1、1,Applied Information Economics: An Executive Overview,2,What is AIE?,Applied Information Economics (AIE) is the practical application of scientific and mathematical methods to quantify the value of IT-enabled business investments,“Quantifying the risk and comparing its risk/return with other invest
2、ments sets AIE apart from other methodologies. It can substantially assist in financially justifying a project - especially projects that promise significant intangible benefits.” The Gartner Group “AIE represents a rigorous, quantitative approach to improving IT investment decision makingthis inves
3、tment will return multiples by enabling much better decision making. Giga recommends that IT executives learn more about AIE and begin to adopt its tools and methodologies, especially for large IT projects.” Giga Information Group,3,Real Solutions to,the economics of information the economics of IT
4、infrastructure the economics of risk the economics of flexibility the economics of productivity when headcount is not reduced the economics of portfolio prioritization Bottom Line: AIE assesses and prioritizes IT investments based on quantitative and economically rational methods,4,Some AIE Users,U.
5、S. Federal Government VA Census GSA BEP HUD EPA Booz-Allen & Hamilton State of North Carolina Giga Information Group American Express The Discovery Channel The Axa Group 6 major companies The Banking Industry Technology Secretariat Blue Cross Blue Shield of Illinois,5,AIE Benefits: For The Frugal,Me
6、asuring risk results in avoidance of investments which are likely to fail Measuring risk allows managing risk and increased chance of success Measuring all “intangible” benefits helps find methods to maximize benefits Measurement of risk and all “intangibles” allows optimum prioritization of multipl
7、e proposed investments Average payback on AIE analysis is well over 20:1 by avoiding risks and maximizing benefits One client found AIE to be the highest return and lowest risk investment in their entire portfolio,6,Major AIE Processes,AIE methods impact 4 critical components of the decision-making
8、process,Business Cases for Individual Investments,Ongoing Performance Metrics,Strategic Planning & Portfolio Management,Technology & Business Forecasts,7,Risk Return Analysis,AIE Building Blocks,AIE consists of many elements that build on each other The most fundamental part of AIE is the measuremen
9、t of risk & return on IT projects,IT Portfolio Management,Infrastructure Value Models,Optimization Methods,IT Change Economics,8,Basic Risk/Return Analysis,Procedure,AIE,AIE,Deliverables,Tools,Organization,9,How Much Analysis?,No Classification Required,Abbreviated Deliverable,Accept w/o Further Ana
10、lysis,Reject w/o Further Analysis,Proceed with Risk/Return Calculation,Expected Investment Size ($),Confidence Index,.2,.4,.6,.8,1.0,0,10k,100k,1M,10M,100M,10,Example Classification,3,4,5,6,7,8,9,10,11,12,13,14,15,16,17,18,0.3,0.4,0.5,0.6,0.7,0.8,0.9,1,10,100,1,000,10,000,1,2,Expected Investment Siz
11、e ($000),Confidence Index,No Classification Needed,Do Abbreviated Risk-Return Analysis: 6. DLSW Router Network Redesign 9. Extended Hours 18. Doc. Access Strategy,Do Full Risk-Return Analysis: 8. Pearl Indicator and Pearl I/O interface 11. Richardson Data Center Consolidation 15. MVS DB2 Tools,Rejec
12、t; Consider Other Options: 1. Data Strategy 2. Enterprise Security Strategy 3. Remote Server Redundancy 12. MQ Series: Base 13. Development Environment 2000 (mf) 14. “Source Control” Source Code Mgmt 16. Enterprise InterNet,Success Factor Adjustments: 4. Network OS migration to Novell 5.x 10. Optimi
13、ze Single Code Base,Accept without Further Analysis: 5. Lucent switch upgrade 7. Image Server Relocation 17. Enterprise IntraNet to all sites,11,Clarify The Decision Model,During Clarification we translate the “Intangibles” into measurable unitsThese are ultimately modeled in a spreadsheet,12,The “I
14、ntangible”,Possible Meanings After Clarification,“Employee Empowerment”,“Information Availability”,“Customer Relationship”,Less management overheadCertain decisions are more accurate and faster,Time and cost of searching is reducedCertain costly errors are less frequent,Increased repeat business,Exa
15、mples of Clarification,Tools like “The Clarification Chain” are used to identify unit-of-measure variables hidden beneath the “intangible” label I offer a challenge that given any intangible, I can clarify it and identify a method of measurement within 15 minutes (Ive never lost),13,Conduct Measurem
16、ents,We use the variety of measurement methods previously discussed We usually start with what we know now (i.e. calibrated estimates) More elaborate measurements (large controlled experiments or surveys) are only taken if we can show they are economically justified,14,The Meaning of Measurement,Som
17、etimes one believes that a thing is “immeasurable” only because they do not actually understand the concept of measurement The “Measurement Theory” definition of measurement: “A measurement is an observation that results in information (reduction of uncertainty) about a quantity.” Any “reduction of
18、uncertainty” about a quantity can be of value,?,15,Normal Distribution,Uniform Distribution,Lognormal Distribution,Hybrid,Threshold confidence,15%,85%,Ideal Values: Point,Real-world Meas.,Real-world Measurements vs. Ideal Values,16,When asked to provide a subjective 90% confidence interval, most man
19、agers provide a range that only has about a 40%-50% chance of being right,Actual 90% Confidence Interval,Calibrated Estimates,Measuring your own uncertainty about a quantity is a general skill that can be taught with a measurable improvement Studies show that most managers are statistically “overcon
20、fident” when assessing their own uncertainty Training can “calibrate” people so that when they provide a 90% confidence interval, it still has a 90% chance of being right (even though it is subjective),Perceived 90% Confidence Interval,17,Giga Analysts,Giga Clients,Statistical Error,“Ideal” Confiden
21、ce,30%,40%,50%,60%,70%,80%,90%,100%,50%,60%,80%,90%,100%,70%,Assessed Chance Of Being Correct,Percent Correct,99,# of Responses,Calibrated Probability Assessments,An Experiment with Giga Information Group,18,Other Scientific Methods,Probability distributions are also derived from standard statistica
22、l methods for: Controlled Experiments Random Sampling Regression methods Software metrics Meta-analysis of data Note: These methods are only used when the effort is economically justified,19,The value of additional information can be calculated for each uncertain variable in the analysis Measurement
23、 efforts will be more productive by focusing on variables that matter the most (results are often surprising) This method is based on the probability of a change in a decision with additional information and the difference in the value of the decision,Calculate the Value of Information,$,$,20,The De
24、cision Theory Formula:,What it means:Information reduces uncertaintyReduced uncertainty improves decisionsImproved decisions satisfy business objectives (by definition),The Economic Value of Information,21,The IT Measurement Inversion,Typical Attention,Economic Relevance,Receives Most Attention,Leas
25、t Relevant to Approval Decisions,Receives Least Attention,Most Relevant to Approval Decisions,Costs Initial Development Costs Ongoing Maintenance/Training Costs Benefits A specific benefit (productivity, sales, etc.) Utilization (when usage starts and how quickly usage grows) Chance of Cancellation,
26、See my article “The IT Measurement Inversion” in CIO Magazine (its also on my website at under the “articles” link),22,Conduct Risk/Return Analysis,Administrative Cost Reduction,Total Project Cost,% Improvement in Customer Retention,5%,10%,15%,10%,20%,30%,$2 million,$4 million,$6 million,23,Analyzi
27、ng the Distribution,25%,50%,75%,100%,125%,-25%,0%,Risk of Negative ROI,“Expected” ROI,ROI = 0%,Probability of Positive ROI,Return on Investment (ROI),The “cancellation hump”,24,Return,Risk,10%,20%,30%,40%,10%,20%,30%,40%,50%,60%,Probability of less than a risk-free return,A proposed IT investment wi
28、th a 15% risk and 54% return,X,Plotting the Risk and Return,25,Example of Risk Effects,50%,40%,30%,20%,10%,0%,0%,50%,100%,150%,200%,Expected IRR over 5 years,Chance of a negative IRR,These are real IT investments of $2M-$3M plotted against a clients investment boundaryThe 27% ROI investment is actua
29、lly preferred to the 83% ROI investment,Region of Unacceptable Investments,Region of Acceptable Investments,Articles by Hubbard: “Hurdling Risk” CIO Magazine and “Risk vs. Return” InformationWeek (articles linked at ),26,Make Recommendations,The recommendations include: To accept or reject the inves
30、tment Possible modifications to the proposed investment Various risk management tactics Deliverables include The written report The spreadsheet The presentation,27,“Full” RRA Overview,Optimize Investment, Make Recommendations,28,?,Advanced Methods: Example,The Axa Group is doing a world-wide data ce
31、nter consolidation Of the 11 data centers in Europe there are over 1013 possible consolidations We formulated the problem as a type of “optimal spanning tree” with a dynamic programming algorithm - we narrowed the field down to the few most economically optimal,Belgium,France,Germany,Italy,England,S
32、pain,Switzerland,Portugal,Austria,29,Typical Client Engagements,Individual Risk/Return Analysis on an IT investment 5 to 10 weeks depending on investment size No license fee charged (client doesnt retain use of tools) Implementation of the AIE method 10 to 14 weeks per major IT portfolio License fee
33、 required Ongoing assistance on a case-by-case basis Outsourcing of the AIE analysis process can be negotiated We have recently been offering retainer options for significant discounts on consulting fees and licenses,30,In Conclusion.,AIE is about getting the most out of the IT investment Decisions would be very different - and much better - if intangibles, risk, redefined roles, and optimization methods were used AIE is theoretically well-founded and has a measurable benefit The problems AIE solves will only become more prevalent,
