanjolfsson and Hitt, 1998). Thus it appears that the shortfall of IT productivity is as much due to deficiencies in measure and methodologies adapted.
2.5.2: Return on Investment Methodologies:
The above discussion on productivity paradox shows the significance of methodologies adapted by the managers or researchers to measure the return on investment in technology. The use of different accounting measures such as Return on Asset (ROE) or Return on Equity (ROE) on the same investment can draw different results while analysing return on investment. The another drawback is the lack of accountability of these traditional methodologies for the non-financial benefits which leads to the more less return than in actual. As most of the investment managers or Information technology managers make their decision based on these figures, it becomes very essential to analyse these methodologies to make a correct decision. The reason for growing interest in these methodologies is because the large sum of amount are being invested in such technologies by the firms and it requires a solid justification on such capital expenditures to the shareholders and other stakeholders of firm (Irani, 1999).The public announcement of such investment by corporate has always positive impact on the share value of the firm. Most common methodologies adopted by the different public and private sector firms are analysed in this section.
In spite of different methodologies developed by the researchers, there is often an confusion on selecting the best methods while making decision. The reason behind this is different methods are developed in different context which is difficult to be generalised though the major objective is to find the actual return on investment. As the amount of investment increases measuring pay off of investment becomes even more critical. The researchers have categorised ROI matrices in three broad categories which are profitability, productivity and consumer value (Hitt and Bryjolfsen, 1996).ROI analysis were mostly based on traditional appraisal technique such as Net present value (NPV) and Internal rate of return (IRR).These capital budgeting methodologies has their own limitation mainly in terms of lack of accounting time period and intangible (non-financial) benefits. They were based on past data and doesn’t incorporate factor which can possibly affect the analysis of return on investment (Kohli and shearer, 2002). Thus ROI measure solely cannot rely on the financial impact on bottom line of the company.
Few researchers have classified the appraisal technique into four approaches which are economic approach, strategic approach, analytical approach and integrated approach (Irani et al 1997).This has been referred as taxonomy of IT investment appraisal techniques.
Economic (Ratio based)
Return on Investment (ROI)
Cost Benefit analysis
Economic (Discounting Techniques)
Net present Value (NPV)
Internal Rate of Return (IRR)
Economic (Future value approach)
Real option pricing theory
Critical success factor
Application portfolio approach
Analytical approaches (Portfolio
Computer based techniques
Multi attribute utility theory
Scenario planning and screening
Table: taxonomy of IT investment appraisal techniques (Adapted from Khakasa, 2009)
All the above mentioned approaches with their respective techniques to evaluate return on investment have their own advantages and disadvantages. Thus it is difficult to implicate which one is superior to another or any single approach which justifies ROI completely. There is no silver bullet in this case. The interesting fact the researchers have found is decision makers often rely on methods which do not fall within the boundaries of formal investment appraisal methodologies because decision are mostly based on their personal feelings about the potential investment called as “Act of Faith” or gut instinct “(Bardhan et al 2004).But recent research states the managers and decision makers have been found using different methodologies while analysing investment portfolio to minimise limitation risk of each.
2.5.3 Research Finding:
Few research findings on analysis of ROI methodologies are examined below
The research carried out in 41 commercial banks of Kenya shows that ratio-based techniques (Economic approach) is mostly used by the respondents among which NPV and IRR are most famous one. The most adapted technique to analyse ROI is the risk technique (74%) and least used technique is computer based (4%).Balance score card is being used by 56% and 40% respondents chose information economics (Khakasa,2008). The research can be concluded that still the managers make their decision based on the traditional methodologies which may be due its straightforward nature of calculation and passed on from senior managerial level. The complexity of other methodologies might be limiting its uses instead of being more flexible to the change factors. This might be the case specific to Kenya where economy is comparatively behind and availability of human resource and current technologies might be limiting the use of modern approaches especially computer based techniques. The maturity in the market and level of competition can sometime define the risk of investment and in such case management need to more careful on selecting the best methodologies.
Another research carried out in the year 1992 shows a completely different result. Out of 80 respondents from 11 industries in USA, 84% of the respondents used the financial methods such as NPV and IRR to measure Return on Investment while very few focussed on the managerial or competetive implication of the business by the future investment in technologies. (Bacon, 1992). The above research was carried out in the 90s when the concept of productivity paradox was running through most of the researchers mind. This finding can be one of the basic reasons for such results because most of the calculations are based on the techniques which focussed more on set of datas and financial figures rather than non-financial and other benefits which were not able to justify the investment completely. Beside those were the days where the concept of investing in IST was gradually increasing and IT investments were considered more as of expenditures rather than investment on long term asset investment. The scenario of investment has completely changed and it has come a long way.
2.5.4. Critical Analysis:
As said above there is no silver bullet in the case of selecting ROI analysis methodologies. Beside the above literature review shows that adapting any of the methodologies doesn’t not justify the investment completely. The techniques used and approaches adapted by management depends upon various factors not only the financial criteria as it used to be in past. It is highly unlikely that any one methodology will cover all the criteria of ROI analysis and prediction of cost-benefit analysis will be at accuracy level as desired. Hence selecting any one of the approaches might be as incomplete analysis of ROI .Hence; it has to be multiple approaches practiced together depending upon the various factors identified such as integrated approach which combines the economic, strategic and analytical approach. Another conclusion drawn is the ROI analysis doesn’t depends on statistical figures completely. The various factors such as potential risk, enivronment factors need to be studied thoroughly to select the best options. The most important aspect is incorporating change factors in analysis which can be a critical factor in justifying the ROI. There are certain questions need to be answered before selection of methodologies
What are the strategic objectives of Analysis?
How significant is current IT investment on the overall enterprise i.e. holistic cost benefit analysis.
How can be best data and information collected to decide on analysis methodology which suits the strategic objective?
How ROI analysis fits in overall decision context of IST investment?
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