online file w14.1 nucleus research’s roi...

Chapter Fourteen: Economics and Justification of Electronic Commerce 14-1

Online File W14.1 Nucleus Research’s ROI Methodology

ROI is best used when comparing potential EC projects with other internal projects and success factors—not with those ofother companies. It also is important for a company to develop a standard methodology and make it part of every technologyreview and investment.

The ROI CalculationTo compute ROI for 1 year, divide the year’s net benefits by the initial cost of the project and multiply that by 100.For instance, if a project initially cost $50 and returned $100 in net benefits (benefits minus costs), then the ROI in thefirst year would be (100 ÷ 50) × 100, or 200 percent. However, technology rarely recovers its costs in the first year; moreaccurate calculations use a 3- or 5-year horizon. With a 3-year horizon, the ROI calculation is the average net benefitsper year divided by 3. This is then divided by the initial cost and multiplied by 100:

ROI � (((Net year 1 + Net year 2 + Net year 3) / 3) / Initial cost) × 100

An average ROI calculation yields numbers that are directly comparable with those one would find with othercorporate investments, the cost of capital, or a simple bank certificate of deposit.

Payback PeriodIn many cases, the payback period may be more important than the ROI. Payback period provides an indication of riskand offers insight into the company’s flexibility. Payback period is the point in time at which total benefits equal totalcosts. Let’s look at an example. Say that the initial cost of a project is $600 and that the net benefits are as shown in thefollowing table:

Year 1 Year 2 Year 3

Net benefit � $200 Net benefit � $300 Net benefit � $300

In the first year, the company spent $600 but got $200, so it is out $400 at the end of the year. In the second year,it makes $300, but it is still short $100. It takes half of the third year to cover the $100, resulting in a payback period of2 years.

Why is payback important? Consider the following scenario: You’ve just deployed the perfect Web site with e-commercelinks to all your legacy systems. It took you a year’s time and significant costs, but you have beaten everyone else to themarket. Your 3-year ROI will be 1,000 percent, but the payback period is 2 years, meaning that you will not cover your costsfor some time. What if someone develops a new development tool that allows you and the competitors to create a betterapplication in a much shorter time? You know you should use this tool to redesign your site, but you still have not coveredyour initial costs.

No matter how attractive the ROI and how good the NPV, long payback periods are not preferable because technologychanges quickly. One should be flexible enough to discard a technology decision when a superior solution comes along.

CostsGathering cost information usually is easier because most companies know what they have spent or are planning to spend.To ensure that the company gathers the right costs:

◗ Count everything that is directly associated with the project (e.g., purchase of a new server).◗ Do not count infrastructure items not associated with the project (e.g., leveraging the existing network servers).◗ Count infrastructure items that were driven by the project (e.g., the company purchased a server because of this project

and two others like it; therefore, prorate and include one-third of the costs).

Direct BenefitsBenefits are either direct or indirect. Direct benefits include items such as decreased paper costs, reduced accounts receivable,reduced use of express mail, reduced or reassigned staff, sales of old hardware, and so on. These are tangible savings. Savingsmay be one time (e.g., reduced personnel) or recurring. Recurring savings should be included in every year’s computation.

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14-2 Part 6: EC Strategy and Implementation

Online File W14.1 (continued)

Indirect BenefitsIndirect benefits can also be somewhat intangible. For example, indirect savings may include reducing the time needed totest new software by 25 percent. If you expect the company to increase sales by 10 percent because of a new sales supportsystem, do not include both the profit on the increased sales and the value of your salespeople becoming 10 percent moreefficient. You should reasonably expect that the increased salesperson efficiency causes the increase in profit. It is alwaysbetter to count the more direct result (profit) rather than the indirect result (increased productivity).

The following are some guidelines in assessing the value of an indirect benefit:

◗ Measure or estimate the expected change in time or productivity. For example, if you estimate that 1,000 employees eachwill save 10 minutes per year, the change in productivity is 166.6 hours.

◗ Correct this amount based on the inefficient transfer of time. For example, if you save an hour, the employee may workonly an additional one-half hour. Therefore, the correction factor is 0.5 hour.

◗ Multiply the gain by the fully loaded cost of an employee (including retirement benefits, vacation, insurance, etc.) to calcu-late the value of the benefit. If you are using multiple loaded costs, do this calculation for each category of employee.

◗ Reducing costs often looks better on paper than in reality. After implementing the project, go back and look for a corroboratingmeasurement. For example, if you estimated the legal department would save 10 percent of their time, then you would try todetermine the following:◗ Did the legal department reduce its staff by 10 percent?◗ Did the legal department’s expenditures grow at a rate slower than the rate for the rest of the organization?◗ Are the lawyers 10 percent more productive?

If any one of these is correct, your initial estimate was correct.

Calculating ROI and Other MetricsCalculate the net values at the initial year and for each subsequent year. Calculate the ROI using the formula presentedearlier:

ROI � (((Net year 1 + Net year 2 + Net year 3) / 3) / Initial cost) × 100

The payback period is a little more difficult to calculate, but as mentioned earlier, it is a very important indicator ofrisk. Follow the formula presented earlier. However, automated ROI calculators make it easier to change assumptions andrerun the analysis.

Formulas for NPV Analysis

Where n � number of years and i � interest rate for investment (cost of capital). It is also known as the discount rate.The PV factor is then multiplied by the future amounts to figure its value today, and compared to the discounted cost overthe same periods to compute the NPV.

Where:

t � specific year: 1, 2, etc.T � project life (e.g., 5 years, 10 years, etc.)i � interest rate (discount rate)A � income at period tC � initial investment, or PV of all investments over T.

Sources: Adapted from the ROI Knowledge Center at nucleusresearch.com (accessed March 2009) and from baselinemag.com (accessedMarch 2009).

NPV = aT

t= 1

At11 - i2t

- C

PV = 1

11 - i2n


REFERENCES FOR ONLINE FILE W14.1Baseline. baselinemag.com (accessed March 2009).

Online File W14.2 Handling Intangible Benefits

The following are suggestions about how to handle intangible benefits.

◗ Think broadly and softly. Supplement hard financial metrics with soft ones that may be more strategic in nature and thatmay be important leading indicators of financial outcomes. Measures such as customer and partner satisfaction, customerloyalty, response time to competitive actions, and improved responsiveness are examples of soft measures. Subjectivemeasures can be objective if used consistently over time. For instance, customer satisfaction measured consistently on a5-point scale can be an objective basis for measuring the performance of customer-facing initiatives (Lu 2007).

◗ Pay your freight first. Think carefully about short-term benefits that can “pay the freight” for the initial investment inthe project. For example, a telecom company found that it could justify its investment in data warehousing based on thecost savings from data mart consolidation, even though the real payoffs from the project would come later from increasedcross-selling opportunities.

◗ Follow the unanticipated. Keep an open mind about where the payoff from IT and e-business projects may come from,and follow opportunities that present themselves. Eli Lilly & Co. created a Web site called InnoCentive (innocentive.com)to attract scientists to solve problems in return for financial rewards (“bounties”). In the process, Lilly establishedcontact with 8,000 exceptional scientists, and Lilly’s HR department has used this list of contacts for recruiting.

◗ Prioritize the benefits. Some benefits are more significant than others. Try to rank them or set weights on them. Notethat the priorities may change over time and across applications.

◗ Intangible costs. Make sure to investigate the intangible cost as well. These may be interfering with production, makingsome employees unhappy, or creating conflicts with distributors.

Sources: Compiled from Lu (2007), Standing and Lin (2007), and Devaraj and Kohli (2002).

REFERENCES FOR ONLINE FILE W14.2Devaraj, S., and R. Kohli. The IT Payoff: Measuring Business

Value of Information Technology Investment. Upper SaddleRiver, NJ: Financial Times Prentice Hall, 2002.

Lu, J. “A Model for Evaluating E-Commerce Based onCost/Benefit and Customer Satisfaction.” InformationSystems Frontiers, 5, no. 3 (September 2007).

Standing, C., and C. Lin. “Organizational Evaluationof the Benefits, Constraints, and Satisfaction ofBusiness-to-Business Electronic Commerce.” Journalof Electronic Commerce, 11, no. 3 (Spring 2007).

Nucleus Research. ROI Knowledge Center at nucleusresearch.com/tutorial.html (accessed March 2009).


Online File W14.3 Issues in Implementing Traditional Justification Methods

Business ROIWhen conducting cost–benefit analyses, it is advisable to distinguish between business ROI and technology ROI (see alinean.com/P_ROIcalculator.asp).

Business ROI relates to the EC investment benefits incurred for the improvement of the business and its operations,such as:

◗ Improved user ability to access all the resources to deliver key business processes◗ Streamlined and lower costs of business processes both inside and outside the organization◗ Collaboration by people across locations to gain operational efficiencies◗ Embedded training within the EC application to ensure organizational compliance◗ Increased satisfaction among users as well as partners◗ Transformation of the organization by streamlining access to information and automating processes such as online filing

of expense statements, ordering office supplies, and making travel arrangements

Here is a simple example of computing business ROI.

Example: ROI for Coffeehouses’ and Restaurants’ Wi-FiAs of 2006 a large number of coffeehouses and restaurants were installing Wi-Fi hotpoints for their customers. Notablewere Starbucks and McDonald’s (Chapter 7). Does it really pay off (especially when it is provided for free)? Spark (2006)cites the following two examples:

Schlotzsky’s, owner of 600 deli restaurants, installed free hotspots in 30 of their restaurants in 2004. For those30 restaurants, the company figures that 6 percent of customers come for the free access and free computers. As a result,Schlotzsky’s estimates that in-store computing generates 15,000 additional customer visits a year. With customers spend-ing an average of $7 per visit, that’s more than $1 million in revenue per store per year.

Dan Welch, who owns three World Cup Coffee shops in Portland, Oregon, estimates that his free Wi-Fi network hasadded 10 percent to his overall revenue. Welch credits Wi-Fi consumers with spending three times as much on foodcompared with the average consumer. (Note: To find these free Wi-Fi places, enter jiwire.com.)

Technology ROITechnology ROI relates to the EC investment benefits incurred by improvements in the integration of technology and itsdeployment, such as:

◗ Architecture that supports continued growth and proliferation of an EC project throughout the organization◗ Simplified purchase, use, and deployment of technology◗ Establishment of an open development environment to ensure seamless integration and access to information◗ Embedded collaboration across all of an organization’s applications◗ Reduced complexity of managing content, applications, infrastructure, and stand-alone tools

Usually, several EC and IT projects share technology ROI, so it is difficult to allocate costs to specific EC projects.Technology ROI is often ignored in traditional ROI analysis, where the focus generally is only on the business ROI.Although the business case and ROI must drive the decision-making process, the technology ROI constitutes the evalua-tion of soft costs, which, if ignored, can bias the business ROI. Without the rigor of analysis offered by ad-hoc ROI calcu-lators, EC projects may not live up to the scrutiny of financial experts.

REFERENCE FOR ONLINE FILE W14.3Spark, D. “ROI for Coffee House Wi-Fi.” CareFreeWiFi,

January 19, 2006. carefreewifi.ca/WiFi ROI.htm (acces-sed March 2009).


Online File W14.4 Advanced Methods for Justifying EC and IT InvestmentsValue Analysis

Keen (1981) developed the value analysis method to assist organizations in evaluating investments in decision support systems(DSSs). The major problem with justifying a DSS is that most of the benefits are intangible and not readily convertible intomonetary values. Some—such as better decisions, better understanding of business situations, and improved communication—are difficult to measure even in nonmonetary terms. These problems in evaluating DSSs are similar to the problems in evaluat-ing intangible benefits for other types of systems. Therefore, value analysis can be applied to several types of IT and EC invest-ments in which a large proportion of the added value is derived from intangible benefits. The value analysis approach includeseight steps, grouped into two phases.The steps of the value analysis approach are shown in Exhibit W14.4.1.

In the first phase, the decision maker identifies the desired capabilities and the (generally intangible) potential bene-fits. The developers estimate the cost of providing the capabilities; if the decision maker feels the benefits are worth thiscost, a small-scale prototype of the DSS (or another IT application) is constructed. Then, the prototype is evaluated.

The results of the first phase provide information that helps with the decision about the second phase. After usingthe prototype, the user has a better understanding of the value of the benefit, and of the additional features the full-scalesystem needs to include. In addition, the developers can make a better estimate of the cost of the final product. The ques-tion at this point is: What benefits are necessary to justify this cost? If the decision maker feels that the system canprovide these benefits, a full-scale system is developed.

Though it was designed for DSSs, the value analysis approach is applicable to any information technology that can betested on a low-cost basis before deciding whether to make a full investment. The current trend of buying rather than devel-oping software, along with the increasingly common practice of offering software on a free-trial basis for 30 to 90 days,provides ample opportunities for the use of this approach. Organizations may also have opportunities to pilot the use ofnew systems in specific operating units and then implement them on a full-scale basis if the initial results are favorable.For further discussion, see Fine et al. (2002).

Information EconomicsThe information economics approach is similar to the concept of critical success factors in thatit focuses on key organizational objectives, including intangible financial benefits, impacts onthe business domain, and impacts on IT itself. Each of the key organizational objectives hasseveral components. In addition, more metrics can be added (see McKay and Marshall 2004).Information economics incorporates the technique of scoring methodologies, which are used inmany evaluation situations.

Scoring MethodologyA scoring methodology evaluates alternatives by assigning weights and scores to various fac-tors and then calculating the weighted totals. The analyst first identifies all the KPIs andassigns a weight to each one. Each alternative in the evaluation receives a score on each factor,usually between 0 and 100 points or 0 and 10 points. These scores are multiplied by the weight-ing factors and then totaled. The alternative with the highest score is judged the best (or pro-jects can be ranked, as in the ROI Iowa closing case (p. 621)). Then, one can perform sensitiv-ity analysis to see the impact of changing the weights.

The information economics approach uses organizational objectives to determine which fac-tors to include and what weights to assign in the scoring methodology. The approach is flexible

Identify value(intangible benefits)

Establish maximumcost willing to pay

Build prototype ifcost is acceptable

Evaluateprototype

2 3 41Phase 1

Phase 2

Enhance functionalityof full-scale system

Build full-scalesystem if benefits

justify it

Identify benefitsrequired tojustify cost

Establish cost of full-scale system

7 6 58

EXHIBIT W14.4.1

information economicsAn approach similar tothe concept of criticalsuccess factors in that itfocuses on key organiza-tional objectives, includ-ing intangible financialbenefits, impacts on thebusiness domain, andimpacts on IT itself.

scoring methodologyA method that evaluatesalternatives by assigningweights and scores tovarious aspects and thencalculating the weightedtotals.

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enough to include factors in the analysis such as impacts on customers and suppliers (the value chain). Executives in an orga-nization determine the relevant objectives and weights at a given point in time, which are subject to revision if there arechanges in the environment. These factors and weights are then used to evaluate IT alternatives; the highest scores go to theitems that have the greatest potential to improve organizational performance. Note that this approach can incorporate bothtangible and intangible benefits. If there is a strong connection between a benefit of IT investment (such as quicker decisionmaking) and an organizational objective (such as faster product development), the benefit will influence the final score even ifit does not have a monetary value. Thus, the information economics model helps solve the problem of assessing intangible ben-efits by linking the evaluation of these benefits to the factors that are most important to organizational performance.

Approaches like this are very flexible. The analyst can vary the weights over time; for example, tangible benefits mayreceive heavier weights at times when earnings are weak. The approach can also take risk into account by using negativeweights for factors that reduce the probability of obtaining the benefits.

Most information systems projects are not stand-alone applications. In most cases, they depend on enabling infra-structures already installed in the organization. These infrastructure technologies include mainframe computers, operat-ing systems, networks, database management systems, utility programs, development tools, and more. Because many ofthe infrastructure benefits are intangible and spread over many different present and future applications, it is difficult toestimate their value or to evaluate the desirability of enhancements or upgrades. In other words, it is much more diffi-cult to evaluate infrastructure investment decisions than investments in specific information systems application projects(see Lewis and Byrd 2003). Two methods are recommended for evaluating infrastructure investments: benchmarks andmanagement by maxim.

Using Benchmarks to Assess Infrastructure InvestmentsOne approach to evaluating infrastructure is to focus on objective measures of performanceknown as benchmarks. These measures often are available from trade associations within anindustry or from consulting firms. A comparison of measures of performance or of an organi-zation’s expenditures with averages for the industry or with values of the more efficientperformers in the industry indicates how well the organization is using its infrastructure.If performance is below standard, corrective action is indicated. The benchmark approachimplicitly assumes that IT infrastructure investments are justified if they are managed effi-ciently. Benchmarks come in two very different forms: metrics and best-practice benchmarks.

Metric benchmarks provide numeric measures of performance; for example: (1) ITexpenses as percent of total revenues, (2) percent downtime (time when the computer isunavailable), (3) central processing unit (CPU) usage as a percentage of total capacity, and(4) percentage of IS projects completed on time and within budget. These types of measuresare very useful to managers, even though sometimes they lead to the wrong conclusions. Forexample, a ratio of IT expenses to revenues that is lower than the industry average may indi-cate that a firm is operating more efficiently than its competitors. Or it may indicate that thecompany is investing less in IT than it should and will become less competitive as a result. Metric benchmarks can helpdiagnose problems, but they do not necessarily show how to solve them. Therefore, many organizations also use best-practice benchmarks.

With best-practice benchmarks, the emphasis is on how information system activitiesare actually performed rather than on numeric measures of performance. For example, anorganization may feel that its IT infrastructure management is very important to its perfor-mance. It could then obtain information about best practices on how to operate and manageIT infrastructure. These best practices may be from other organizations in the same industry,from a more efficient division in its own organization, or from another industry entirely. Theorganization would then implement these best practices for its entire IT infrastructure tobring performance up to the level of the leaders.

Management by Maxim for IT InfrastructureOrganizations with multiple business units, including large, multidivisional ones, frequently need to make decisions about theappropriate level and types of infrastructure that their individual operating units will support and share. These decisions areimportant because infrastructure can amount to more than 50 percent of the total IT budget and because it can increase effec-tiveness through synergies across the organization. However, because of substantial differences among organizations with

benchmarksAn approach to evaluatinginfrastructure that focuseson objective measures ofperformance.

metric benchmarksA method that providesnumeric measures ofperformance.

best-practicebenchmarksBenchmarks that empha-size how informationsystem activities areactually performed ratherthan on numeric measuresof performance.

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regards to their culture, structure, and environment, what is appropriate for one will not necessarily be suitable for others.The fact that many of the benefits of infrastructure are intangible further complicates this issue.

Broadbent and Weill (1997) suggest a method called management by maxim to deal withthis problem. This method brings together corporate executives, business-unit managers, and ITexecutives in planning sessions to determine appropriate infrastructure investments through a5-step process. In the process, managers articulate business maxims—short well-defined state-ments of organizational strategies or goals—and develop corresponding IT maxims that explainhow IT can support the business maxims. This approach can work where there is no sharedinfrastructure or where the infrastructure category is a utility.

Real-Option Valuation of IT InvestmentA promising new approach for evaluating IT and EC investments is called real options. Itsobjective is to recognize that EC investments can increase an organization’s performance in the future. This is espe-cially important for emerging technologies that need time to mature and may involve sequential investments in ECso that the firm can gain major future benefits. The concept of real options comes from the field of finance, wherefinancial managers have applied it to capital budgeting decisions. Instead of only using traditional measures, suchas NPV, to make capital decisions, financial managers are looking for opportunities that may be embedded in capitalprojects. These opportunities, if taken, will enable the organization to alter future cash flows in a way that willincrease profitability.

These opportunities are called real options (to distinguish them from financial options that give investors the right tobuy or sell a financial asset at a stated price on or before a set date). Common types of real options include the option toexpand a project (to capture additional cash flows from such growth), the option to terminate a project that is doingpoorly (to minimize loss on the project), and the option to accelerate or delay a project (e.g., the delay of an airportexpansion). Current IT investments, especially for infrastructure, can be viewed as another type of real option. Such capitalbudgeting investments make it possible to respond quickly to unexpected and unforeseeable challenges and opportunitiesin later years. If the organization waits in its investment decisions until the benefits have been established, it may bevery difficult to catch up with competitors that have already invested in the infrastructure and have become familiar withthe technology.

By applying just the NPV concept (or other purely financial measures) to an investment in IT infrastructure, an orga-nization may decide that the costs of a proposed investment exceed the tangible benefits. However, if the project createsopportunities for additional projects in the future—that is, if it creates opportunities for real options—the investmentalso has an options value that should be added to its other benefits (see Benaroch 2002, Devaraj and Kohli 2002).

Benaroch (2002) illustrates a real-options approach in the investment in an electronic sales channel. The 4-stepoptions-based process attempts to understand and plan for the risk involved while attempting various configurations tomaximize the value of the investment. The four steps are:

1. Define the investment and identify the risks.2. Recognize shadow options (i.e., mapping the risks and options to control them).3. Identify investment configurations.4. Identify the most valuable configurations.

The mathematics of real-option valuation are well established but unfortunately are too complex for many managers(see Dixit and Pindyck 1995). For a discussion on using real-option pricing analysis to evaluate a real-world IT projectinvestment in four different settings, see Li and Johnson (2002). Rayport and Jaworski (2004) applied the method inevaluating EC initiatives.

The Balanced Scorecard and Dashboard MethodsBalanced ScorecardThe balanced scorecard method evaluates the overall health of organizations and projects.Initiated by Kaplan and Norton (1996), the method advocates that managers focus not onlyon short-term financial results but also on four other areas for which metrics are available.These areas are (1) finance, including both short- and long-term measures; (2) customers (howcustomers view the organization); (3) internal business processes (finding areas in which to

management by maximA 5-step process thatbrings together corporateexecutives, business-unitmanagers, and IT execu-tives in planning sessionsto determine appropriateinfrastructure investments.

balanced scorecardmethodAnalysis of a variety ofmatrices (finance, inter-nal operation, agility,customer opinions) forevaluating the overallhealth of an organization.

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excel); and (4) learning and growth (the ability to change and expand). The key idea is that an organization should con-sider all four strategic areas when considering IT investments.

The balanced scorecard (BSC), which is similar to information economics, assumes that in addition to financial results,IT investments in people, skills and capabilities, databases, knowledge, and so forth are the leading indicators of an orga-nization’s success. In their framework, van Grembergen et al. (2003) relate the BSC to the results of IT investment.

Kaplan and Norton (2006) applied the method to corporate strategy. As summarized in Chapter 13, the BSC approachproposes that organizations develop metrics, collect data, and analyze it from several perspectives beyond the financialoutcomes.

Plant et al. (2003) modified the BSC for EC application by incorporating four additional perspectives—brand, service,market, and technology—and found them to be critical to the development and execution of e-business strategies. Theyapplied their modified BSC to the e-business strategies of 44 companies in the United States and Europe. Identifying the com-panies as either leaders or laggards in their industries, their research indicated that the leaders possessed three characteristics:

◗ Leaders had the ability to understand their own value proposition and put in place robust, relevant, and timely measure-ment systems that enabled them to judge the real-time effectiveness of their strategy.

◗ Leaders understood the value proposition from multiple perspectives: both internal to the organization (e.g., from afinancial or process perspective) and external to the organization (e.g., the customer perspective).

◗ Leaders continually monitor their position relative to their objective goal criteria, adjusting the criteria, metrics, andstrategy as necessary.

Sawhney (2002) attempted to use the BSC to measure the performance of EC systems, including intangible benefits.He examined the EC systems from two perspectives: that of the e-business and that of the user. For more on the BSC, seeLawson et al. (2004).

Performance DashboardRayport and Jaworski (2004) developed a variant of the BSC called the performance dashboard, which they advocate forthe evaluation of EC strategy. Several other attempts to fit the BSC approach to IT project assessment have been made[e.g., see van Grembergen et al. (2003) and the Balanced Scorecard Institute (balancedscorecard.org)]. The methodologyactually is embedded in several vendors’ products (e.g., sas.com/solutions/bsc). Cognos 8 Business Intelligence balancedscorecard requires free registration to see the demo at cognos.com/solutions/projects/balanced-scorecard.

Other MethodsSeveral other methods exist for evaluating IT investments. For example, most large vendors provide proprietary ROI calculators.However, according to King (2002), proprietary calculators may be biased and may lead to a sometimes-unjustified decisionto adopt a project. To make the decision less biased, some companies use a third-party evaluator, such as IDC (idc.com)or META Group (metagroup.com), to conduct ROI studies. An example of such a calculator is SAP Business Case Builder (see sap.com/solutions/casebuilder). Several vendors offer nonproprietary ROI calculators (e.g., CIO View Corporation).

According to Rubin (2003), every IT project must be tied to a specific business objective, with its priority indicated,so as to measure the project’s success in terms of a specific primary business value. Rubin developed a special “whiteboard”that includes metrics and their stakeholders. For details and examples, see Rubin (2003). Two methods follow.

The Exploration, Involvement, Analysis, and Communications ModelDevaraj and Kohli (2002) proposed the exploration, involvement, analysis, and communications (EIAC) model for evaluat-ing IT projects. The method is composed of nine phases, divided into four categories: exploration (E), involvement (I),analysis (A), and communication (C). For details, see Devaraj and Kohli (2002).

Activity-Based CostingGerlach et al. (2002) and Roberts (2003) proposed another approach for assessing IT investment—suggesting the use ofan activity-based costing (ABC) approach to assist in IT investment analysis. For details on how ABC works, see a manage-ment or managerial accounting textbook. Using a case study, Gerlach et al. (2002) showed that the company that utilizedABC derived significant benefits from a better understanding of IT delivery costs and a rationale for explaining IT costs todepartment managers. Mutual understanding of IT costs is a necessary condition for shared responsibility of IT, which, inturn, leads to effective economic decision making that optimizes resource utilization and the alignment of IT with busi-ness strategy. In addition, the use of ABC helps in reducing operational costs.


KEY TERMSbalanced scorecard method 7benchmarks 6best-practice benchmarks 6

information economics 5management by maxim 7

REFERENCES FOR ONLINE FILE W14.4Benaroch, M. “Managing Information Technology Invest-

ment Risk: A Real Options Perspective.” Journal ofManagement Information Systems, 19, no. 2 (2002).

Broadbent, M., and P. Weill. “Management by Maxim:How Business and IT Managers Can Create IT Infra-structures.” Sloan Management Review (Spring 1997).

Devaraj, S., and R. Kohli. The IT Payoff: Measuring BusinessValue of Information Technology Investment. Upper SaddleRiver, NJ: Financial Times Prentice Hall, 2002.

Dixit, A. K., and R. S. Pinkyck, “The Options Approachto Capital Investment.” Harvard Business Review(May–June 1995).

Fine, C. H., et al. “Rapid-Response Capability in Value-Chain Design.” MIT Sloan Management Review (Winter2002).

Gerlach, J., et al. “Determining the Cost of IT Services.”Communications of the ACM (September 2002).

Kaplan, R. S., and D. P. Norton. Alignment: How to Applythe Balanced Scorecard to Corporate Strategy. Cambridge,MA: Harvard Business School Press, 2006.

Kaplan, R. S., and D. P. Norton. The Balanced Scorecard:Translating Strategy into Action. Boston, MA: HarvardBusiness School Press, 1996.

Keen, P. G. W. “Value Analysis: Justifying DSS.” Manage-ment Information Systems Quarterly (March 1981).

King, J. “User Beware.” Computerworld, March 18, 2002.

Lawson, R., et al. “Automating the Balanced Scorecard.”CMA Management, February 2004.

Lewis, B. C., and T. A. Byrd. “Development of a Measurefor IT Infrastructure Construct.” European Journal ofInformation Systems ( June 2003).

Li, X., and J. D. Johnson. “Evaluate IT InvestmentOpportunities Using Real Options Theory.” InformationResources Management Journal ( July–September 2002).

McKay, J., and P. Marshall. Strategic Management ofe-Business. Milton, Australia: Wiley, 2004.

Plant, R., L. Willcocks, and N. Olson. “Measuring E-Business Performance: Towards a Revised BalancedScorecard Approach.” Information Systems and eBusinessManagement, 1, no. 3 (2003).

Rayport, J., and B. J. Jaworski. E-Commerce, 2nd ed.New York: McGraw-Hill, 2004.

Roberts, A. “Project Aquarius: Measuring the Impact ofTechnology.” Management Services, 2003.

Rubin, H. A. “How to Measure IT Value.” CIO Insight,May 1, 2003.

Sawhney, M. “Damn the ROI, Full Speed Ahead.” CIOMagazine, July 15, 2002.

van Grembergen, W. V., et al. “Linking the IT BalancedScorecard to the Business Objectives at a Major CanadianFinancial Group.” Journal of Information Technology Casesand Applications (2003).

metric benchmarks 6scoring methodology 5


Online File W14.5 Assessing e-CRM ROI

A formal business plan must be in place before the e-CRM project begins—one that quantifies the expected costs, tangi-ble financial benefits, and intangible strategic benefits, as well as the risks. The plan should include an assessment of thefollowing:

◗ Tangible net benefits. The plan must include a clear and precise cost–benefit analysis that lists all the planned projectcosts and tangible benefits. This portion of the plan should also contain a strategy for assessing key financial metrics,such as ROI, NPV, and IRR. It also should specify a payback period.

◗ Intangible benefits. The plan should detail the expected intangible benefits, and it should list the keyperformance indicators (KPIs) that will measure successes and shortfalls. Often, an improvement in customer satisfac-tion is the primary goal of the e-CRM solution, but in many cases this key value is not measured before and after theproject.

◗ Risk assessment. The risk assessment is a list of all the potential pitfalls related to the people, processes, andtechnology that an e-CRM project involves. Having such a list helps to lessen the probability that problems will occur.

Implementation CostsImplementation costs often are split between EC and IT costs and business-unit costs.

EC and IT costs include the following:

◗ e-CRM software licensing and support contracts◗ Licensing and support contracts for EDI and extranet tools, databases, operating systems, and other software◗ Hardware purchases and support contracts, specifically server-, storage-, and network-related expenses◗ Software integration and customization, including design, development, testing, and maintenance◗ Implementation labor◗ Ongoing administration and support labor

Business-unit costs include the following:

◗ Planning and requirements meetings◗ User training and learning time◗ Process change management

Tangible and Intangible BenefitsBenefits typically include increases in staff productivity, cost avoidance, revenues, and margins, and reduced inventorycosts (due to the elimination of errors). The following are some of the objectives that should be considered:

◗ Reduce the cost of sales.◗ Reduce sales administration overhead.◗ Improve the lead-to-sale closure ratio.◗ Increase customer retention.◗ Improve customer satisfaction and loyalty.

Potential Pitfalls and RisksSome potential pitfalls of e-CRM include the following:

◗ Taking on more than can be delivered. The e-CRM solution should target specific sales or service business functions orspecific groups of users. Additionally, it is essential to manage the project’s scope, goals, and objectives throughout theproject life cycle.

◗ Going over budget and getting behind schedule.◗ Ease of use and adequate training are essential to minimize poor user adoption.◗ Expensive maintenance and support may occur.

(continued)



◗ Isolation. The effectiveness of a project may suffer if the CRM data are not used throughout the company.◗ Garbage in, garbage out. Because e-CRM systems require so much data entry, users often put in placeholders, misguided

estimates, or inaccurate information, which leads to poor analytical results and decision-making errors.◗ Failure to measure success. Measurement of preproject status and postproject achievements is essential for a company to

show success.

Teradata (teradata.com) offers an approach for measuring the ROI for CRM that begins with setting ROI objectives andends with tracking CRM performance over time, analyzing it, and revising and refining CRM efforts accordingly.

REFERENCES FOR ONLINE FILE W14.5Alter, A. “The Bitter Truth About ROI.” CIO Insight,

July 2006.Baseline. baselinemag.com (accessed March 2009).

Pisello,T.“CRM ROI: Facts or Fiction?” CIO.com, February 3,2004.

Online File W14.6 E-Procurement Complexities in Marketplaces

Setting up e-procurement metrics is difficult because e-procurement may require significant investment in technology,redesigned processes, and employee training. In addition, purchasing or procurement capabilities in businesses typicallyevolve from simple online buying of supplies and materials to full-scale involvement in e-marketplaces. This evolutionoften occurs in four phases:

1. Internal buy-side system. In this phase, the purchasing department conducts its buying activities online. Buyers canwork from consolidated catalogs, featuring products from multiple, preferred suppliers, and then complete transac-tions on the Web. This phase builds the foundation for expansion of the e-procurement initiative.

2. Direct purchasing system. In this phase, the purchasing organization and the supplier network become more closelyaligned. Leveraging any prearranged purchasing contracts with suppliers, the purchasing departments share detailedinformation with suppliers over the Web to eliminate wasted steps for purchase order confirmation, credit checks, andshipping address verification.

3. E-marketplace involvement. In this phase, the purchasing company either joins or develops an e-marketplace. ThisWeb-based intermediary unites buyers, sellers, and brokers, to both increase competition among suppliers and givesuppliers access to a larger population of buyers. E-marketplaces usually offer dynamic pricing, aggregation of orders,multiple suppliers, price visibility across suppliers, and opportunities to collaborate. E-procurement activity in a market-place can take two forms:

◗ Participation in a consortium of trading exchanges (CTEs)◗ Creation of private trading exchanges (PTEs)

E-procurement allows one to search for buyers or sellers. Within these e-marketplaces, buyers or sellers mayspecify prices or invite bids and initiate and complete transactions. Many e-marketplaces can also handle manage-ment of payables, settlement, customer care, and other administrative services.

4. Collaboration. In this last phase, the company connects internal procurement processes and systems with those ofyour suppliers via a partner extranet—basically, a secure connection between systems accomplished over the publicInternet. When supplies or materials are needed, these collaborating systems automatically communicate orders,check availability, schedule shipments, and exchange payment—all without requiring involvement from the purchas-ing staff. E-marketplaces can provide an easy way for organizations to integrate their systems with many suppliers atonce by establishing mutual standards for e-procurement.


Online File W14.7 The ROI on RFID

RFID (radio frequency identification) is a technology that incorporates the use of the radio frequency (RF) portion of theelectromagnetic spectrum to uniquely identify an object. RFID is increasingly used in industry as an alternative to the barcode (Chapter 7). The advantage of RFID is that it does not require direct contact or line-of-sight scanning.

Thus far, RFID technology has basically been used in smart bar codes to track shipments. Recently, in response to madcow disease, the U.S. government has considered tagging cows with RFID tags to track their movement. RFID is likely togain momentum; Wal-Mart and the U.S. Department of Defense are among the early adopters. However, Brennan (2005), ofthe AlwaysOn Network, suggests that the early wave of RFID adoption overlooks the true capabilities and potential of thetechnology—and doesn’t allow adopters to reap the full benefits because of the mandate from a major customer, such asWal-Mart. The true ROI of RFID will involve comprehensive implementations with real opportunities on behalf of all partici-pants in the supply chain because it is part of the wider movement toward sensor-actuator, always-on devices. The capa-bilities of smart tags range from monitoring the date of perishable goods and automatically reducing the price as theexpiration approaches to sounding an alarm when a careless forklift operator places a palette of flammable chemicals in arestricted area. According to Brennan, in order for RFID to progress to more advanced functions, organizations will have torestructure their systems—from application software to servers to administration.

True ROI will only come with a complete redesign of business processes to make better use of this new technology, asopposed to integration with legacy systems that will not last very long. More than one-third of respondents in an October2004 HP-sponsored RFID survey said that integration with legacy systems was their “biggest expense”; less than 10 percentwere spending comparably on the new infrastructure that will soon be necessary. Worse yet, more than half the respondentsanswered that their largest investment was solely in the peripheral hardware needed for RFID implementation (tags, readers,etc.). Vempati (2004) offers many reasons why proceeding with a less-than-optimal system architecture can lower the ROIby increasing the total cost of ownership (TCO) over time. Increased costs from legacy system maintenance and IT stafftraining compose the higher TCO.

This will create some challenges for the traditional corporate infrastructure. RFID tags usually hold information abouta product in the standard Electronic Product Code (EPC) format. The EPC identifies the individual item, but additionalinformation is written in the Physical Markup Language (PML), which is based on the more commonly known eXtensibleMarkup Language (XML). The vast amount of RFID data can easily overwhelm any database. But native XML databases arenot only more capable of handling the deluge of information, but they also are better at searching and sorting data inorder to filter it and only process what is necessary. IBM’s next-generation database will contain both relational and nativeXML storage engines, and Oracle and Microsoft are likely to respond with their own product offerings.

The real need for XML databases is when EPC information is combined with other PML data from sensor actuators in abusiness context. Imagine an item moving through the supply chain: It is scanned as it leaves the warehouse, again as itenters the truck, its temperature is monitored in the truck, and it is continually tracked at all possible points down theline until it is sold. The challenge is how a single place can store all this data. In the most likely scenario, separate data-bases will hold the information about a given item at every point in the supply chain. This means that the whole network,not just a database, will need to be queried in order to get all the product information. This implies that all the databaseswould need to be connected to each other; XML databases will likely be most capable of doing that. Effective standards forthis type of communication are being developed and the infrastructure buildup will be huge. Cisco predicts that by 2010,80 percent of the traffic on its network will be EPC related.

RFID will eventually revolutionize business processes throughout the supply chain and result in greater efficiency andvalue. However, simply adding smart tags before shipping will not exploit the full potential of the RFID benefits.


REFERENCES FOR ONLINE FILE W14.7Baseline. “How to Calculate ROI.” September 6, 2006.

baselinemag.com/article2/0,1540,2012723,00.asp (accessedMarch 2009).

Brennan, I. “ROI on RFID: Now That’s the Future.” AlwaysOn Network, January 11, 2005. alwayson-network.com/comments.php?id�7849_0_11_0_C (no longer availableonline).

Vempati, S. S. “RFID Architecture Strategy.” Infosys.com whitepaper, December 2004. scribd.com/doc/6735941/Infosys-White-Paper-on-RFID-Architecture-Strategy (accessedMarch 2009).

ONLINE FILE W14.8Application Case

GE AIRCRAFT ENGINES’ DIGITAL OPTIONSMore than 25 years ago, GE Aircraft Engines (GEAE) createda system that enables the remote monitoring of aircraftengines. Each aircraft engine has hundreds of sensors thatrelay information to an onboard computer while the aircraftis in flight. The data are then transmitted via a satellite to aground-based computer system. Over the years, this datacollection system has blossomed into an entire operationssystem for engine control. GEAE has used this informationtechnology to create digital options.

GEAE uses the collected information to inform andeducate its engineers and maintenance workers. Thisenables the company to continually improve its engines,and thereby improve customer service. GEAE created arevenue-generating digital option by selling some of theinformation it collected back to the airlines. It sells infor-mation such as guidelines on how and when to serviceengines, which engines perform better under what flyingconditions, and the costs of maintaining fleets in-houseversus outsourcing their maintenance.

The system, called OnPoint Solutions, provides customerswith comprehensive solutions to meet their diverse opera-tional, financial, and technical demands. With an improved,simplified product portfolio that includes maintenance, mate-rial, and asset management services, GE provides the flexibil-ity to develop an OnPoint Solution to meet the customer’s

specific need. To achieve this, it established a flexibleprocess to ensure customer satisfaction.

Compared with traditional aircraft engine maintenanceservice options, OnPoint enables GE to provide more significantbenefits to customers. From flexible cash-flow timing, tooptimized and guaranteed cost of ownership, to shared finan-cial risk, GE remains committed to working with customers tofind the appropriate solution for every service need.

Further, GEAE has improved customer relationships throughits ability to predict and identify when an engine part needsreplacement, notifying customers so that parts are ready andavailable when the plane lands. This has enabled the airlines tominimize maintenance time and keep their airplanes in the air.Thus, GEAE’s digital option has led to improved product designs,improved customer service, and additional revenue.

Questions1. What digital option did GEAE create?

2. List some other options that GEAE might be able tocreate.

3. What metrics can GEAE use to calculate ROI of the ECproject (the electronic feedback information system)?

4. Why is this considered e-commerce?

REFERENCES FOR ONLINE FILE W14.8GE Aviation. “The Next Level of Service: OnPoint Solutions.”

GEAE.com, 2007. geae.com/services/on point_nextlevel.html (accessed March 2009).

Sviokla, J., and A. Wong. “CRM Is Not for Micromanagers:Get Value from CRM, Use IT to Empower People—Not

Keep Tabs on Them.” CIO Magazine, 2003. cio.com.au/article/15642/crm_micromanagers (accessed March2009).



THE SUCCESS STORY OF E-CHOUPALIn the remote villages of southern India, most farmers areilliterate and have never used a computer. They grow soy-beans, wheat, and coffee on small plots of land. After thefarmers harvest their crops, it generally takes them up to2 days to transport the crops to the local auction. Due to alack of information, they have been unaware of currentmarket prices.

ITC, one of India’s leading agribusiness companies,set up an e-market called e-choupal (echoupal.com), theHindi word for “gathering place.” Run by a sanchalak (anoperator, usually a male) and accessed by a PC at theoperator’s home, Internet cafés, or kiosks in public places,e-choupals act as community meeting places as well as e-commerce hubs.

The e-choupal model required ITC to make relatively largeinvestments in creating and maintaining its own IT networkin rural India. It also had to identify and train local farmersto manage each e-choupal. The e-choupal computer or kiosklinks to the Internet via phone lines or, increasingly, by aVSAT connection. Each e-choupal serves an average of 600farmers in 10 surrounding villages within a 5-kilometer radius.Each e-choupal costs between US$3,000 and US$6,000 to setup and about US$100 per year to maintain. The farmers canuse the system to obtain information for free. A public oathobligates the sanchalak to serve the entire community; thesanchalak benefits from increased prestige and a commissionpaid for each e-choupal transaction.

Farmers benefit from more accurate pricing information,improvements in the product-weighing process, faster pro-cessing time, prompt payment, and access to a wide range ofinformation, including accurate market prices and markettrends, which help them decide when, where, and at whatprice to sell. Also, farmers are able to access information onsoils and planting improvements, crop planning, and buildingrelationships that ensure the flow of supplies. Farmers usethe e-choupal system to purchase seed and fertilizer, order

soil-testing kits, share best practices, and check grain prices,including those at the Chicago Board of Trade.

The e-choupal system has had a measurable impact onwhat the farmers choose to plant and where they sell theirproducts. In areas covered by e-choupals, the percentage offarmers planting soy, for example, has increased dramatically,from 50 percent to 90 percent in some regions. The volumeof soy marketed through “mandis” (open-air markets) hasdropped by as much as half.

Further, by selling through the e-choupal, farmers taketheir crops directly to ITC collection points, saving on the costof packing and transportation that would be involved in goingto the auction market. By reintermediation (as discussed inChapter 2), instead of disintermediation, ITC saves $5 per ton,as well.

The e-choupal system has decreased ITC’s net procure-ment costs by about 2.5 percent (it saves on commissionfees and on transportation costs it would otherwise pay totraders who serve as its buying agents at the mandi), and ithas more direct control over the quality of what it buys. Thecompany reports that it recovered its equipment costs in thefirst year of operation and that the venture as a whole isprofitable. By 2004, the e-choupal system had grown to1,000 kiosks. The farmers have been able to save moneywithout changing their lifestyle. For a video on the e-choupal system see (compassioninpolitics.wordpress.com/2009/01/31/e-choupal-case-study-from-india-information-technology-and-social-enterprise),

Questions1. List the metrics that can measure the EC success of the

e-choupal system.

2. How does e-choupal differ from a regular electronicmeeting place?

REFERENCES FOR ONLINE FILE W14.9Anupindi, R., and S. Sivakumar. “ITC’s E-Choupal:

A Platform Strategy for Rural Transformation.”Conference on Global Poverty: Business Solutions andApproaches, Cambridge, MA, December 1–3, 2005.

Digital Dividend. “What Works: ITC’s E-Choupal andProfitable Rural Transformation.” December 1, 2005.digitaldividend.org/case/case_echoupal.htm (accessedMarch 2009).

Hammond, A. L., and C. K. Prahalad. “Selling to the Poor.”Foreign Policy, 142 (2004).

Sawhney, M. “Fields of Online Dreams: E-Commerce CanFlourish Anywhere if You Build the Right BusinessModel.” CIO Magazine, 2002.



ALLIANCE INSURANCE EXERCISEAlliance Insurance is a national insurance company thatprovides B2B automobile, property, and industrial insurancein major U.S. metropolitan areas. It has 16 field offices thatsupport 450 field inspectors who visit insured sites toconduct inspections and settle insurance claims. About250 auditors oversee transactions to ensure that the businessis running smoothly.

With the current system, inspectors get preliminary prop-erty or damage information over the phone. After collecting theinformation, they make site visits to assess the nature of thecustomer’s needs, return to the office to run the numbers andprepare the paperwork, and then make another on-site appoint-ment to finish the transaction. Inspectors fill out weekly activ-ity logs and audit their transactions to ensure accuracy andhigh quality of service. Oftentimes, the field inspectors comeback to the office only to find out that their next visit is in thesame general location that they just returned from.

One major limitation of the current system is thatfield inspectors must frequently return to the office toconsult the volumes of manuals to accurately insure clientsor settle claims. Frequent updates of insurance rates andrisk estimates and a constant flow of new products havemade it impossible for the inspectors to carry these manualswith them.

Alliance Insurance is considering a mobile computinginfrastructure that will enable field inspectors to accessonline manuals as well as other information necessary toconduct business. The system will also enable the centraloffice to make appointments for the field inspectors as wellas conduct mailings and other official business. In otherwords, the field inspectors will work from a virtual mobileoffice.

Note: This case is to be used as an exercise.

ASSIGNMENT FOR ONLINE FILE W14.101. Divide the class into two teams. One team will identify

the costs metrics—tangible as well as intangible—of themobile computing system. In determining costs, considerhardware, software, application development, integrationwith back-office applications, and other implementationcosts. The second team will identify the benefit metrics ofthe mobile computing system. The teams should con-sider productivity, cost reduction, reduced duplication,and so on when determining benefit metrics.

a. Use a spreadsheet program to create a spreadsheetand assign your team’s costs and benefits esti-mates. Share these with the other team for theircomments.

b. Each group should write a report identifying spe-cific metrics to recommend to Alliance Insuranceso that it can conduct a post-implementation ROI.

online file w14.1 nucleus research’s roi...

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