Methodologies for Investment Evaluation

Abstract

The evaluation of information technology (IT) investments has been a recognised problem area for the last four decades, but has recently been fuelled by rising IT budgets, intangible benefits and considerable risks and gained renewed interest of both management and academics. IT investments already constitute a large and increasing portion of the capital expenditures of many organizations, and are bound to absorb a large part of future funding of new business initiatives. However, for virtually all firms, it is difficult to evaluate the business contribution of an IT investment to current operations or corporate strategy. Consequently, there is a great call for methods and techniques that can be of help in evaluating IT investments, preferably at the proposal and decision-making stages. The contribution of this chapter to the problem area is twofold. First, the different concepts, which are used in evaluation are discussed and more narrowly defined. When speaking about IT investments, concepts are used that originate from different disciplines. In many cases there is not much agreement on the precise meaning of the different concepts used. However, a common language is a prerequisite for the successful communication between the different organizational stakeholders in evaluation. In addition to this, the chapter reviews the current methods for IT investment evaluation and puts them into a frame of reference. All too often new methods and guidelines for investment evaluation are introduced, without building on the extensive body of knowledge that is already incorporated in the available methods. Four basic approaches are discerned: the financial approach, the multi-criteria approach, the ratio approach and the portfolio approach. These approaches are subsequently compared on a number of characteristics on the basis of methods that serve as examples for the different approaches. The chapter concludes with a review of key limitations of evaluations, suggestions on how to improve evaluation practice and recommendations for future research. This chapter draws on earlier work as published in Renkema and Berghout (1997), Berghout (1997), and Renkema (1996; 2000).