Comparative Methods for Advocating Information Technology Investments
Most importantly, the improved utilization of existing assets can be a very significant
figure. That same utility, through improved engineering methods, can demonstrate a
direct link between improved engineering methods and the ability to defer feeder,
substation or main construction. A small achievable decrease of 2°/0 in a capital budget of
$25 million represents $500,000 annually. This is in addition to savings in line losses,
where some utilities of this size have documented reductions of 3. 5°/0,resulting in savings
approaching $1 million annually.
As opposed to cost savings, the potential to increase revenue needs to be considered in
economic evaluation. The application of the system to assist in targeted marketing
programs and improved ability to attract new commercial customers to the service
territory provides possible new sources of revenue. Every new commercial customer
could represent an increased revenue stream of $100,000 annually. Could this system
improve the chances of attracting even three additional customers per year, for a revenue
increase of $300,000 per year, with the benefits recurring annually once that customer is
on the system?
Taken together, the $12.5 million investment can be demonstrated to pay back in
approximately four years after completion. The more typical analysis is to calculate the
Internal Rate of Return (IRR) for the project. Making some assumptions regarding the
overall project time frame and the phasing of benefits, the IRR for this project could be
demonstrated to be as high as 15%. This may still not be a high enough return to pass the
internal project “hurdle rate”. This is depicted in the attached following figure.
“Informate” versus “Automate”
Historically, technology has been seen as a substitute for human labor. Managers have
believed that more technology means fewer people needed. The smarter the technology,
the dumber the people could be. This was believed to fi.uther reduce labor costs. But
technology can not only automate, it can “informate”. The term “informate” has be
attributed to Prof. Shosana Zuboff of the Harvard Business School. Inforrnating occurs
when the process originally intended to be automated is turned into data. As automation
occurs, a parallel information stream is generated. This data stream invites interpretation
of the data for other uses. The information stream supports people gaining new insight to
the process and new ways of operating can be created. The automation and information
gained creates new learning opportunities for the organization.
The paradox is the urge to automate has resulted in the opposite of the historically
intended effect of automation. Firms must meet requirements for smarter workers now
making their own decisions at the source of the data. The inforrnating process results in a
de-stabilization of the hierarchical structure of most firms. The most visible change due
to IT is the inevitable “flattening” of the corporate hierarchy.
Benefits of Managerial Flexibility
The organizational effects make economic evaluation more difhcult. Technology cannot
be viewed on a one-for-one direct substitute for labor. The inforrnating potential of the
IT investment must be economically evaluated, yet standard economic evaluation
methods cannot be readily applied.
The value of managerial flexibility, and a strategy for quantification in the organization,
is an area addressed in the EPRI funded Report TR- 100233 “Advocating Investments in
Information Technology”. Of several approaches included in the research, one of the
more interesting approaches suggested is to apply Option Pricing Theory (OPT) to real
IT investments to enable the direct quantification of important types of managerial
flexibility. The key concept of applying OPT to a project like AM/FM/GIS is that any
investment can be considered an option on the future value of the completed project. Any
investment can be structured in stages. Completion of stage one gives the right, but not
the obligation, to continue investing in future stages. Each stage, in a series, is an option
on an option. This series is called a compound option. The derivations of the
mathematics are complex, but are provided in the EPRI report in Section 5.5, with a few
very simple examples of how this might be applied to a real world IT investment ROI
(Return on Investment) presentation. For those interested, I would recommend a detailed
review of the EPRI work. It’s interesting, but heavy reading.
While the Option Pricing Theory approach is an intriguing concept, most executives and
engineering managers to whom cost justifications will be presented will have been
schooled in the traditional approached to economic justification, or Net Present Value
318?(NPV) methods, as taught in schools for the past thirty years. These methods have been
derived from Industrial Engineering and Engineering Economics methods applied to
manufacturing projects. The emphasis of these methods has been on automation. Option
Pricing Theory is intriguing, but the newness of the methods, and the complexity of the
derivation, make it less useful for cost benefit presentations today given the intended
audience.
Conclusion
The presentation of a business case for an AM/FM system is a formidable task. The
benefits of automation alone may not be sufficient to provide a solid business case for the
investment. A usefhl concept is that of managerial flexibility and the benefits of
“informating”. The benefits of “informating” versus “automating” are well known by all
whom have presented business cases in the past, although the term “informating” may not
have been used. Often, the benefits of informating have been categorized as strategic for
lack of a better term. Attempts by EPIU to develop methods to quantifi managerial
flexibility and the result of informating has resulted in some interesting Option Pricing
Theory applications, but the complexity and uniqueness of the approach is unlikely to be
accepted by most executives and engineering managers schooled in the traditional
Engineering Economic principals. The informating concept, however, is inherently
appealing, and together with the more tangible examples provided here, may provide
insight for those preparing a business case for IT investments and AM/FM/GIS in today’s
business climate.
Figure A - Sample Cost Benefit Analysis for XYZ Utility Company
