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com
T Th he e V Va al lu ue e o of f I IT T: :
H Ho ow w E Ec co on no om mi ic cs s c ca an n h he el lp p I IT T M Ma an na ag ge em me en nt t

I In nt tr ro od du uc ct ti io on n
Recently there was a question on LinkedIn.
If IT is an asset, how do you measure its net return?
Do you see how it improves company performance? Do you know how to actually show a profitable
return on IT assets during and after it has been deployed?

This serves as an excellent example of how common thinking about business and economics
can lead to confusion. Clearer thinking about economics can help managers solve this problem.
The question is an important one. The question clearly shows awareness that a firm needs a
return on its assets. However the full question is in a sense wrong, its assumptions can lead one
astray.

Two key principles of Austrian Economics apply:
Subjective Value
Marginal Utility

Other important insights are:
Assets are not homogenous.
Assets are part of a larger chain of production.

You cannot truly measure an Information Technology Departments net return in isolation. This
is because IT is part of a larger chain of production that generates a return. IT is also not a
homogenous asset. It contains different parts, which may or may not be utilized by different
parts of the firm.

The larger question though is important. How can you show that IT improves performance?

The first step is to grasp is that IT is part of a larger chain of production. Lets call these
individual chains within the firm business processes. The business processes use assets to
generate cash. Profitable processes generate more cash than they use. Each business process
utilizes many assets, including inventories, capital goods, buildings, IT and telecom equipment,
salaried labor, etc. which are basically sunk costs. On their own the assets dont generate
revenue. People had to assemble to assets to create the business process and then they have to



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actually do the work required to generate revenue. The business process is what generates the
net return on assets, not the assets themselves. Many of individual assets may absolutely be
necessary, just as removing one cog from a mechanical watch may cause it to fail. Without IT
for example communication with the customers and suppliers may fail. IT may be a necessary
but not a sufficient condition of firm performance. It is the business process as a whole that
must generate a return on all the component assets.

U Un nd de er rs st ta an nd di in ng g E Ex xi is st ti in ng g B Bu us si in ne es ss s P Pr ro oc ce es ss se es s
We understand that assets are not homogenous and assets are part of a larger chain of
production. The next step then is to understand the actual business processes in use. (Map
them out.)

We now have to ask how is each IT asset serving the different business processes? Subjective
value now comes in to play. Basically one maps IT to the business processes. Those responsible
for each business processes can then determine the return on all underlying assets.

Corollary:
If an IT asset isnt serving a business process then a return is not being generated by it and it
can be sold, released, or re-allocated. Problem solved for that asset.

M Ma ar rg gi in na al l U Ut ti il li it ty y
Weve taken care of all the assets that arent being used and arent generating a return. How do
we deal with the rest? We ask what is the marginal utility of any change?

With any asset there are several options:
Keep stable
Add / Upgrade (technically you may not be changing an asset but adding another one.)
Remove (sell / release)
Re-allocate (change its usage)
Remember that in many cases assets are a sunk cost. You cant measure a change in return
from keeping an asset, thats part of a business process, which is stable. However IT can
measure the return of marginal changes. Therefore this part of the question can be answered,
but only in regards to marginal changes:

Do you see how it improves company performance? Do you know how to actually show
a profitable return on IT assets during and after it has been deployed?

Corollary:



Berlin Pacific Vendor Management 212-247-2502 sales@berlinpacific.com
In some cases we can sell an asset that is a sunk cost and replace it with something else for less.
Sometimes the asset is undesirable to others so one might as well use it. Theres an opportunity
cost for no utilization.

Shared Assets
What if an IT asset is shared among multiple business processes? This is where marginal utility
comes in to play. When an asset is shared it cant be mapped directly 1 to 1 to a business
process. It supports multiple business processes. Usually one can get a sense of what percent of
capacity supports each business process utilizes. One can look for marginal returns by either
adding, selling, removing, or re-allocating:

Making sure capacity is allocated to the highest value uses / business processes. (Minimizing
opportunity costs.)
Adding capacity if this will enable a business process to make more money. (Measuring the
return of net marginal sales after net marginal costs vs. additional investment.)
Reducing capacity if excess capacity can be sold, or future costs avoided, without decreasing
service levels to business processes present and future needs.

Improving Existing Business Processes
As we noted performance improvements are marginal. Theyre in addition to what is already
happening today. When making new a IT investment or re-allocating resources one has to show
- How did this enable a business process to make more money? In fact it is the other way
around business process improvements must be found that generate an ROI, a Return on
Investment. This ROI then justifies the purchase of additional IT and other assets. The cost of
the new IT assets is added in with the cost of all the other additional assets. The marginal return
of the improvement to the business process is then measured to find a return on assets and
ROI. (In some cases this may be difficult if multiple improvements occur the entrepreneurs
art is to judge there are improvements without being able to measure each one.)

Corollary:
IT managers who want to add value will have to understand the business processes they
support. Theyll need to be able to see how IT enables business processes and marginal
improvement to profitability. Similarly business managers have to understand the nature of
their IT and other assets currently available internally or for purchase and how they can
improve the business.

Example:
A large firm has many highly paid and productive employees who do all their work over the
network. The network goes down frequently. All employees now have nothing to do, and the
company loses their output and labor. The question becomes what is the marginal increase in
worker productivity and profits if the network doesnt go down and what do we value it at.



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This assumes we understand the nature of the business process and the cost of it being idle.
Without this it becomes difficult to justify further investment.

If this figure is $1,000,000 a year in lost net profit (sales variable cost 0 change in operating
expenses) then there is a very high return investing $100,000 in improvements that actually
reduce downtime substantially. A low margin business process will see a huge percentage
increase in profits from decreasing substantial downtime as return on assets increases. If the
opportunity cost is only $10,000 then finance will probably decide it is not worth investing
$100,000 in IT for this marginal improvement.

New Business Processes
New business processes are a marginal change to the firm. When designing the business
process from scratch people need to determine all the assets needed and their costs. People
can use value engineering to determine means of cost reduction without compromising the
quality and functionality of the business process. There can be multiple objectively different
ways to reach what is subjectively the same result, and the least expensive one can be chosen.
This is similar to improvements to business processes and the corollary applies here too.

Maintenance
In many cases for IT systems to function they must be maintained. This is an ongoing cost and
different from an asset, which is a sunk cost. On the one hand the ongoing cost of maintenance
can be simply eliminated, while an asset generates no costs. On the other hand, in real life
many IT employees doing maintenance are essentially sunk costs as they cant be hired on
demand but must be paid regularly to stick around.

IT employees doing maintenance work, must therefore also be treated as assets and mapped to
business processes.

Note on Value
You have to know not just the price of everything, but the value as well. Value must exceed cost. Sometimes value
is measurable in dollar terms, sometimes it is a judgment call by management. (An example judgment call: if
employees feel less frustrated and less demoralized because IT systems just work it may be worth spending more
even if productivity wouldn't be clearly or measurably affected because employees could route around the issue,
or the downtime doesn't affect profits directly.)

Examples
An IT admin is paid to make sure a key system that backups and stores everyones files does not
go down, as most people would be unable to work and sales and fulfillment would suffer. Since
the IT admin is part of keeping a key business process running it does not matter how much
work or how little work the IT Admin does, as long as the business process does not go down.
The return is generated by the business process as a whole and any downtime decreases the
return as a whole. If the IT Admin is able accomplish this in one hour a day or twelve it does not
impact return. To increase the return, the IT admin would have to enable another business



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process. (However one wouldnt want her to be overworked and unable to respond to
emergencies.)

A trading desk may have a very high opportunity cost for downtime. If a traders computer
crashes preventing buying and selling, this could cost the firm a lot of money. Therefore
spending extra to make sure the traders PCs always work makes sense. The marginal cost is
outweighed by the opportunity cost.

One can imagine an employee who maintains systems flawlessly that arent very important
anymore to the business, or the systems can go down because of redundancy, or it can lose
performance because it has overcapacity. Increasing the performance of a system or process
with excess performance is a waste.

Conclusion
To measure the return on an asset like IT one must do several different things.
Recognize that IT assets are not homogenous.
Recognize that IT assets are part of a larger chain of production, or business process.
Understand what the business processes are and their components and the return each process
generates.
To increase the return on IT one must take in to account:
Subjective Value the value of IT is not objective or inherent in itself, it is based on how it serves
business needs or goals and relates to the organization.
Marginal Utility increasing return can only be done through marginal changes that create
utility. Doing the same thing wont increase returns, as return all else being equal is stable.
Therefore one needs to approach increasing returns on IT as a change process. Individual
marginal changes subjectively add value to the business. Changes can include investing in new
assets, re-allocating assets, or selling or releasing assets. Each of these changes though must be
done with an understanding of how they affect the business and add value. The anticipated
cost of each marginal change can then be compared against the anticipated marginal profit the
change makes possible. Later the decision can be validated, and the return and performance
improvement can be measured.