The activity based cost (ABC) approach has been used to relate costs and benefits to various cost pools that drive product profitability within an organization, so that relationships can be established between investments and product profitability. In this paper, using a particular case, we demonstrate the value of the ABC approach for IT investment justification under certain conditions, and discuss its implications

Peacock, Eileen

Tanniru, Mohan

English

AIS Electronic Library (AISeL)

Association for Information SystemsAIS Electronic Library (AISeL)AMCIS 2000 Proceedings Americas Conference on Information Systems(AMCIS)2000Activity Based Justification for IT InvestmentsEileen PeacockOakland University, peacock@oakland.eduMohan TanniruOakland University, tanniru@oakland.eduFollow this and additional works at: http://aisel.aisnet.org/amcis2000This material is brought to you by the Americas Conference on Information Systems (AMCIS) at AIS Electronic Library (AISeL). It has been acceptedfor inclusion in AMCIS 2000 Proceedings by an authorized administrator of AIS Electronic Library (AISeL). For more information, please contactelibrary@aisnet.org.Recommended CitationPeacock, Eileen and Tanniru, Mohan, "Activity Based Justification for IT Investments" (2000). AMCIS 2000 Proceedings. 177.http://aisel.aisnet.org/amcis2000/177Activity Based Justification for IT Investments   Dr. Eileen Peacock, School of Business Administration, Oakland University, peacock@oakland.edu Dr. Mohan Tanniru, School of Business Administration, Oakland University, tanniru@oakland.edu  Abstract  The activity based cost (ABC) approach has been used to relate costs and benefits to various cost pools that drive product profitability within an organization, so that relationships can be established between investments and product profitability.  In this paper, using a particular case, we demonstrate the value of the ABC approach for IT investment justification under certain conditions, and discuss its implications.   Case A few years ago, a manufacturing firm decided to provide their sales team access to product configuration knowledge using expert systems to reduce rework costs and order processing delays. After they developed the system for configuring a simple product and used centralized access-to-access product configuration knowledge, they wanted to do the same for complex products.  But, this required access to large databases and significant user interaction, and the only effective way to make this work was to provide their sales people with a notebook that had the configuration knowledge, database and other related software (worth about $8,000). The issue was could they justify the investment when such a technology had to be provided to over 400 sales people? The firm could not clearly justify the benefits of such an investment, but after some long debate, made a decision to wrap this investment under “sales force automation” and went ahead with it for “competitive reasons.” Interestingly, one of the primary motivators for this large investment (product configuration of complex products) has been discontinued.  The question that lingers on still is would the firm have made a different decision if it had an opportunity to assess the impact of its investment on product profitability, especially of complex vs. simple products?   We will address this question in the following research using the ABC approach to IT investment analysis.  Introduction IT literature has proposed several methods to evaluate IT projects.  These include both the traditional approaches such as NPV, IRR, payback, etc., and non-traditional methods such as risk analysis, heuristic approaches, multi-criteria based models, etc. [1,2,3,7,8].  In these days when the focus of management is to control costs by identifying various cost pools that have a direct impact on the product profitability and bottom-line, it is critical that we assign the "IT costs” to various activities associated with each product.   Of course, there are situations when IT investments may be treated as infrastructure costs and not assigned to any particular product.  The ABC approach [4,5,6,9] addresses the consumption of resources by the product. As ABC attempts to match resources (the IT investment) with the consumers of these resources (products), the specific question we ask is, “How is the IT investment influencing the product profitability?"    Research Model A research model (shown in Figure 1) was developed and is being tested against the investment scenario discussed above.  The technology investments are studied under three different design architectures: distributed processing (notebooks), centralized processing with on-line interaction (current system for simple products), and centralized processing with remote batch processing (current system for complex products). Each of these design architectures link IT and business activities (sales force activities) differently.  Three different operational scenarios are considered for the sales activity, where the relationship between the business activities (e.g. selling) and products sold spans from "direct" to "overlapping".    Our hypothesis is that when technology architecture is distributed across business activities and when business activities are distributed across products (lower-left hand corner of Figure below), then the ABC approach is appropriate and easy to apply for IT justification.  As a matter of fact, activity based IT justification can help set the stage for effective assessment of such investments on product profitability.  On the other hand, if the design  architecture is distributed across activities but business activities are overlapping (are not distributed) across products, or vice versa, then the ABC approach for justification becomes more complex.  Accurate information is needed to ensure proper assignment of all IT costs to various activities associated with product profitability.  However, when the design architecture is centralized and the business activities are highly overlapping (upper, right-hand corner), then the effort to implement an ABC based IT justification may not be worth the cost of gathering the needed information. In other words, it may be better to treat the IT investment as an infrastructure cost. W will refer to this as Activity Based Justification  (ABJ).   1100 Two Dimensions: System and Activity RelationshipSystem dimension Expense - D istributed vs CentralizedNo AllocationNeededAllocationof Effort/ProductAllocation ofEffort and Expenseby productAllocation ofExpense/ProductActivity-EffortDirectvsOverlappingImplications and Conclusions Currently, the problem discussed is being addressed in detail and by the time of the conference, we will have the analysis complete and will present the results. The primary motivation for this research is to ask the basic, yet age old question, how much information is adequate to make a decision (here, it is investment decision) and when would such information add value not only to answer the question: is this a worthwhile investment, but also the question: is this investment worthwhile in some cases and not in others?  We hope to address this question, thus helping us provide a means to justify investments based on the impact they have activities, which determine the product profitability?   References Agarwal, R., Roberge L. and M. Tanniru, "MIS Planning: A Methodology for Systems Prioritization," Information and Management 1994, 27, pp. 261-274. Agarwal R., Tanniru, M. and M. DaCruz, "Knowledge Based Support for Combining Quantitative and Qualitative Judgments in Resource Allocation Decisions," Journal of MIS, Summer 1992, Vol.9, No.1, pp. 165-184. Clemons, E. K. (1991), "Evaluation of Strategic Investment in Information Technology," Communications of the ACM, 34(1): 22-36. Cooper, R. and R.S. Kaplan.  Activity-Based Costing Systems: Measuring the Costs of Resource Usage. Accounting Horizons September 1992, pp. 1-13.  Cooper, R.  The Two-Stage Procedure in Cost Accounting, Part I, Journal of Cost Management Summer 1987 pp. 43-51 and Part II Fall 1987, pp. 39-45. Johnson, R. Activity-Based Information: A Blueprint for World-Class Management Accounting. Management Accounting.  June 1988, pp. 23-30.  Kumar, R.L.  A Note on Project Risk and Option Values of Investments in Information Technologies, Journal of  Management Information Systems, Vol. 3. No. 1. 1996. Parker,  M.M., Trainor, W.E. and R.J. Benson, Information Strategy and Economics Linking Information Systems Strategy to Business Performance. Prentice Hall 1990. Storm, D.J., and S.J. Sullivan.  CIM Investment Justification: The “Fresh Start” Approach. Journal of Cost Management, Spring 1989 pp.4-13.  1101

Activity Based Justification for IT Investments

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Activity Based Justification for IT Investments

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