Does ROI (Return on Investments) Matter? Essay Example

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    Business
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    Undergraduate
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Does ROI (Return on Investments) Matter?

Does ROI (Return on Investments) Matter?

Introduction

Investment in a business means putting up funds in an asset or a fund with the hope of earning some monetary return in the future. These returns can be in form of capital appreciation, dividends and also interest among other forms of monetary returns. Investments can be done in information technology firms, assets and also industries among other areas that can generate funds. When an investment yields funds for the investor we call the returns or earnings return on Investment and there are a number of techniques that can be used to determine the amount an investor would receive upon making an investment. All ventures that are started for purposes of providing goods and services for a profit have a value that is attached to themand IT (information technology)is no exception. The value of the business or project is important in determining the rate of return one should expect to get after making an investment into the project or business. This paper is going to look at returns on investments in information technology (IT) and thereafter determine if they matter.

How Chief Finance Officers Determine the Value of Information Technology Investments

Many businesses have found it difficult to create special techniques for determining the value of information technology investments and they end up using traditional techniques of determining the value of investments that is the capital budgeting techniques such as payback period, internal rate of return, discounted cash flow methods as well as return on investments among other techniques. Information technology experts have responded to the techniques being used to determine the returns of investments in the information technology sector claiming that the techniques are too low. It has also been noted that very few information technology firms use the return on investment technique to determine the value of investment in the department.

Approaches used to determine the Business Value of Information Technology

There are two main approaches that have been used to help in the quest to determine the business value of information technology and these include the variance approach and the process approach.

The Variance Approach

The variance approach is used to measure the relationship that exists between an IT (information technology) investment and the performance of a business with regards to revenue, costs and market share among other performance factors. The approach tells us what information technology affects. For a long period of time businesses have been using computers among technologies in their operations however, when they are drafting and presenting their achievements the computers were not being accredited in the companies’ productivity and the situation led to the statement ‘IT productivity paradox’ making one wonder what the value of the computers is to the businesses (Davaraj&Kohli, 2002).

According to research conducted by researchers and scholars on many businesses in the United States of America, the results on the productivity of computers and information technology on their productivity were mixed. Some businesses reported that information technology bore zero output to the business while other companies considered information a major factor in their productivity. For example Strassmann conducted a research in 1990 on 38 companies in the United States of America and the result of the research was that there was no correlation between investing in information technology and the performance of the businesses (Dedrick, 2003). Another research was conducted by Brynnjolfsson and Hitt in 1996 revealed contradicting results from the research conducted by Strassmannthis is because in the 367 firms that were researched they reported an 81% gross return after investing in information technology and the net returns ranged from 48% to 67% (Dedrick, 2003).

The variance approach is effective in determining the business value of information technology because it provides statistics that show the effectiveness of information technology. However, although this approach is useful it focuses on the general effects of information technology in the business and therefore one cannot tell the specific sectors of the business it was effective in. it is also important to note that information technology may not have similar effects on all businesses. Some businesses perform better with the use of information technology while in other businesses information technology may have no impact on their performance.

The Process Approach

This approach attempts to explain how an investment in information technology affects the productivity of a business.Soh and Markus developed a framework or a model that shows the process of value creation of information technology in a business. The first stage involves looking at the relationship between the investments in information technology that is the information technology expenses and the information technology (IT) assets. In this stage whatever is bought or acquired (expenses) is converted into the business’s asset so that it may be used in the information technology process. The second stage of the information technology value creation process involves showing the impact the investment in information technology has on the performance of the business (Soh & Markus, 1995).

Does ROI (Return on Investments) Matter?

The IT Conversion Process

The information technology conversion process includes the costs involved in creating value of information technology to the business’ performance and the life cycle of the technology itself.

The Total Cost of Ownership or Operation

The business has to ensure that they use technology (IT) that will minimize costs of the business while still maintaining a high quality of service delivery. The costs incurred in the use of information technology resulted in the creation of the total cost of ownership concept (TCO) which helps the business to assess the costs incurred in purchasing, using as well as maintaining the technology. These costs are reflected in the final statement. Other costs incurred in the conversion process include; training personnel, electricity, space and depreciation among others. Total costs of ownership are also called total costs of operations and they provide a basis in the determination of the value of the information technology investment in the business. The costs can vary they are not always similar after acquisition of the technology (Fitzgerald, 1998).

The Life Cycle of the Technology

The business will get more value from the technology if it knows how to use the technology to its maximum capacity and the right time to change to another technology. This is because pre-disposal of technology will make the business not to realize the full potential of the acquired technology thus not being able to realize the full value of the technology to the performance of the business. Technology depreciates in value and therefore its value is expected to depreciate with time; however that is not the case because in the early days of acquiring new machinery the personnel is learning how to utilize the machinery which results in higher total costs of operations. With time the total costs of operation decrease because there is mastery in the use of the technology thus more output. To realize the effectiveness of technology it is necessary to use it to its expected life cycle before acquiring new technology (Bannister, 2001).

The Usage Process

The usage process is concerned with how the business can increase the business value of the investments in information technology by looking at the effectiveness of information technology against the strategies and the goals of the business. Information technology used has an impact on the processes in the business; however its effectiveness is in the capacity of enabling (value drivers) as it is not directly involved in the operations of the business. These value drivers alsoknown as business applications are classified into three specific categories and these include; IT business value drivers which impact the business directly, derived IT value drivers which make up the IT infrastructure and the architecture of the business ‘data and finally the IT value enablers which organize the information technology in the business.

The Impact of Information Technology

The role of information technology in businesses is changing from enhancing effectiveness of the operations of a business to the role of innovation in the business this was after thorough evaluations of the information technology investments. This change should necessitate a change in the focus of information technology in businesses from saving costs to being the value drivers of the business as well as increasing productivity (Hammer and Mangurian, 1987).

The frameworks discussed above have revealed that information technology increases efficiency, effectiveness, flexibility and also innovations in a business. These values are now being used to develop the value of information technology in a business. Development of technology such as use of the internet has proven to be of great value to the business as it has opened up new market opportunities for the business, attracted more customers, improved communication, improved decision making and increased the amount of information to enable the business to compete more effectively.

Returns in Information Technology

Information technology on its own bears no returns, the returns of information technology are in the business. Therefore to determine the returns of information technology in a business we have to look at the goals and strategies of the business and the technology the business should be in alignment with them. These goals and strategies include intimacy of their customers, product leadership and also excellence in operations. Information technology should enhance efficiency in a business by developing systems that will ensure high and quality volumes among other unique traits that will bring about increasedefficiency of the business hence efficiency of the IT systems (Treacy & Wiersema, 1997). There are other benefits that a business can enjoy from using information technology such as increased publicity from attention from the media which increases the popularity of the business as well as its products and or services.

Conclusion

All investments in a business should have returns that the business should enjoy whether in monetary form or not and an investment in information technology is equally important to a business. Although information technology investments do not yield direct returns, their returns are still evident and can be felt in the returns of the business itself. Returns matter because they help us determine the effectiveness and efficiency of the investments made.

References

Treacey, M. & Wiersema, F. (1997). Discipline of Market Leaders: Choose your Customer, Narrow your Focus, Dominate your Market. Perseus Publishing.

Soh, C. & Markus, M. (1995). How IT Creates Business Value: A Process Thoery Synthesis. Proceedings of the Sixteenth International Conference on Information Systems. Pp. 29- 41.

Davaraj, S & Kohli, R. (2002). The IT Payoff, Measuring the Business Value of Information Technology Investments. New Jersey: Prentice Hall.

Dederick, J, Gurbaxani, V. & Kraemer, K, J. (2003). Information Technology and Economic Performance: A Critical Review of the Empirical Evidence. University of California: Irvine.

Bannister, F. (2001).Dismantling the Silos: Extracting New Value from IT Investments in Public Administration.Information Systems Journal, vol. 11, pp. 65-84.

Ballantine, J, A, & Galliers, R, D and Stray, S, J. (1996).Information Systems/Technology Evaluation Practices: Evidence from European Organizations. Journal of Information Technology, vol. 11, pp. 129-141.

Brancheau, J, C & Wetherbe, J, C. (1987). Key Issues in Information Systems Management.MIS Quarterly, vol. 11, no. 1, pp. 23-45.

Brynjolfsson, E. (1993). The Productivity Paradox of Information Technology.Communicationsof the ACM, vol. 36, no. 12, pp. 67-77.

Fitzgerald, G. (1998). Evaluating Information Systems Projects: A Multidimensional Approach.Journal of Information Technology. Vol. 13, pp. 15-27.

Glazer, R. (1997).Measuring the Value of Information: The Information-Intensive O rganization.IBM Systems Journal, vol. 32, no. 1, pp. 99-110.

Markowitz, H, M. (1952).Portfolio Selection.Journal of Finance, vol. 7, no. 1.

Hammer, M and Mangurian, G, E. (1987). The Changing Value of Communications Technology, Sloan Management Review. Pp. 65-71.