ROLE OF THE IT FUNCTION:
COSTS, ANALYSIS,
DEVELOPMENT
Based on materials by David Schuff
IT’s impact on the bottom line

Two things:
Reduce costs
Increase profit
Increase revenue

Everything else relates to one of these two things.
 Agree?
Try it…
Paying for IT

How does a company pay for technology
initiatives?

Where does the money come from?

So how do you know if it is worth it?
Who pays?



For the corporate network?
For an application needed by a
single department?
For a new server intended to
support that application?
 What
if the department only
needs 10% of that server’s
capacity?
What is the role of
the “chargeback” in
all of this?
The Major “Functions” of the IT Function

Operations
 Technical
support
 Network planning and administration

Application Development
 Software

implementation
What about “managing contracts”?
Looking at the application
development function


Analysis/Design
Development
The business analysts
Analysis
The development team
Design
Development
The Systems Development Life Cycle
(SDLC)
Business Requirements
Technical Requirements
Technical Design
The SDLC

What are its strengths?

What are its weaknesses?

When it is appropriate?

What is the role of alternative development strategies?
Rapid prototyping
 Joint application development

Requirements Gathering

Why is it important in the context of the SDLC (and
software development in general)?

How does it affect testing?

From where do you get the requirements?
 What
are the difficulties?
Business Requirements versus Technical
Requirements

What is the difference?

Which one is more important?
 Does

it depend on who’s asking the question?
Should the business unit review the technical
specifications?
The requirements “game”


In reality, how are requirements used by vendors? By
clients?
What is the right level of detail?
Can you have too much detail?
 Which party benefits from greater detail?


Why do requirements change?
Is this a bad thing?
 How should the client deal with these changes? The vendor?
 How do you build a set of requirements that “last?”

The Wall



What is “throwing
requirements over the wall”?
What is the implication of this
in practice?
Why do companies do it?
How do you know if it is worth it?

Cost justification

Measures of cost and benefits
 Intangible

costs versus tangible costs
Techniques
 Net
present value
 Expected value
Net present value



Consider a development project:
 Year 1: $20,000 expenditure
 Year 2: $5,000 savings
 Year 3: $7,500 savings
 Year 4: $7,500 savings
Formula for NPV:
SFV(1+i)-n
Is it worth it?
 Do you break even: $20000 in spending versus $20000 in income?
Consider a 5% discount rate (cost of capital):
NPV = (-20000)(1.05)-0 + (5000)(1.05)-1 +
(7500)(1.05)-2 + (7500)(1.05)-3 = -20000 + 4761.91 + 6802.72 +
6478.78 = -1956.59
So you would lose $1956.59 on this project!
Expected value


E(X) = xP(x)
where x is the outcome and
P(x) is the probability of that outcome
Why raffles are bad deals (for players)
 Suppose
there are 100 tickets at $1 and the prize is
$50
 E(X) = -1(1) + 50(.01) = -1 + .50 = -$.50
 So
on average you lose $.50 on every ticket
Applying this to an IT project

Is a security system worth the money?
 The

system costs $10,000 and prevents all downtime
If I do not have a backup system there is a
 5%
chance we’ll have 10 days of downtime
 10% chance we’ll have 5 days of downtime
 30% chance we’ll have 1 day of downtime

Each day of downtime costs $10000
 So…
The computation…




E(X) = -10000 + (100000)(0.05) + (50000)(.10) +
(10000)(0.30) =
-10000 + 5000 + 5000 + 3000 = $3000
So the expected value of investing in the system is
$3,000
We save $3,000 by implementing the security system
Another way of looking at it:
 The expected loss from not having the system is
$13,000, which is more than the cost of the system
But what if you have this scenario?

There is a .01% chance you’ll have 10,000 hours of
downtime
 That’s


(0.0001)(10000)(10000) = $10,000
$10,000 is not a lot, but can you afford the
$100,000,000 loss if it occurs?
So what do you do to protect against that loss?
Combining NPV and expected value


NPV is discounted value of future cash flows
But those cash flows might be uncertain

So you could look at discounted values of expected future
returns

So now, given a 5% cost of capital:
NPV = (E(Xyear1))(1.05)-0 + (E(Xyear2))(1.05)-1 +
(E(Xyear3))(1.05)-2 + … =

How do you compute E(Xyeary)??
Computing expected future cash flows

Back to our security system example
 We claim there is a $3000 benefit in the second
year
 This assumes 100% certainty in the outcome
 What should we use for the expected cash flow for
year two if we are:
 80% certain there will be a $3000 benefit
 20% certain there will be a $1000 benefit
Discussion



Beyond Valuation: Options Thinking in Project
Management
Should IT projects include people from the business
unit in the development process?
In an business that uses technology (for example, a
bank), is it more important to have
 People
in IT with knowledge of the business…
or
 People in the business units with knowledge of
technology?
More discussion

Imagine you are a project manager for a
technology initiative
 What
skills are important to have in your team
members (technical and otherwise)?