Comparative Methods for Advocating Information Technology Investments

Comparative Methods for Advocating Information Technology Investments

Anthony M. DiMarco
Executive Manager, Enterprise Professional Services
Intergraph Corporation

Abstract
Information systems can improve the quality and timeliness of decisions. Presented are several approaches to develop business justification for an AM/FM and related systems, of strategic importance to the utility industry in an era of increasing competition. This paper will address investment strategies advocated by EPRI (Electric Power Research Institute), examples of savings realized by utilities, and definition of terms for presenting a business case to executive management.

Introduction
As technicians, in our enthusiasm to improve on our current methods and business processes, and improve the efficiency of our companies, we often focus our efforts on selecting the right technology and then find delight in the technical details of implementing that technology in the appropriate areas of our businesses. This area of investigation, the selection and design of the right “tool”, is the realm of the engineer and computer scientist. However, the best technology will never be implemented in the practical world of the professional manager and utility executive without a clear and concise presentation of a sound business case for the investment.

Automated Mapping and Facilities Management, and Geographic Information Systems are no exception. In fact, due to the sizable costs normally associated with the conversion of the necessary data into a useable form for the system, AM/FM/GIS systems are large investments. An AM/FM/GIS is typically a major project expense that cannot be implemented using discretionary fimds hidden away in some department budget. In addition to the sheer size of the investment, the benefits have typically been difficult to quantifi and touted as intangible and strategic. This paper will review a basic approach for quantizing the usual tangible savings associated with the successful implementation of such systems, and present an interesting approach advocated by EPRI for quanti~ing the strategic benefits of such systems as a result of “improved managerial flexibility”. Undervaluing Information System Benefits

Computer and communications systems, and specifically AM/FM/GIS, must be used to improve current operations and serve an explicit strategic mission. The improvement in 315?current operations can be quantified, and some examples of what can be accomplished will be provided in the following sections. The notion that a system serves some explicit strategic mission leads to the fundamental problem of AM/FIWGIS systems justification. Economic evaluation based against a non-quantifiable goal, thus the benefit of the investment can be undervalued.

Information Technology (IT) investments provide cost reductions in the following ways. IT can decrease the entropy of existing work. In other words, IT can improve individual and group productivity by providing structure and efficiencies throughout the defined business process. In addition, IT can reduce the uncertainty of fhture outcomes by making the process predictable and consistent, thereby improving the quality of the end product or service. But perhaps most importantly, and most likely to be undervalued, is the ability of IT to increase management ability to adaptively respond. The idea of managerial flexibility, is the heightened ability of management to respond to changes in the environment, and to changes in the competitive playing field.

AM/FM/GIS Tangible Benefit Quantification
The tangible benefits of an AM/FM/GIS can be categorized as labor savings, outside cost reductions and asset utilization savings. Labor savings are the direct result of automation. Automation can be thought of as “doing things right”. By improving the efficiency of a given process, we can reduce the necessary labor, and reduce staffing requirements to achieve savings in productivity. Outside cost reductions are savings as a result of the elimination of direct costs to external agencies. Outside cost reductions might include the elimination of external document reproduction costs or other supplies or services required in the current process. Asset utilization savings are the benefits that the IT investment provides evidenced by improving the ability to more effectively utilize existing investments in plant capacity. An example of asset utilization savings might be the ability for an electric utility to meet load growth with its existing distribution facilities and forego additional construction expenditures, all as a result of better engineering analysis of the distribution system as enabled by the IT investment.

Typical AM/FM/GIS System Cost Benefit Analysis
For atypical AM/FM/GIS system in an electric or gas utility serving 1 million customers, the costs for a system might be in the range of $2 million for the base hardware and software, $500,000 for software configuration, application customization and interfaces, and perhaps $10 million for complete data conversion. This system could cost in the range of $12.5 million to implement, not counting training cost% other costs Of ch~ge management and the recurring cost of maintenance, software support and enhancement. 316?Data conversion is still the largest part of the investment and growing as a percentage, as hardware, software and commercial-off-the-shelf (COTS) software becomes more available at a lower cost.

The benefits for that same utility, based on benefits achieved in other typical installations, might break down as a direct labor reduction of 50°/0 in the personnel responsible for maintaining the facility records, with significant reductions of 50°/0 or more for the time spent by larger numbers of personnel who access and utilize the information. In a typical utility of this size, as many as 25 draftsman might be displaced and as many as 250 people might be impacted by the system, affecting 50% of the 10% of their time spent retrieving and using records, for a net overall 5°/0reduction. Using loaded salaries of $50,000, the real labor savings could be as high as $1,875,000 annually.

In addition, a typical utility distributes maps electronically can eliminate the outside costs for map microfilming, and paper and supplies for map reproduction and distribution. Typically, hundreds of thousands of copies of maps are reproduced and distributed annually. The materials costs and reduction in outside costs can exceed $100,000 annually.

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