The Case for IT
Chapter 4
Announcements
• Quiz return after class
• Three people still need to form project team
– See me after class
2
Today’s Outline
• Economic Measures
• Justifying expenditure on IT
– As infrastructure cost
– As profit driver
– As proprietary advantage
• Three examples
– SABRE
– IBM
– MedCo
• Building a Business Case
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Important Financial Measures
• Return on Investment / Rate of Return
• Return on Equity
• Return on Assets
• Internal Rate of Return
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Return on Investment
• Also known as rate of return
• = ratio of money gained/lost to investment
amount
• Eg.
– Invest $1,000 at start,
– end with $1,075
– Return on investment = 75/1000 = 7.5%
• Often annualized ROI is used
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Return on Equity
• = Return on net worth
• Measures the return to common stockholders
• ROE =
Net Income / Average stockholder’s equity
= (net income/sales) * (sales/total assets) * (total assets/avg stockholders equity)
(known as DuPont Formula)
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Return on Assets
• ROA = Net Income / Total Assets
• = (Net Income / Sales) * (Sales / Assets )
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Time Value of Money
• The present value of something its value in
today’s dollars
• Eg. Having $110 a year from now is equivalent
to having $100 if the bank is giving 10% return
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Net Present Value
• Value of cash flows in today’s dollars
Where
t - the time of the cash flow
n - the total time of the project
r - the discount rate
Ct - the net cash flow (the amount of cash) at time t.
C0 - the capital outlay at the beginning of the investment time ( t = 0 )
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Internal Rate of Return
• Annualized effective compounded return rate
• = Discount rate that results in net present value
of zero from series of cash flows
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Comparison with financial options
• Security option:
– The right to buy a security at a fixed, predetermined
price (called the exercise price) on or before a fixed
date (called the maturity date)
• Eg. The right to buy (up to) ten Google Stock,
one year from today for $450 each
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This week’s case:
IT Doesn’t matter
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Main Ideas
• Competitive Advantage from IT is possible, but
challenging
• ‘IT Doesn’t matter’ responses
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Chapter 4: Making the Case for IT
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Table 4.1: IT Investment Categories
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Business Case for IT
• Investments in reusable, value-enabling
infrastructure lower costs, improve asset
efficiency and create strategic options for future
growth
• Investments in value-creating IT applications
drive profitable growth through further cost
reductions and revenue generation
• Value-sustaining IT applications and
infrastructure provide strategic differentiation
and proprietary advantage
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SABRE
1957
• IBM and American Airlines team up to form SABRE, the SemiAutomatic Business Research Environment. It's based on
SAGE, the Semi-Automatic Ground Environment -- the first
major system to use interactive, real-time computing -- which
IBM helped develop for the military.
1960
• The first Sabre reservation system is installed in Briarcliff
Manor, N.Y., on two IBM 7090 computers. It processes 84,000
telephone calls per day.
1964
• The Sabre system, and its nationwide network, is completed at
a cost of $40 million and becomes the largest commercial realtime data-processing system in the world. It saves American
Airlines 30% on labor costs.
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SABRE
1972
• The Sabre system is upgraded to IBM S/360 and moved to a
new consolidated computer center in Tulsa, Okla. It is used for
all of American Airlines' data processing facilities.
1976
• The Sabre system is installed in a travel agency for the first
time, triggering a wave of travel automation. By the end of the
year, 130 locations have the system.
1984
• Sabre introduces BargainFinder, the industry's first automated
low-fare search capability. Competitors sue American Airlines,
saying its Sabre system unfairly gives its flights priority on the
displays seen by travel agents. American agrees to discontinue
any preferential treatment of its flights.
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SABRE
1985
• Sabre introduces easySabre, allowing consumers with PCs to tap into the
Sabre system to make airline, hotel and car rental reservations.
1989
• On May 12, the ultrareliable Sabre system goes down for 12 hours. The
cause: a latent bug in disk-drive software that destroys file addresses.
1996
• Sabre launches Travelocity.com.
2000
• AMR Corp., the parent of American Airlines, spins off The Sabre Group as
an independent company.
2001
• Sabre Holdings Corp. begins migrating its massive, 25-year-old mainframe
system for air-travel shopping and pricing to HP NonStop servers and Linux
servers.
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Table 4.2: Leveraging Infrastructure at
IBM: IT Operations
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Table 4.3: IBM: Enterprise Support
Processes
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Arguments for IT
• New applications give competitive advantages
• Open standards, reliable infrastructure give rise
to more innovation
• IT can give both operating efficiencies and
business insight
• Reusable modules, shared middleware,
common interfaces get around traditional pitfalls
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Role of infrastructure
• Examples of traditional infrastructure
– What value do they create?
– How do businesses account for them?
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Role of infrastructure
• IT infrastructure
– Specific IT operations (data center, network, call
centers)
– Support for enterprise processes (procurement,
ERP, finance, HR)
• Value creation
– Efficiency
– Speed to market
– Flexibility
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Proprietary Advantage
• More than just cost-cutting!
• Must change competitive positioning
– Successful entry into growing market or exit from
shrinking one
– Achieving top position in attractive industry and
sustaining it
– Attracting loyal investors
• Very few competitive advantages are
sustainable!
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Table 4.4: Driving Profitable Growth at
IBM
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Table 4.5: Creating Proprietary
Advantage at IBM
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Differences of IT vs. other infrastructure
costs
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Questions, Break, Presentation
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MedCo IT option
• Business plan to launch internet-enabled remote
patient monitoring business
• Patients with pacemakers place device over
pacemaker to collect data on rhythm, blood pressure,
etc.
• Data sent from patient’s home by internet to physician,
family, health care providers
• Cash flow expectations suggest:
–
–
–
–
–
$300 million investment over 5 years to develop
Positive cash flow in 5 years
$2 billion in revenues by year 10
… but there are risks
See curve in fig 4.3(a)
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Figure 4.3(a) Three Cash flow scenarios for
MedCo Patient Monitoring Investments
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Alternative investment strategies
MedCo A:
• 2 years and $150 million spent developing databases,
networks, call centers
• Next 18 months, proprietary remote monitoring business
applications and user interface built for $25 million
• Final 18 months $125 million custom installations, networking
patients etc.
• What if this leads to $600 million cash flow from year 13
MedCo B:
• Leverage existing IT infrastructure (databases, networks, call
centers in 2 years for $25 million
• Minimizes custom integration, rollout time
• Proprietary advantage only lasts 3 years
• Cash flow approach $1.5billion
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Figure 4.3(b) MedCo A and MedCo B
Patient Monitoring Investments
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MedCo B options
• MedCo B can also use existing infrastructure
for other income generating products
– Other diseases
– Charging family members for service
• These options are available because of initial
investment
• They do not have to be exercised if the market
changes
• Therefore give a lower risk
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Figure 4.3(c) MedCo B Leverages
Infrastructure and Exercises Options
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Figure 4.3(d) the Value of Leveraging
Infrastructure and Exercising Options
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Writing a Business Plan
• Two different scenarios:
– A plan written for the purpose of attaining venture
capital funds
– A plan for reorganizing the financial structure within
a company
• Both require excellent writing, clear objectives
and positive projections
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Business Plan Success
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Personal Introduction, visit
Find out objectives of VC
Tell story
Negotiate
Treat all interactions as part of proposal
Executive summary is key
Be careful with writing, formatting, packaging
Maintain momentum
Don’t count cash till you have it
Expect mostly no answers and move on!
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What Investors look for
• People/management that can get the job done
• Innovative technology that can be
commercialized
• Large, rapidly expanding market
• Strategy to gain “unfair advantage”
• Attractive per price share
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Business Plan Components
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Executive Summary
Customer Need and Business Opportunity
Business Strategy and Key Milestones
Marketing Plan
Operations Plan
Management and Key Personnel
Financial Projections
Appendices
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Business Plan Components
• Executive Summary
– Business opportunity, technology, product, market,
management
– Proposed financing
• Amount
• Use of proceeds
– Five-year income summary and requirements
• Customer Need and Business Opportunity
– Product and technology description, uses
• Business Strategy and Key Milestones
– Cumulative cash need and head count at each
milestone
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Business Plan Components
• Marketing Plan
– Customer need
– Market segmentation
– Channels of distribution
– Sales strategy and plans
– Five-year sales forecast
– Competition and positioning
• Operations Plan
– Engineering plan
– Manufacturing plan
– Facilities and administration plan
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Business Plan Components
• Management and Key Personnel
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Incentive compensation program
Detailed resumes
Organization
Staffing plan and headcount projections
• Financial Projections
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Assumptions
Five-year pro forma forecasts
Income statement
Balance sheet
Cash flow statement
• Appendices
– (If needed)
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Reminder
• Project Team
– after class if you don’t have team yet
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