Welcome back to the IS/IT Governance Course. This is the second module. We call this module: Evaluating IT Investments. We have two broad goals in this module. Evaluate individual IT investments, and then Incorporate Risk in the IT investment Evaluation. We will start with the evaluate individual IT investments. Needless to say, IT provides many affordances. So, in an organization, there will be many demands to implement different kinds of IT systems. However, there are only so many resources to implement all those projects. So, we have to decide which projects should be implemented. So this is about allocating limited resources that will maximize the return of the investment. In practice, this means identifying which projects should be funded so that we receive the value that we are expecting from IT. This means that we have to estimate, that is, evaluate different IT investments. There are three kinds of estimating. The first is an order of magnitude estimate. That is, in this kind of estimate we have a general idea about what system we want. We only know the top-level, high-level broad contours of the solution. This kind of an estimate is a very rough estimate. We may be off by as much as 50 percent in this kind of estimate. However, after in order of magnitude estimate, we may decide that this is worth pursuing or looking into further. So, we get into what is called a budget estimate. A budget estimate will be used to decide whether this project is worth pursuing. If we decide that this project is worth pursuing, we will allocate the budgeted amount for the next year's investment. So, a budget estimate has more details than an order of magnitude estimate, but this is still a top down estimate and it can be off by as much as 25 to 30 percent. Once a project has been approved, then we need what is called a definitive estimate. In the definitive estimate, we know individual elements that need to be executed to complete the project. In the Microsoft Project terminology, in a definitive estimate we know what packages that need to be completed to complete the project. So, this kind of an estimate is very precise. It will be within plus or minus five percent. Okay, so let's look at the order of magnitude estimate first. To give you an analogy, let's say you have a home and you want to add a sort of extension to your home. So you ask a contractor about adding an extension to your home without getting into what you want this extension to include. The contractor may say it's going to cost about $350 per square foot for the extension. This is very similar to a company deciding that they want to consider implementing an ERP system. So, they may want to know, what is the cost of implementing an ERP system? They start by inquiring with top ERP vendors like SAP, Microsoft, and Oracle, to give them an order of magnitude or a ballpark estimate for implementing an ERP system, and these vendors come back and say, expect a project cost of about one percent of revenue. So, without getting into which modules will be implemented, what level of customization the company is interested in doing, the vendors will quote a figure like, assume about one percent of revenue. The only function of a ballpark estimate should be to evaluate whether it would be useful to get a more accurate estimate. In contrast to a order of magnitude top-down estimate, in bottom-up estimating we know the work. That is, we know all the individual work packages that need to be executed to complete the project. In between an order of magnitude top-down estimate and a bottom-up estimate, is the budget estimate where we make more detailed estimates to decide whether to pursue a project. The key idea behind a budget estimate is to consider the total cost of owning a system. The total cost of owning a system includes three elements. The first element is acquisition and procurement cost. Acquisition and procurement cost includes the cost of developing the specifications for the system and the actual hardware and software cost. The second element of cost of ownership is operation and maintenance cost. Once a system has been implemented, what are the cost? That is, IT labor cost, and space, and energy, and furniture cost to operate and maintain the system. The last element of the cost of ownership is end-of-life management. Once the system has lived its life, what is the cost of transferring data from the old system to the new system, and what is the cost associated with physically decommissioning a system? So, a budget estimate includes acquisition and procurement, operation maintenance, and end-of-life management cost. That is, the total cost of owning the system. In the next video, we're going to use an Excel-based example to look at a top-down budget estimate. Thank you.
