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IS infrastructure into the investment decision-making process
Pergamon PII: S0166-4972(97)00060-6
Technovation, 17(11/12) (1997) 695-706 © 1997 Elsevier Science Ltd All rights reserved. Printed in Great Britain 0166-4972/97 $17.00 + 0.00
Integrating the costs of a manufacturing IT/IS infrastructure into the investment decisionmaking process Z. Irani, J.-N. Ezingeard and R. J. Grieve Department of Manufacturing and Engineering Systems, Brunel University, Uxbridge, Middlesex UB8 3PH, UK
Abstract Due to the increasing level of organisational investment in Information Technology (IT) and Information Systems (IS), significant amounts of capital need justifying. However, many companies are reporting their inability to justify their investment in IT~IS because of the nature of costs and benefits associated with its implementation. The reason for this is that many organisational budgeting processes rely on financially oriented appraisal techniques as an integral part of the decision-making process. These accountancy frameworks are often used to assess the 'bottom-line' financial impact of an investment by setting tangible project costs against those quantifiable benefits and savings predicted to be achievable. However, traditional appraisal techniques are considered to be no longer appropriate in justifying investments in IT/IS because of the nature of intangible benefits, together with the complexity of direct and indirect cost implications. Hence, the predictive value of using many traditional investment appraisal techniques is increasingly being questioned. The authors of this paper have identified and then classified a variety of appraisal techniques that are used during the justification of capital investments in IT/IS. The taxonomy developed provides a critique of characteristics for both traditional and non-traditional appraisal techniques. The authors then identify a range of cost implications associated with the adoption of IT/IS, with a particular focus on manufacturing applications. These cost implications are then developed into a taxonomy of direct and indirect costs, which clearly need consideration during the investment decision-making process. © 1997 Elsevier Science Ltd. All rights reserved.
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1. INTRODUC'nON During the recession of the late 1980s and early 1990s many organisations were forced to reformulate their Information Technology (IT) and Information Systems (IS) budgets, which resulted in many companies significantly reducing their investments in new systems and technology. However, investment confidence in IT/IS appears to be rising again, with Cane (1992) reporting that the worldwide revenue from the IT industry generated an estimated revenue of $840 billion in 1985, $1490 billion in 1990 and $2100 billion in 1995. Further predictions suggest that, by the millennium, the whole IT industry will account for some 10% of world economic activity, which is a doubling of the 1990 figure (Heath and Swinden, 1992). These statistics are further substantiated by a recent 'Computers in Manufacturing Survey' (Bowman, 1996a), which reported an 8% rise in UK corporate IT expenditure during 1996. Further predictions estimate that in 1997, the level of IT investment in the UK will reach £3 billion. Similar investment statistics are cited in the United Stated, where Datamation (1996) reported an average IS budget rise of 6.2% during 1996. This rise in IT/IS expenditure is considered to be attributable to many industries turning to IT/IS to help deal with the ever more intensive competitive pressures faced by businesses. The momentum driving many IT/IS investments appears to be strategically oriented, with typical benefits including shorter time to market, quicker delivery responses, higher product quality, global trading and increases in flexibility (Randhawa and West, 1992). However, according to Bessant (1991), IT rarely lives up to its promises, and in reality has even led to reductions in productivity growth. Further evidence seems to indicate that this also applies to manufacturing companies, although much literature on Manufacturing Resource Planning (MRPII) seems to indicate various degrees of dissatisfaction (Burns et al., 1991). It therefore appears that large sums of money are being spent on IT/IS, with many techniques being available to help organisations evaluate their investments in this technology. However, according to Parker and Benson (1989), most Chief Executive Officers (CEOs) are not comfortable with the available set of tools and techniques used to justify their investments in IT/IS. It appears that these methodologies lack the precision in definition and results that CEOs expect. This may therefore suggest that those investment justification processes which are used to evaluate capital investments in IT/IS are imperfect, and that, secondly, many organisations feel uneasy and even dissatisfied with the appraisal techniques available.
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The authors of this paper report, through a review of the published literature, manufacturing industry's changing expectations of IT/IS, and identify the limitations of those traditional appraisal techniques used to evaluate the adoption of these technologies. The authors then present a classification of both traditional and non-traditional appraisal techniques, together with a taxonomy of direct and indirect cost factors. The paper finally concludes with those considerations that need integrating into a robust justification criterion which addresses the cost implications of an IT/IS infrastructure in a manufacturing environment.
2. INVESlMENTSIN IT/IS: A MANUFAClIJRING PERSPECTIVE Although the reduction of inventory holdings, reduced personnel levels, controlled levels of work in progress, improved stock turns etc. still feature strongly in the business demands of many manufacturing organisations, the issue is not to increase efficiency alone but to increase efficiency and effectiveness within the supply chain. As a result, Enterprise Resource Planning (ERP) or Manufacturing Resource Planning (MRPII) is often the natural choice, as it offers an information system approach towards helping businesses meet such requirements. Organisational investments in MRPII have changed little over recent years, with Bowman (1996b) reporting sales of MRPII packages accounting for 23% of total manufacturing software investments. However, despite years of investment in manufacturing management software, there are few signs of market fatigue. In the UK alone, over the last five years, the proportion of process companies using some variation of manufacturing management software has grown from 64% to 73%. This rise in sales represents a real increase of around 1000 new customers over a five-year period. A similar message is echoed by medium-sized UK manufacturing companies who employ between 200 and 500 people, In this sector, three-quarters of manufacturing companies have installed some form of manufacturing management system (Bowman, 1996b). This increasing level of MRPII sales may be attributable to: (i) the purchase of new software modules; (ii) the upgrade of existing modules; (iii) the need for more integrated business solutions; (iv) the misalignment between the business needs and current systems in operation; or (v) the implementation of new systems based on technological developments. However, the benefits achievable through the implementation of MRPII appear to have attracted only 25% of small manufacturing companies (those employing less than 200 people) in the UK
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(Bowman, 1996b). This would therefore suggest that the lack of project management skills, together with the perceived scope of benefit and cost implications associated with the adoption of MRPII, are of sufficient concern to discourage its widespread implementation. Yet many software and hardware vendors see this sector of the industry as a burgeoning opportunity, and forecast that small companies will invest in IT faster than any other sector because they are increasingly finding themselves unable to compete without a better IT infrastructure (Manufacturing Computer Solutions, 1997). The 1996 'Manufacturing attitudes' survey carried out by Benchmark Research (1996) and reported by Conspectus (1996) revealed that UK manufacturers see IT investments as crucial in enabling new approaches to manufacturing competitively priced goods. The survey also showed that manufacturers want their IT/IS systems to go beyond the confines of the shop floor, with many companies reporting their increasing need of IT/IS to take the strategic view of the organisation. The survey also reports industry's increasing needs for an enterprise-wide approach, which brings together product development, manufacturing, supply chain management and even the ability to manage a product's life-cycle. Manufacturers, according to the report, acknowledge significant IT/IS paybacks at departmental/operational level and now want IT/IS to deliver strategic transformational change at an enterprise-wide level. Further encouraging news from the 1996 'Manufacturing attitudes' survey is that UK manufacturers see IT/IS investments as their most significant weapon, in their bid to shorten the gap on the 'World Class competitive score board'. Fig. 1 provides a summary of the main survey conclusions on the impact of IT/IS on British manufacturing industry. The survey reports IT/IS as a key driver in reducing the so-called 'death of geography', as it allows Original Equipment Manufacturers (OEMs) to extend their design and manufacturing functions out to their suppliers, thus allowing a supplier and assembler at different global locations to work concurrently on the same manufacturing project and to share information across sites. Respondents to the survey (Benchmark Research, 1996) recognised the value of this extended enterprise model as the future of manufacturing; a future in which companies form strategic alliances in developing and manufacturing products, acting as one 'virtual' organisation which pools skills and resources towards a common goal. However, many UK manufacturers remain unable to take advantage of these possibilities, with the survey further reporting 70% of respondents still using 'paper systems' to disseminate
manufacturing information, and only 37% saying they use IT to manage information flows. Further key findings that are likely to accelerate investment in IT/IS are that 73% of UK manufacturers say the main competitive thrust for the UK manufacturing base will be as a provider of goods tailored closely to the customer's precise requirements. The survey reports that many organisations are beginning to consolidate their efforts in exploiting the potential of enterprise-wide systems that can deliver a whole host of savings and benefits at a strategic and operational level. This approach to justification appears to be preferred over the adoption of new technology based on the limitations of traditional departmental/operational benefits and saving. Therefore, the portfolio of savings and benefits achievable through the adoption of IT/IS would suggest the corporate justification process as simply being a capital budgeting formality. However, this is often not the case. Investments in IT/IS and MRPII, from a manufacturing perspective, offer many operational benefits and savings which can be easily accommodated within traditional accountancy frameworks. However, it is the nature of the intangible costs and benefits that they are often unable to be accounted for during traditional justification processes. As a result, many manufacturing companies are finding themselves unable to account for the full implications of their IT/IS deployments.
3. INVESTMENTDECISION-MAKINGPROCESSES Research into the justification of Computer Integrated Manufacture (CIM) suggests that the justification process is one of the major barriers to MRPII implementation (Huber, 1986; Boaden and Dale, 1990). In many manufacturing companies, a formal justification proposal must be prepared and accepted by the decision makers before any expenditure is sanctioned. Primrose (1991) identifies manufacturing industry's perception of investment justification as a budgetary process that gives a final 'yes' or 'no' - 'pass' or 'fail' verdict on the success of a project proposal. As a result, managers may view project justification as a 'hurdle' that has to be overcome, and not as a technique for evaluating the project's worth. This is particularly significant where, during the preparation of a project proposal, managers spend much time and effort investigating the technical aspects of the project. They become committed to the belief that, from a technical perspective, the investment is essential. However, they still have to produce evidence to jump the 'hurdle'. Therefore, team members may be easily susceptible to persuasion by vendors and con-
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sultants and may be prepared to accept untypical demonstrations which show unrealistically high levels of savings. Hence, project members may focus their efforts on trying to identify and estimate maximum benefits and savings, at the expense of overlooking the full cost implications. Traditional investment appraisal techniques, such as Return on Investment (RoI), Internal Rate of Return (IRR), Net Present Value (NPV) and Payback approaches, are often used to appraise capital investments in IT/IS (Willcocks, 1994). These methodologies are based on conventional accountancy frameworks, and are often facilitated under the auspices of the finance director. They are specifically designed to assess the bottom-line financial impact of an investment, often setting project costs against quantifiable benefits and savings predicted to be achievable (Hochstrasser, 1992; Farbey et al., 1993). However, the vast array of traditional and non-traditional appraisal techniques leaves many organisations with the quandary of deciding which approach to use, if any. Consequently, there has been much debate about the types of techniques that constitute meaningful justification (Small and Chen, 1995). Table 1 provides a summary of both traditional and non-traditional appraisal techniques, together with their respective literature sources. These techniques have then been grouped into four classifications: economic; strategic; analytical; and integrated. Furthermore, the classifications of economic and analytical approaches have been divided into two further groups.
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Economic appraisal techniques are structured in nature, and include those traditionally used by accountants. They are based on the assignment of cash values to tangible costs and benefits but largly ignore intangible factors. However, project risk can be acknowledged through the manipulation of variables. Strategic approaches are less structured in nature but combine tangible and intangible project implications, whilst acknowledging the impact of the project on the long-term future of the organisation. However, projects using this approach are considered somewhat risky. Analytical appraisal techniques are highly structured in design but subjective in nature, with their use often including tangible and intangible factors. These techniques are also able to acknowledge project risk. Finally, integrated approaches combine subjectivity with formal structure. These approaches integrate financial and non-financial dimensions together, through the acknowledgement and assignment of weighting factors to the intangible implications of the project. Here again, project risk can be integrated into certain techniques. The basis for the taxonomy presented in Table 1 is to classify the variety of techniques available through identification of their respective characteristics. Preliminary research presented by Farbey et al. (1992, 1994) proposes that project characteristics affect the way in which investment decisions are made. This therefore suggests that the use of a specific appraisal technique might be more appropriate for a particular investment. Hence, the objective of Table 1 is to identify the characteristics of traditional and non-traditional appraisal techniques, thus allowing the
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TABLE 1. Summary of appraisal techniques, approaches and references Appraisal technique Payback
Classification
Characteristics
Reference sources
Economic approach: (ratio-based)
Purely quantitative in terms of benefits and costs Purely quantitative in terms of benefits and costs Purely judgmental in nature
Economic approach: (discounting technique)
Huang and Sakurai (1990); Dugdale (1991) Pavone (1983); Suresh and Meredith (1985) Parker et al. (1988); Hares and Royle (1994) Kaplan (1984); Kakati and Dhar (1991)
Purely quantitative financial technique with possible modified hurdle rates to account for the qualitative or strategic aspect Purely quantitative financial technique Kaplan (1984); Hares and Royle 0994) with possible modified hurdle rates to account for the qualitative or strategic aspect Strategic decision as a measure of Meredith and Suresh (1986); Swamidass and Waller (1991); Naik and success Chakravarty (1992) Parker et al. (1988); Hocfistrasser Integration of strategic, operational and financial decisions into measures of (1992) success Rockart (1979); Hochstrasser and Purely judgmental in nature. Integration of strategic, operational and financial Griffiths (1991) decisions into measures of success Scoring technique with a formal Suresh and Meredith (1985) structure to a judgmental approach Nelson (1986) Scoring technique with a formal structure to a judgmental approach Scoring technique with a formal Saaty (1988) structure to a judgmental approach Optimised approach involving analytical Burstein (1986); Primrose and Leonard formulations with numerical solutions (1987) and different programming techniques Purely judgmental in nature. Scoring SwamidassandWaller (1991); Remenyi and Heafield (1995) technique with a formal structure to a judgmental approach Purely judgmental in nature. Scoring Meredith and Suresh (1986);Money et technique with a formal structure to a al. (1988) judgmental approach Purely judgmental in nature. Possible Sloggy (1984) integrated approach where strategic, operational and financial decisions are integrated into measures of success Garrett (1986); Kennedy and Sugden Purely judgmental in nature. Possible integrated approach where strategic, (1986) operational and financial decisions are integrated into measures of success Evaluation where financial aspects are Parker et al. (1988) considered first and strategic criteria applied next Possible integrated approach where Kaplan and Norton (1996) strategic, operational and financial decisions are integrated into measures of success
Return On Investment (ROI) Cost-Benefit Analysis (CBA) Net Present Value (NPV)
Intemal Rate of Return (IRR)
Technical importance/Research and development
Strategic approach
Competitive advantage
Critical success factors
Non-numeric
Analytic approaches: (portfolio)
Scoring models Analytical Hierarchy Process (AHP) Computer-based techniques
Risk analysis
Analytical approaches: (other)
Value analysis
Multi-attribute utility theory
Integrated approaches:
Scenario planning and screening
Information economics
Balanced scorecard
matching of the most appropriate appraisal technique to a particular investment project. The inability of many manufacturing companies to quantify the full implications of their MRPII investments, from both a cost and a benefit perspective, questions the predictive value of those organisational justification processes that are totally dependent on traditional appraisal techniques. The problem appears to lie in the unsuitability of those appraisal techniques
classified as economic approaches, with their sole reliance during the justification process suggesting selective investment appraisal. The reason for this is that these techniques only address tangible costs and benefits associated with the project, and are unable to accommodate the often significant strategic dimensions of many IT/IS investments. Furthermore, many of the costs associated with implementing new technology cannot easily be quantified and are therefore often overlooked (Hochstrasser, 1992). These factors
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have significant implications during the investment decision-making process and, as Small and Chen (1995) suggest, may force many companies to adopt one of the following strategies: (i) refuse to undertake IT/IS projects that could be beneficial to the longterm competitiveness of the organisation; (ii) invest in projects as an 'act of faith'; or (iii) use creative accounting to pass the budgetary process.
who suggest that many manufacturing companies fail to account for the full complement of IT-related costs. Hogbin and Thomas (1994) report the use of a contingency factor of between l0 and 25% of project costs being added to the identified costs, particularly in the initial business case. However, this figure will often depend on the types of costs incurred, together with the level of detail supporting the estimates and any other associated assumptions. A further l 0-15% may be added to include project management costs.
4. COSTIMPLICA'HONSOF IT/IS PROJECTS 4.1 the tendencyto underestimatecosts The costs of IT projects are often perceived to be easier to estimate than the benefits. However, this is rarely the case. The costs of IT/IS often appear more tangible in nature because the assumptions and dependencies on which they are based are often not fully acknowledged, or are poorly understood. It is considered widespread practice to account for the upper estimates for costs and the lower estimates for benefits during the investment decision-making process (Hogbin and Thomas, 1994). However, there may be political and organisational reasons for understating the cost implications of an IT/IS investment: the main one being the need to gain support for, and acceptance of, the project from senior managers. In a recessionary climate, a concern for cost justification, quick returns and indeed application of IT/IS for cost reduction purposes would seem to be paramount (Price Waterhouse, 1991). This again could pressure proponents of IT/IS into understating costs. Hochstrasser (1992) and Farbey et al. (1993) have reported the increasing actions of project champions - - project leaders who are totally committed towards the success of the investment and who often ignore the full cost implications of their IT/IS investment, including optimistic estimates of benefits and savings. This management practice may have severe project implications. For example, in the case of an MRPII system, which typically has high running costs, the failure to identify the full cost implications, when combined with the use of over-optimistic savings and benefits, may result in several extra years of use to achieve expected financial returns (Primrose, 1991). Hochstrasser (1992) points out that most companies tend to underestimate the total cost of their IT/IS projects, with between 30 and 50% of costs occurring outside the official IT/IS budget. In one large manufacturing company studied by Willcocks and Lester (1991), user department IS and training costs were 29% of total costs but were hidden in other departmental, often non-IS-related budgets. Further empirical evidence is offered by Ezingeard and Race (1996)
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Initial cost estimates which contribute towards determining the level of IT/IS investment required are often governed by the performance characteristics set during the system requirements planning stage. However, such estimates of system costs are often restricted to the following issues: (1) hardware and software performance required to process types and volumes of transactions; (2) the development work content needed to provide a given set of functions; (3) shared processing facilities, for example, terminals/peripherals and networks; (4) functions which are extra to a given user's immediate requirement - - for example, mandatory security facilities; (5) system design factors which might protect performance in the long term but which have shortterm development costs; (6) ongoing operating expenses; and (7) the balance of development costs against eventual maintenance costs. In addition, there is the issue of whether the entire project cost implications should include both direct and indirect cost factors (Hochstrasser, 1992; Hogbin and Thomas, 1994). In the instance of a new system, which can use available processing power, the investment cost may be calculated as a marginal cost of the processing power needed to run the extra application. This marginal cost may be acceptable for one new system but will lead to an understatement of the total costs for all systems. It is particularly the case where the full processing costs include operating and management expenses - - for example, the implementation of an MRPII system. Once the initial cost estimates of a proposed IT/IS system have been decided and the system justified, a process of recording the cost implications and allocating these cost factors to departmental budget often begins. This process is known as 'charge out' and is where the project costs are offset against the benefits achievable (Hogbin and Thomas, 1994). This management process has evolved from where IT costs
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were once all in one centralised IT department. However, many IT costs are often incurred and accounted for at a departmental level, with each department buying its own hardware and software and sending people on training courses from its own departmental budget. Hence, without some structured mechanism of allocating cost implications at a departmental level, it would appear to be extremely difficult to keep track of exactly how much expenditure is IT related. Clearly, charge out is not an easy process or a management panacea, and should be seen as just one of the many techniques available in the management 'toolbag'. Additional techniques may also include, among other things, IT planning processes, project benefits appraisal, management performance measures and cost identification and control.
4.2 Acknowledgingdirect and indirect cost implications of an IT infrastructure As hardware and equipment costs continue to fall in price, IS-related human and organisational costs are set to rise (Wheatley, 1997). Strassmann (1990, 1992) concluded that at the US Department of Defense, for every $1 spent on IT equipment, a further $7 needed to be spent on people and training. Hochstrasser (1992) suggests that human and organisational costs can be as much as three to four times as high as direct project costs. Invariably, however, these costs are rarely fully budgeted for in IS investment proposals, and may partially explain the phenomenon of 'cost creep' which occurs over the course of most IS projects. The holistic cost implications of an IT/IS deployment can quite often be divided into direct and indirect cost factors (Hochstrasser, 1992; Hogbin and Thomas, 1994). Direct costs are those factors that can be easily attributed to the implementation and operation of IT. Although these costs often go beyond the initial user specification of the system, it is the focus made by senior management on these aspects which often dictates the project's budget and ultimate justification. Direct project costs are often underestimated and go beyond the obvious hardware, software and installation costs associated with an IT/IS infrastructure. Direct costs may also include unexpected additional hardware accessories such as increases in processing power, memory and storage devices. Installation and configuration costs are also classified as direct costs, and typically include consultancy support, installation engineers and networking hardware/software. Table 2 provides a summary of common direct costs associated with IT/IS projects, together with a selection of their respective examples.
However, it is often the indirect costs associated with the adoption of IT/IS that are more significant than those direct costs identified in Table 2. Indirect costs can largely be divided into human and organisational factors, with one of the largest indirect human costs being that of management time. This is the time that is specifically spent on integrating new systems into current work practices. Furthermore, as a result of newly adopted technologies, management may spend much time revising, approving and subsequently amending manufacturing and IT/IS related strategies. A significant amount of resource will also be used to investigate the potential of the IT/IS and in experimenting with new information flows and modified reporting structures. For example, an investment in MRPII affects the whole organisation, with the new system impacting on all employee job functions. Everybody will need time to absorb the new work practices at both an operational and management level. Wheatley (1997) suggests that a further indirect human cost, which is often overlooked, is that of system support and trouble shooting. He claims this cost factor to be the largest part of many IT/IS-related expenses. Indeed, many large firms are now finding it quicker and more efficient to employ their own technicians to provide this service. This appears to be the preferred option, over the reliance on software vendors who initially try to solve the problems remotely, and, when unable to, then make personal visits which add to the cost of the system. System support cost factors are often substantial, with Wheatley reporting the results of a recent survey which found that one-third of respondent companies could not estimate the additional cost of supporting IT/IS in relation to its original purchase price. The vast majority of those companies that did venture an estimate thought the cost to be a small fraction of the original cost of acquisition. However, one-quarter of companies thought that IT/IS support costs would be less than 20% of their purchase price, with only 4% prepared to concede that such costs might exceed the original purchase price. In fact, according to Wheatley's survey, which draws on estimates from industry analysts, typical lifetime support costs are at least 400% of the original purchase price. However, recent initiatives suggest that vendors are starting to perceive cost of ownership as the new 'competitive frontier' which can offer them a sales advantage. A final indirect cost implication may be a result of employees developing new skills, and therefore increasing their flexibility and overall contribution towards the organisation. Hence, they may then request revised pay scales. Any further costs associa-
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TABLE 2.
Direct IT/IS project cost implications
Direct project costs associated with IT/IS implementation Environmental operating costs Initial hardware costs Initial software costs Installation and configuration costs System development costs Project management costs Project overheads Training costs Maintenance costs Unexpected hardware costs Unexpected software costs Security costs Consumables
Examples of direct project costs associated with IT/IS implementations
Air conditioning facilities, uninterruptahle power supply, computer furniture File server, visual display unit (VDU), network printer MRPII package, operating system, networking software Management consultancy support, installation engineers, network wiring, junctions and connectors 'External' customising time, 'In-house' customising time Organisational resources: manpower, project planning tools, time Running costs: electricity, space. Networking costs: telecommunication time, rises in insurance premiums Vendor software familiarisation courses, upgrade training courses Yearly service contracts Secondary data and storage devices, upgrades in processing power Vendor software upgrades, operating systems upgrades Protection against viruses and abuse Print cartridges/ribbons, disks and paper
ted with employee pay and rewards, together with the cost implications of increases in staff turnover, clearly need integrating into a justification criterion. Table 3 provides a summary of the indirect human costs associated with the adoption of IT/IS. However, indirect costs are not simply restricted to human factors but encompass organisational issues as well. Organisational costs are caused by the transformation from old to new work practices, based on the impact of the new system. At first, a temporary loss in productivity may be experienced, as all employees go through a learning curve while adapting to new systems, procedures and guidelines. Additional organisational costs may also be experienced once the basic functions of the system are in place. These costs are associated with management's
TABLE 3.
attempts to capitalise on the wider potential of the system, at an enterprise/strategic level. Further costs include management's attempt to integrate information flows and increase its availability. An example of these costs in a manufacturing environment could be the development of an Electronic Data Interchange (EDI) link between a customer and the supplier's MRPII production schedule. This additional technology links an organisation to its customers and suppliers. The 'openness' in communication allows a customer to view its supplier's capacity before raising a purchase order, therefore preventing unrealistic delivery demands on the supplier. Alternatively, it may allow a supplier to view stock/buffer records to determine whether a delivery is needed. Hence, the implementation of MRPII may result in the adoption of a new 'knock-on' technology, together with its associated cost factors; but there are also 'knock-on' savings in efficiency, which need acknowledging.
Indirect human IT/IS project cost implications
Indirect human costs Management/staff resources Management time Cost of ownership; system support Management effort and dedication Employee time Employee training Employee motivation Changes in salaries Staff Turnover
Manufacturing application
Examples of indirect human costs
MRPI1 CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII
Integrating computerised production planning and control into work practices Formalising the design process using computerised technology Devising, approving and amending IT and manufacturing strategies Devising, approving and amending IT, product design and manufacturing strategies Vendor support/trouble-shooting costs Vendor support/trouble-shooting costs Exploring the potential of the system Linking and integrating new systems together, e.g. CAM, DNC, C1M Detailing, approving and amending the computerisation of product BOMs Re-dranghting of essential drawings on the new computer system Being trained to manipulate vendor software, and training others Being trained and training others on the computerisation of the design function Interest in computerised production planning and control reduces as time passes Interest in automated design and draughting reduces as time passes Pay increases based on improved employee flexibility Pay increases based on improved employee flexibility Increases in interview costs, induction costs, training costs based on the need for skilled human resource Increases in interview costs, induction costs, training costs based on the need for skilled human resource
CAD
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Any additional 'knock-on' costs, direct and indirect, together with efficiency saving, will need to be taken into account during the justification of the IS (Willcocks, 1994). This is essential to allow for the complete functionality and potential of the new system to be achieved. Furthermore, the adoption of MRPII and any 'knock-on technology' is likely to result in the redesign of organisational functions, processes and reporting structures. As pointed out by Hochstrasser (1992), companies with extensive IT infrastructures in place tend to change their corporate shape by reducing the number of management levels. This is often achieved by redefining the role of many management functions, through increasing their flexibility and overall contribution to the organisation. The costs of organisational restructuring or business process reengineering are considered to be expensive, particularly if isolated groups within the company resist change and are unwilling to make the transition. These costs therefore need acknowledging and building into a justification costing structure. Table 4 provides a summary of the indirect organisational costs associated with the adoption of IT/IS.
5. CONCLUSIONS The authors of this paper have reported manufacturing industry's changing view of IT/IS, from its once operationally focused applications, which improved organisational efficiency, to their increasing strategic expectations. This long-term view of IT/IS as a mechanism that can deliver significant competitive advantage has been the driving force behind many corporate investments. However, this increasing level of expenditure has again identified the inadequacies of many investment decision-making processes. It appears that traditional approaches to project justification, i.e. economic, focus on nonstrategic, short-term, tangible benefits, with the larger 'enterprise-wide picture' often missing from the formal justification process. The authors of this paper have built on the research idea presented by Farbey et al. (1992, 1994), who propose that project characteristics affect the way in which investment decisions TABLE 4.
are made. This theoretical proposition has resulted in the authors of this paper developing a taxonomy of appraisal techniques and identifying their respective characteristics, thus allowing the matching of the most appropriate technique to a particular investment project. A further limitation in the use of those appraisal techniques identified as economic, in the taxonomy developed, is that they are often unable to accommodate the full cost implications of an IT/IS investment. Hence, the drawback of these approaches during project justification is increasingly becoming a barrier to the implementation of a manufacturing IT/IS project (Huber, 1986; Boaden and Dale, 1990), thus possibly affecting the competitiveness of many manufacturing organisations. The use of those economic investment appraisal techniques identified in this paper is further complicated by the largely ignored, and even when identified often underestimated, costs of an IT/IS investment. This inability to identify the 'true' costs associated with the adoption of IT/IS is considered to be attributable to the myopic approach adopted by many industries towards identifying the 'holistic' cost implications of IT/IS. Traditional justification processes based on the use of economic appraisal techniques tend to focus on direct cost factors, with the often more significant indirect cost implications being omitted from the formal decision-making process. This not only questions the 'value' of traditional justification processes but also has implications regarding the actual 'successes' of many IT/IS deployments. The reason for this is that many IT/IS investment decisions appear to be based on the consideration of the obvious and quantifiable. However, as empirical research suggests, indirect project costs can quite often be up to four times as high as the direct project costs. Therefore, many companies appear not to be identifying the full cost implications of their IT/IS investments, which may affect the overall project outcome. Many authors report that more research is required to identify the full cost implications of IT/IS. The authors of this paper have identified some of the direct and indirect cost factors associated with manufactur-
Indirect organisational IT/IS project cost implications
Indirect organisational costs Losses in organisational productivity Strains on organisational resource Business process reengineering Organisational restructuring
Examples of indirect costs Developing and adapting to new systems, procedures and guidelines Maximising the potential of the new technology through integrating information flows and increasing information availability The redesign of organisational functions, processes and reporting structures Covert resistance to change
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ing investments in IT/IS projects, with examples drawn from the literature. The identification and acknowledgement of these cost implications during an IT/IS deployment could avoid some of the difficulties encountered when using traditional approaches to investment justification. Furthermore, their identification will give companies a better insight into the actual implications and successes of their manufacturing IT/IS investments. However, the lack of widespread use of non-traditional appraisal techniques - analytical and integrated approaches - - as mechanisms for partially addressing some of the 'softer' indirect costs identified in this paper, would suggest a restriction of their application due to their complicated and subjective nature, and, more importantly perhaps, their lack of applicability in manufacturing environments.
Acknowledgements The authors of this paper would like to acknowledge the referees' comments which helped to improve the quality of this paper.
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Datamation (1996) (June), 16. Dugdale, D. (1991) Is there a correct method of investment appraisal?. Management Accounting 69, 46--50. Ezingeard, J.-N. and Race, P. (1996) A survey of current practice of value assessment in the management of manufacturing information and data systems. Proceedings of the 2nd International Conference on Management Integrated Manufacturing, 26-28 June, Leicester University, UK, pp. 407-414. Farbey, B., Land, F. and Targett, D. (1992) Evaluating investments in IT/IS. Journal of Information Technology 7, 109-122. Farbey, B., Land, F. and Targett, D. (1993) IT Investment: A Study of Methods and Practices. Management Today and Butterworth-Heinemann, UK. Farbey, B., Targett, D. and Land, F. (1994) Matching an IT/IS project with an appropriate method of evaluation: A research note on evaluating investments in IT/IS. Journal of Information Technology 9, 239-243. Garrett, S.E. (1986) Strategy first: A case in FMS justification. Proceedings of the 2nd ORSA/TIMS Conference on Flexible Manufacturing Systems: Operations Research Models and Applications, ed. Stecke, K.E. and Suri., R., pp. 17-29. USA. Hares, J. and Royle, D. (1994) Measuring the Value of Information Technology. John Wiley and Sons, Chichester, UK. Heath, W. and Swinden, K. (1992) The chips are down for Europe. Management Today (October), 92-110. Hochstrasser, B. (1992) Justifying IT Investments. Conference Proceedings: Advanced Information Systems; the new technologies in today's business environment, pp. 17-28. Hochstrasser, B. and Griffiths, C. (1991) Controlling IT Investment; Strategy and Management. Chapman and Hall, London, UK. Hogbin, G. and Thomas, D.V. (1994) Investing in Information Technology: Managing the Decision Making Process. McGraw-Hill/IBM Series, Cambridge, UK. Huang, P. and Sakurai, M. (1990) Factory automation: The Japanese experience. IEEE Transactions on Engineering Management 37, 102-108. Huber, R.F. (1986)CIM: inevitable but not easy. Production Engineer (April), 52-57. Kakati, M. and Dhar, U. (1991) Investment justification of flexible manufacturing systems. Engineering Costs and Production Economics 21, 3043. Kaplan, R. S. (1984) Yesterday's accounting undermines production. Harvard Business Review 62, 95-101.
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Kaplan, R. S. and Norton, D. P. (1996) Using the balanced scorecard as a strategic management system. Harvard Business Review 74, 75-85. Kennedy, A. J. and Sugden, K. (1986) Post-completion auditing: A source of strategic direction?. Management Accounting 67, 34-37. Manufacturing Computer Solutions (1997) SMEs the biggest investors, says Compaq (February), 14. Meredith, J. R. and Suresh, N. C. (1986) Justification techniques for advanced technologies. International Journal of Production Research 24, 1043-1057. Money, A., Tromp, D. and Wegner, G. (1988) The quantification of decision support benefits within the context of value analysis. MIS Quarterly 12, 223-236. Naik, B. and Chakravarty, A. K. (1992) Strategic acquisition of new manufacturing technology: A review and research framework. International Journal of Production Research 30, 1575-1601. Nelson, C. A. (1986) A scoring model for flexible manufacturing systems project selection. European Journal of Operations Research 24, 346359. Parker, M. and Benson, R. (1989) Enterprise-wide information economics: Latest concepts. Journal of Information Systems Management 6, 7-13. Parker, M., Benson, R. and Trainor, H. (1988) Infor-
mation Economics: Linking Business Performance to Information Technology. Prentice-Hall International, USA. Pavone, V. J. (1983) Methods for economic justification of an arc welding robot installation. Welding Journal 62, 39-46. Price Waterhouse (1991) Information Technology Review. London, UK. Primrose, P.L. (1991) Investment in Manufacturing Technology. UMIST, Manchester, and Chapman and Hall, London, UK. Primrose, P. L. and Leonard, R. (1987) Performing investment appraisals for advanced manufacturing technology. Journal of Cost Management for the Manufacturing Industry 1, 34 42. Randhawa, S. U. and West, T. M. (1992) Evaluating automated manufacturing technologies: Part II - A methodology for evaluation. Computer-Integrated Manufacturing Systems 5, 276-282. Remenyi, D. and Heafield, A. (1995) Business process re-engineering: Some aspects of how to evaluate and manage the risk exposure. Proceedings of the
2nd European Conference on Information Technology Investment Evaluation, pp. 161-173. Rockart, J. F. (1979) Chief executives define their own data needs. Harvard Business Review 57, 81-93. Saaty, T.L.C. (1988) The Analytical Hierarchy Process. McGraw Hill, New York, USA.
Sloggy, J. E. (1984) How to justify the cost of an FMS. Tooling and Production 50, 72-75. Small, M. H. and Chen, J. (1995) Investment justification of advanced manufacturing technology: An empirical analysis. Journal of Engineering and Technology Management 12, 27-55. Strassmann, P. (1990) The Business Value of Computers. Information Economic Press, New Canaan, CT, USA. Strassmann, P. (1992) The politics of downsizing. Datamation (15 October) 106-110. Suresh, N. C. and Meredith, J. R. (1985) Justifying multimachine systems: An integrated strategic approach. Journal of Manufacturing Systems 4, 117-134. Swamidass, P. and Waller, M. (1991) A classification of approaches to planning and justifying new manufacturing technologies. Journal of Manufacturing Systems 9, 181-193. Wheatley, M. (1997) Hidden costs of the humble PC. Management Today (January) 52-54. Willcocks, L. (1994) Information Management: The
Evaluation of Information Systems Investments, ed. Willcocks, L. Chapman and Hall, London, UK, pp. 1-27. Willcocks, L. and Lester, S. (1991) Information systems investments: Evaluation at the feasibility stage of projects. Technovation 11, 283-302. Zahir Irani has a BEng (Hons) in Manufacturing Engineering and an MPhil in Manufacturing Systems from the University of Salford, UK. After leaving industry, where he worked for a numberof years in a project managementposition, he joined Brunel University and is now undertaking a PhD in the area of manufacturing information systems. Zahir has retained close links with industry, where he undertakes a number of consultancy roles, and operates as a non-executive director of Velden Engineering (UK) Ltd, advisingon manufacturingand technology strategies. He also has a number of other research interests in the area of business performance improvementwith respect to TQM, BPR, NPI and HRM. Zahir is a visiting research scholar at the Research Institute for Design, Manufacture and Marketing at the Universityof Salford, and has published in a number of internationally refereedjournals and spoken at conferences. He also referees papers for international journals. For further biographical details reference http://www.brunel. ac.uld~empgzni Jean-Noel Ezingeard is a lecturer in Computer Integrated Manufacturing in the
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Departmentof Manufacturing and Engineering Systems at Brnnel University. He is a general engineering graduate from Ecole Centraie de Lille, France. He obtained an MSc in Advanced Manufacturing Systems from Brnnel University in 1991. His PhD research was in the area of manufacturing information and data systems performance measurement and assessment. Dr Ezingeard is a Chartered Engineerand a memberof the Institution of Electrical Engineers, and is a committee memberof its
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Human Computer Integration professional group. His research interests are in the area of management of technology, focusing on manufacturing information and data systems. R.J. Grieve is a Reader in Manufacturing Systems in the Department of Manufacturing and Engineering Systems at Brunel University, UK. He received a BSc degree in Mechanical Engineering from the University of Salford, UK, and a PhD from the University of Manchester Institute of Science and Technology for work concerning the dynamics of the metal cutting process. He is an experienced researcher and consultant in the field of manufacturing processes and materials, industrial robot applications, manufacturing and information system integration and the problems of technology acquisition by industry.
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Technovation, 17(11/12) (1997) 695-706 © 1997 Elsevier Science Ltd All rights reserved. Printed in Great Britain 0166-4972/97 $17.00 + 0.00
Integrating the costs of a manufacturing IT/IS infrastructure into the investment decisionmaking process Z. Irani, J.-N. Ezingeard and R. J. Grieve Department of Manufacturing and Engineering Systems, Brunel University, Uxbridge, Middlesex UB8 3PH, UK
Abstract Due to the increasing level of organisational investment in Information Technology (IT) and Information Systems (IS), significant amounts of capital need justifying. However, many companies are reporting their inability to justify their investment in IT~IS because of the nature of costs and benefits associated with its implementation. The reason for this is that many organisational budgeting processes rely on financially oriented appraisal techniques as an integral part of the decision-making process. These accountancy frameworks are often used to assess the 'bottom-line' financial impact of an investment by setting tangible project costs against those quantifiable benefits and savings predicted to be achievable. However, traditional appraisal techniques are considered to be no longer appropriate in justifying investments in IT/IS because of the nature of intangible benefits, together with the complexity of direct and indirect cost implications. Hence, the predictive value of using many traditional investment appraisal techniques is increasingly being questioned. The authors of this paper have identified and then classified a variety of appraisal techniques that are used during the justification of capital investments in IT/IS. The taxonomy developed provides a critique of characteristics for both traditional and non-traditional appraisal techniques. The authors then identify a range of cost implications associated with the adoption of IT/IS, with a particular focus on manufacturing applications. These cost implications are then developed into a taxonomy of direct and indirect costs, which clearly need consideration during the investment decision-making process. © 1997 Elsevier Science Ltd. All rights reserved.
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1. INTRODUC'nON During the recession of the late 1980s and early 1990s many organisations were forced to reformulate their Information Technology (IT) and Information Systems (IS) budgets, which resulted in many companies significantly reducing their investments in new systems and technology. However, investment confidence in IT/IS appears to be rising again, with Cane (1992) reporting that the worldwide revenue from the IT industry generated an estimated revenue of $840 billion in 1985, $1490 billion in 1990 and $2100 billion in 1995. Further predictions suggest that, by the millennium, the whole IT industry will account for some 10% of world economic activity, which is a doubling of the 1990 figure (Heath and Swinden, 1992). These statistics are further substantiated by a recent 'Computers in Manufacturing Survey' (Bowman, 1996a), which reported an 8% rise in UK corporate IT expenditure during 1996. Further predictions estimate that in 1997, the level of IT investment in the UK will reach £3 billion. Similar investment statistics are cited in the United Stated, where Datamation (1996) reported an average IS budget rise of 6.2% during 1996. This rise in IT/IS expenditure is considered to be attributable to many industries turning to IT/IS to help deal with the ever more intensive competitive pressures faced by businesses. The momentum driving many IT/IS investments appears to be strategically oriented, with typical benefits including shorter time to market, quicker delivery responses, higher product quality, global trading and increases in flexibility (Randhawa and West, 1992). However, according to Bessant (1991), IT rarely lives up to its promises, and in reality has even led to reductions in productivity growth. Further evidence seems to indicate that this also applies to manufacturing companies, although much literature on Manufacturing Resource Planning (MRPII) seems to indicate various degrees of dissatisfaction (Burns et al., 1991). It therefore appears that large sums of money are being spent on IT/IS, with many techniques being available to help organisations evaluate their investments in this technology. However, according to Parker and Benson (1989), most Chief Executive Officers (CEOs) are not comfortable with the available set of tools and techniques used to justify their investments in IT/IS. It appears that these methodologies lack the precision in definition and results that CEOs expect. This may therefore suggest that those investment justification processes which are used to evaluate capital investments in IT/IS are imperfect, and that, secondly, many organisations feel uneasy and even dissatisfied with the appraisal techniques available.
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The authors of this paper report, through a review of the published literature, manufacturing industry's changing expectations of IT/IS, and identify the limitations of those traditional appraisal techniques used to evaluate the adoption of these technologies. The authors then present a classification of both traditional and non-traditional appraisal techniques, together with a taxonomy of direct and indirect cost factors. The paper finally concludes with those considerations that need integrating into a robust justification criterion which addresses the cost implications of an IT/IS infrastructure in a manufacturing environment.
2. INVESlMENTSIN IT/IS: A MANUFAClIJRING PERSPECTIVE Although the reduction of inventory holdings, reduced personnel levels, controlled levels of work in progress, improved stock turns etc. still feature strongly in the business demands of many manufacturing organisations, the issue is not to increase efficiency alone but to increase efficiency and effectiveness within the supply chain. As a result, Enterprise Resource Planning (ERP) or Manufacturing Resource Planning (MRPII) is often the natural choice, as it offers an information system approach towards helping businesses meet such requirements. Organisational investments in MRPII have changed little over recent years, with Bowman (1996b) reporting sales of MRPII packages accounting for 23% of total manufacturing software investments. However, despite years of investment in manufacturing management software, there are few signs of market fatigue. In the UK alone, over the last five years, the proportion of process companies using some variation of manufacturing management software has grown from 64% to 73%. This rise in sales represents a real increase of around 1000 new customers over a five-year period. A similar message is echoed by medium-sized UK manufacturing companies who employ between 200 and 500 people, In this sector, three-quarters of manufacturing companies have installed some form of manufacturing management system (Bowman, 1996b). This increasing level of MRPII sales may be attributable to: (i) the purchase of new software modules; (ii) the upgrade of existing modules; (iii) the need for more integrated business solutions; (iv) the misalignment between the business needs and current systems in operation; or (v) the implementation of new systems based on technological developments. However, the benefits achievable through the implementation of MRPII appear to have attracted only 25% of small manufacturing companies (those employing less than 200 people) in the UK
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(Bowman, 1996b). This would therefore suggest that the lack of project management skills, together with the perceived scope of benefit and cost implications associated with the adoption of MRPII, are of sufficient concern to discourage its widespread implementation. Yet many software and hardware vendors see this sector of the industry as a burgeoning opportunity, and forecast that small companies will invest in IT faster than any other sector because they are increasingly finding themselves unable to compete without a better IT infrastructure (Manufacturing Computer Solutions, 1997). The 1996 'Manufacturing attitudes' survey carried out by Benchmark Research (1996) and reported by Conspectus (1996) revealed that UK manufacturers see IT investments as crucial in enabling new approaches to manufacturing competitively priced goods. The survey also showed that manufacturers want their IT/IS systems to go beyond the confines of the shop floor, with many companies reporting their increasing need of IT/IS to take the strategic view of the organisation. The survey also reports industry's increasing needs for an enterprise-wide approach, which brings together product development, manufacturing, supply chain management and even the ability to manage a product's life-cycle. Manufacturers, according to the report, acknowledge significant IT/IS paybacks at departmental/operational level and now want IT/IS to deliver strategic transformational change at an enterprise-wide level. Further encouraging news from the 1996 'Manufacturing attitudes' survey is that UK manufacturers see IT/IS investments as their most significant weapon, in their bid to shorten the gap on the 'World Class competitive score board'. Fig. 1 provides a summary of the main survey conclusions on the impact of IT/IS on British manufacturing industry. The survey reports IT/IS as a key driver in reducing the so-called 'death of geography', as it allows Original Equipment Manufacturers (OEMs) to extend their design and manufacturing functions out to their suppliers, thus allowing a supplier and assembler at different global locations to work concurrently on the same manufacturing project and to share information across sites. Respondents to the survey (Benchmark Research, 1996) recognised the value of this extended enterprise model as the future of manufacturing; a future in which companies form strategic alliances in developing and manufacturing products, acting as one 'virtual' organisation which pools skills and resources towards a common goal. However, many UK manufacturers remain unable to take advantage of these possibilities, with the survey further reporting 70% of respondents still using 'paper systems' to disseminate
manufacturing information, and only 37% saying they use IT to manage information flows. Further key findings that are likely to accelerate investment in IT/IS are that 73% of UK manufacturers say the main competitive thrust for the UK manufacturing base will be as a provider of goods tailored closely to the customer's precise requirements. The survey reports that many organisations are beginning to consolidate their efforts in exploiting the potential of enterprise-wide systems that can deliver a whole host of savings and benefits at a strategic and operational level. This approach to justification appears to be preferred over the adoption of new technology based on the limitations of traditional departmental/operational benefits and saving. Therefore, the portfolio of savings and benefits achievable through the adoption of IT/IS would suggest the corporate justification process as simply being a capital budgeting formality. However, this is often not the case. Investments in IT/IS and MRPII, from a manufacturing perspective, offer many operational benefits and savings which can be easily accommodated within traditional accountancy frameworks. However, it is the nature of the intangible costs and benefits that they are often unable to be accounted for during traditional justification processes. As a result, many manufacturing companies are finding themselves unable to account for the full implications of their IT/IS deployments.
3. INVESTMENTDECISION-MAKINGPROCESSES Research into the justification of Computer Integrated Manufacture (CIM) suggests that the justification process is one of the major barriers to MRPII implementation (Huber, 1986; Boaden and Dale, 1990). In many manufacturing companies, a formal justification proposal must be prepared and accepted by the decision makers before any expenditure is sanctioned. Primrose (1991) identifies manufacturing industry's perception of investment justification as a budgetary process that gives a final 'yes' or 'no' - 'pass' or 'fail' verdict on the success of a project proposal. As a result, managers may view project justification as a 'hurdle' that has to be overcome, and not as a technique for evaluating the project's worth. This is particularly significant where, during the preparation of a project proposal, managers spend much time and effort investigating the technical aspects of the project. They become committed to the belief that, from a technical perspective, the investment is essential. However, they still have to produce evidence to jump the 'hurdle'. Therefore, team members may be easily susceptible to persuasion by vendors and con-
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sultants and may be prepared to accept untypical demonstrations which show unrealistically high levels of savings. Hence, project members may focus their efforts on trying to identify and estimate maximum benefits and savings, at the expense of overlooking the full cost implications. Traditional investment appraisal techniques, such as Return on Investment (RoI), Internal Rate of Return (IRR), Net Present Value (NPV) and Payback approaches, are often used to appraise capital investments in IT/IS (Willcocks, 1994). These methodologies are based on conventional accountancy frameworks, and are often facilitated under the auspices of the finance director. They are specifically designed to assess the bottom-line financial impact of an investment, often setting project costs against quantifiable benefits and savings predicted to be achievable (Hochstrasser, 1992; Farbey et al., 1993). However, the vast array of traditional and non-traditional appraisal techniques leaves many organisations with the quandary of deciding which approach to use, if any. Consequently, there has been much debate about the types of techniques that constitute meaningful justification (Small and Chen, 1995). Table 1 provides a summary of both traditional and non-traditional appraisal techniques, together with their respective literature sources. These techniques have then been grouped into four classifications: economic; strategic; analytical; and integrated. Furthermore, the classifications of economic and analytical approaches have been divided into two further groups.
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Economic appraisal techniques are structured in nature, and include those traditionally used by accountants. They are based on the assignment of cash values to tangible costs and benefits but largly ignore intangible factors. However, project risk can be acknowledged through the manipulation of variables. Strategic approaches are less structured in nature but combine tangible and intangible project implications, whilst acknowledging the impact of the project on the long-term future of the organisation. However, projects using this approach are considered somewhat risky. Analytical appraisal techniques are highly structured in design but subjective in nature, with their use often including tangible and intangible factors. These techniques are also able to acknowledge project risk. Finally, integrated approaches combine subjectivity with formal structure. These approaches integrate financial and non-financial dimensions together, through the acknowledgement and assignment of weighting factors to the intangible implications of the project. Here again, project risk can be integrated into certain techniques. The basis for the taxonomy presented in Table 1 is to classify the variety of techniques available through identification of their respective characteristics. Preliminary research presented by Farbey et al. (1992, 1994) proposes that project characteristics affect the way in which investment decisions are made. This therefore suggests that the use of a specific appraisal technique might be more appropriate for a particular investment. Hence, the objective of Table 1 is to identify the characteristics of traditional and non-traditional appraisal techniques, thus allowing the
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TABLE 1. Summary of appraisal techniques, approaches and references Appraisal technique Payback
Classification
Characteristics
Reference sources
Economic approach: (ratio-based)
Purely quantitative in terms of benefits and costs Purely quantitative in terms of benefits and costs Purely judgmental in nature
Economic approach: (discounting technique)
Huang and Sakurai (1990); Dugdale (1991) Pavone (1983); Suresh and Meredith (1985) Parker et al. (1988); Hares and Royle (1994) Kaplan (1984); Kakati and Dhar (1991)
Purely quantitative financial technique with possible modified hurdle rates to account for the qualitative or strategic aspect Purely quantitative financial technique Kaplan (1984); Hares and Royle 0994) with possible modified hurdle rates to account for the qualitative or strategic aspect Strategic decision as a measure of Meredith and Suresh (1986); Swamidass and Waller (1991); Naik and success Chakravarty (1992) Parker et al. (1988); Hocfistrasser Integration of strategic, operational and financial decisions into measures of (1992) success Rockart (1979); Hochstrasser and Purely judgmental in nature. Integration of strategic, operational and financial Griffiths (1991) decisions into measures of success Scoring technique with a formal Suresh and Meredith (1985) structure to a judgmental approach Nelson (1986) Scoring technique with a formal structure to a judgmental approach Scoring technique with a formal Saaty (1988) structure to a judgmental approach Optimised approach involving analytical Burstein (1986); Primrose and Leonard formulations with numerical solutions (1987) and different programming techniques Purely judgmental in nature. Scoring SwamidassandWaller (1991); Remenyi and Heafield (1995) technique with a formal structure to a judgmental approach Purely judgmental in nature. Scoring Meredith and Suresh (1986);Money et technique with a formal structure to a al. (1988) judgmental approach Purely judgmental in nature. Possible Sloggy (1984) integrated approach where strategic, operational and financial decisions are integrated into measures of success Garrett (1986); Kennedy and Sugden Purely judgmental in nature. Possible integrated approach where strategic, (1986) operational and financial decisions are integrated into measures of success Evaluation where financial aspects are Parker et al. (1988) considered first and strategic criteria applied next Possible integrated approach where Kaplan and Norton (1996) strategic, operational and financial decisions are integrated into measures of success
Return On Investment (ROI) Cost-Benefit Analysis (CBA) Net Present Value (NPV)
Intemal Rate of Return (IRR)
Technical importance/Research and development
Strategic approach
Competitive advantage
Critical success factors
Non-numeric
Analytic approaches: (portfolio)
Scoring models Analytical Hierarchy Process (AHP) Computer-based techniques
Risk analysis
Analytical approaches: (other)
Value analysis
Multi-attribute utility theory
Integrated approaches:
Scenario planning and screening
Information economics
Balanced scorecard
matching of the most appropriate appraisal technique to a particular investment project. The inability of many manufacturing companies to quantify the full implications of their MRPII investments, from both a cost and a benefit perspective, questions the predictive value of those organisational justification processes that are totally dependent on traditional appraisal techniques. The problem appears to lie in the unsuitability of those appraisal techniques
classified as economic approaches, with their sole reliance during the justification process suggesting selective investment appraisal. The reason for this is that these techniques only address tangible costs and benefits associated with the project, and are unable to accommodate the often significant strategic dimensions of many IT/IS investments. Furthermore, many of the costs associated with implementing new technology cannot easily be quantified and are therefore often overlooked (Hochstrasser, 1992). These factors
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have significant implications during the investment decision-making process and, as Small and Chen (1995) suggest, may force many companies to adopt one of the following strategies: (i) refuse to undertake IT/IS projects that could be beneficial to the longterm competitiveness of the organisation; (ii) invest in projects as an 'act of faith'; or (iii) use creative accounting to pass the budgetary process.
who suggest that many manufacturing companies fail to account for the full complement of IT-related costs. Hogbin and Thomas (1994) report the use of a contingency factor of between l0 and 25% of project costs being added to the identified costs, particularly in the initial business case. However, this figure will often depend on the types of costs incurred, together with the level of detail supporting the estimates and any other associated assumptions. A further l 0-15% may be added to include project management costs.
4. COSTIMPLICA'HONSOF IT/IS PROJECTS 4.1 the tendencyto underestimatecosts The costs of IT projects are often perceived to be easier to estimate than the benefits. However, this is rarely the case. The costs of IT/IS often appear more tangible in nature because the assumptions and dependencies on which they are based are often not fully acknowledged, or are poorly understood. It is considered widespread practice to account for the upper estimates for costs and the lower estimates for benefits during the investment decision-making process (Hogbin and Thomas, 1994). However, there may be political and organisational reasons for understating the cost implications of an IT/IS investment: the main one being the need to gain support for, and acceptance of, the project from senior managers. In a recessionary climate, a concern for cost justification, quick returns and indeed application of IT/IS for cost reduction purposes would seem to be paramount (Price Waterhouse, 1991). This again could pressure proponents of IT/IS into understating costs. Hochstrasser (1992) and Farbey et al. (1993) have reported the increasing actions of project champions - - project leaders who are totally committed towards the success of the investment and who often ignore the full cost implications of their IT/IS investment, including optimistic estimates of benefits and savings. This management practice may have severe project implications. For example, in the case of an MRPII system, which typically has high running costs, the failure to identify the full cost implications, when combined with the use of over-optimistic savings and benefits, may result in several extra years of use to achieve expected financial returns (Primrose, 1991). Hochstrasser (1992) points out that most companies tend to underestimate the total cost of their IT/IS projects, with between 30 and 50% of costs occurring outside the official IT/IS budget. In one large manufacturing company studied by Willcocks and Lester (1991), user department IS and training costs were 29% of total costs but were hidden in other departmental, often non-IS-related budgets. Further empirical evidence is offered by Ezingeard and Race (1996)
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Initial cost estimates which contribute towards determining the level of IT/IS investment required are often governed by the performance characteristics set during the system requirements planning stage. However, such estimates of system costs are often restricted to the following issues: (1) hardware and software performance required to process types and volumes of transactions; (2) the development work content needed to provide a given set of functions; (3) shared processing facilities, for example, terminals/peripherals and networks; (4) functions which are extra to a given user's immediate requirement - - for example, mandatory security facilities; (5) system design factors which might protect performance in the long term but which have shortterm development costs; (6) ongoing operating expenses; and (7) the balance of development costs against eventual maintenance costs. In addition, there is the issue of whether the entire project cost implications should include both direct and indirect cost factors (Hochstrasser, 1992; Hogbin and Thomas, 1994). In the instance of a new system, which can use available processing power, the investment cost may be calculated as a marginal cost of the processing power needed to run the extra application. This marginal cost may be acceptable for one new system but will lead to an understatement of the total costs for all systems. It is particularly the case where the full processing costs include operating and management expenses - - for example, the implementation of an MRPII system. Once the initial cost estimates of a proposed IT/IS system have been decided and the system justified, a process of recording the cost implications and allocating these cost factors to departmental budget often begins. This process is known as 'charge out' and is where the project costs are offset against the benefits achievable (Hogbin and Thomas, 1994). This management process has evolved from where IT costs
Integrating the costs of IT/IS
were once all in one centralised IT department. However, many IT costs are often incurred and accounted for at a departmental level, with each department buying its own hardware and software and sending people on training courses from its own departmental budget. Hence, without some structured mechanism of allocating cost implications at a departmental level, it would appear to be extremely difficult to keep track of exactly how much expenditure is IT related. Clearly, charge out is not an easy process or a management panacea, and should be seen as just one of the many techniques available in the management 'toolbag'. Additional techniques may also include, among other things, IT planning processes, project benefits appraisal, management performance measures and cost identification and control.
4.2 Acknowledgingdirect and indirect cost implications of an IT infrastructure As hardware and equipment costs continue to fall in price, IS-related human and organisational costs are set to rise (Wheatley, 1997). Strassmann (1990, 1992) concluded that at the US Department of Defense, for every $1 spent on IT equipment, a further $7 needed to be spent on people and training. Hochstrasser (1992) suggests that human and organisational costs can be as much as three to four times as high as direct project costs. Invariably, however, these costs are rarely fully budgeted for in IS investment proposals, and may partially explain the phenomenon of 'cost creep' which occurs over the course of most IS projects. The holistic cost implications of an IT/IS deployment can quite often be divided into direct and indirect cost factors (Hochstrasser, 1992; Hogbin and Thomas, 1994). Direct costs are those factors that can be easily attributed to the implementation and operation of IT. Although these costs often go beyond the initial user specification of the system, it is the focus made by senior management on these aspects which often dictates the project's budget and ultimate justification. Direct project costs are often underestimated and go beyond the obvious hardware, software and installation costs associated with an IT/IS infrastructure. Direct costs may also include unexpected additional hardware accessories such as increases in processing power, memory and storage devices. Installation and configuration costs are also classified as direct costs, and typically include consultancy support, installation engineers and networking hardware/software. Table 2 provides a summary of common direct costs associated with IT/IS projects, together with a selection of their respective examples.
However, it is often the indirect costs associated with the adoption of IT/IS that are more significant than those direct costs identified in Table 2. Indirect costs can largely be divided into human and organisational factors, with one of the largest indirect human costs being that of management time. This is the time that is specifically spent on integrating new systems into current work practices. Furthermore, as a result of newly adopted technologies, management may spend much time revising, approving and subsequently amending manufacturing and IT/IS related strategies. A significant amount of resource will also be used to investigate the potential of the IT/IS and in experimenting with new information flows and modified reporting structures. For example, an investment in MRPII affects the whole organisation, with the new system impacting on all employee job functions. Everybody will need time to absorb the new work practices at both an operational and management level. Wheatley (1997) suggests that a further indirect human cost, which is often overlooked, is that of system support and trouble shooting. He claims this cost factor to be the largest part of many IT/IS-related expenses. Indeed, many large firms are now finding it quicker and more efficient to employ their own technicians to provide this service. This appears to be the preferred option, over the reliance on software vendors who initially try to solve the problems remotely, and, when unable to, then make personal visits which add to the cost of the system. System support cost factors are often substantial, with Wheatley reporting the results of a recent survey which found that one-third of respondent companies could not estimate the additional cost of supporting IT/IS in relation to its original purchase price. The vast majority of those companies that did venture an estimate thought the cost to be a small fraction of the original cost of acquisition. However, one-quarter of companies thought that IT/IS support costs would be less than 20% of their purchase price, with only 4% prepared to concede that such costs might exceed the original purchase price. In fact, according to Wheatley's survey, which draws on estimates from industry analysts, typical lifetime support costs are at least 400% of the original purchase price. However, recent initiatives suggest that vendors are starting to perceive cost of ownership as the new 'competitive frontier' which can offer them a sales advantage. A final indirect cost implication may be a result of employees developing new skills, and therefore increasing their flexibility and overall contribution towards the organisation. Hence, they may then request revised pay scales. Any further costs associa-
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Direct IT/IS project cost implications
Direct project costs associated with IT/IS implementation Environmental operating costs Initial hardware costs Initial software costs Installation and configuration costs System development costs Project management costs Project overheads Training costs Maintenance costs Unexpected hardware costs Unexpected software costs Security costs Consumables
Examples of direct project costs associated with IT/IS implementations
Air conditioning facilities, uninterruptahle power supply, computer furniture File server, visual display unit (VDU), network printer MRPII package, operating system, networking software Management consultancy support, installation engineers, network wiring, junctions and connectors 'External' customising time, 'In-house' customising time Organisational resources: manpower, project planning tools, time Running costs: electricity, space. Networking costs: telecommunication time, rises in insurance premiums Vendor software familiarisation courses, upgrade training courses Yearly service contracts Secondary data and storage devices, upgrades in processing power Vendor software upgrades, operating systems upgrades Protection against viruses and abuse Print cartridges/ribbons, disks and paper
ted with employee pay and rewards, together with the cost implications of increases in staff turnover, clearly need integrating into a justification criterion. Table 3 provides a summary of the indirect human costs associated with the adoption of IT/IS. However, indirect costs are not simply restricted to human factors but encompass organisational issues as well. Organisational costs are caused by the transformation from old to new work practices, based on the impact of the new system. At first, a temporary loss in productivity may be experienced, as all employees go through a learning curve while adapting to new systems, procedures and guidelines. Additional organisational costs may also be experienced once the basic functions of the system are in place. These costs are associated with management's
TABLE 3.
attempts to capitalise on the wider potential of the system, at an enterprise/strategic level. Further costs include management's attempt to integrate information flows and increase its availability. An example of these costs in a manufacturing environment could be the development of an Electronic Data Interchange (EDI) link between a customer and the supplier's MRPII production schedule. This additional technology links an organisation to its customers and suppliers. The 'openness' in communication allows a customer to view its supplier's capacity before raising a purchase order, therefore preventing unrealistic delivery demands on the supplier. Alternatively, it may allow a supplier to view stock/buffer records to determine whether a delivery is needed. Hence, the implementation of MRPII may result in the adoption of a new 'knock-on' technology, together with its associated cost factors; but there are also 'knock-on' savings in efficiency, which need acknowledging.
Indirect human IT/IS project cost implications
Indirect human costs Management/staff resources Management time Cost of ownership; system support Management effort and dedication Employee time Employee training Employee motivation Changes in salaries Staff Turnover
Manufacturing application
Examples of indirect human costs
MRPI1 CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII CAD MRPII
Integrating computerised production planning and control into work practices Formalising the design process using computerised technology Devising, approving and amending IT and manufacturing strategies Devising, approving and amending IT, product design and manufacturing strategies Vendor support/trouble-shooting costs Vendor support/trouble-shooting costs Exploring the potential of the system Linking and integrating new systems together, e.g. CAM, DNC, C1M Detailing, approving and amending the computerisation of product BOMs Re-dranghting of essential drawings on the new computer system Being trained to manipulate vendor software, and training others Being trained and training others on the computerisation of the design function Interest in computerised production planning and control reduces as time passes Interest in automated design and draughting reduces as time passes Pay increases based on improved employee flexibility Pay increases based on improved employee flexibility Increases in interview costs, induction costs, training costs based on the need for skilled human resource Increases in interview costs, induction costs, training costs based on the need for skilled human resource
CAD
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Integrating the costs of IT/IS
Any additional 'knock-on' costs, direct and indirect, together with efficiency saving, will need to be taken into account during the justification of the IS (Willcocks, 1994). This is essential to allow for the complete functionality and potential of the new system to be achieved. Furthermore, the adoption of MRPII and any 'knock-on technology' is likely to result in the redesign of organisational functions, processes and reporting structures. As pointed out by Hochstrasser (1992), companies with extensive IT infrastructures in place tend to change their corporate shape by reducing the number of management levels. This is often achieved by redefining the role of many management functions, through increasing their flexibility and overall contribution to the organisation. The costs of organisational restructuring or business process reengineering are considered to be expensive, particularly if isolated groups within the company resist change and are unwilling to make the transition. These costs therefore need acknowledging and building into a justification costing structure. Table 4 provides a summary of the indirect organisational costs associated with the adoption of IT/IS.
5. CONCLUSIONS The authors of this paper have reported manufacturing industry's changing view of IT/IS, from its once operationally focused applications, which improved organisational efficiency, to their increasing strategic expectations. This long-term view of IT/IS as a mechanism that can deliver significant competitive advantage has been the driving force behind many corporate investments. However, this increasing level of expenditure has again identified the inadequacies of many investment decision-making processes. It appears that traditional approaches to project justification, i.e. economic, focus on nonstrategic, short-term, tangible benefits, with the larger 'enterprise-wide picture' often missing from the formal justification process. The authors of this paper have built on the research idea presented by Farbey et al. (1992, 1994), who propose that project characteristics affect the way in which investment decisions TABLE 4.
are made. This theoretical proposition has resulted in the authors of this paper developing a taxonomy of appraisal techniques and identifying their respective characteristics, thus allowing the matching of the most appropriate technique to a particular investment project. A further limitation in the use of those appraisal techniques identified as economic, in the taxonomy developed, is that they are often unable to accommodate the full cost implications of an IT/IS investment. Hence, the drawback of these approaches during project justification is increasingly becoming a barrier to the implementation of a manufacturing IT/IS project (Huber, 1986; Boaden and Dale, 1990), thus possibly affecting the competitiveness of many manufacturing organisations. The use of those economic investment appraisal techniques identified in this paper is further complicated by the largely ignored, and even when identified often underestimated, costs of an IT/IS investment. This inability to identify the 'true' costs associated with the adoption of IT/IS is considered to be attributable to the myopic approach adopted by many industries towards identifying the 'holistic' cost implications of IT/IS. Traditional justification processes based on the use of economic appraisal techniques tend to focus on direct cost factors, with the often more significant indirect cost implications being omitted from the formal decision-making process. This not only questions the 'value' of traditional justification processes but also has implications regarding the actual 'successes' of many IT/IS deployments. The reason for this is that many IT/IS investment decisions appear to be based on the consideration of the obvious and quantifiable. However, as empirical research suggests, indirect project costs can quite often be up to four times as high as the direct project costs. Therefore, many companies appear not to be identifying the full cost implications of their IT/IS investments, which may affect the overall project outcome. Many authors report that more research is required to identify the full cost implications of IT/IS. The authors of this paper have identified some of the direct and indirect cost factors associated with manufactur-
Indirect organisational IT/IS project cost implications
Indirect organisational costs Losses in organisational productivity Strains on organisational resource Business process reengineering Organisational restructuring
Examples of indirect costs Developing and adapting to new systems, procedures and guidelines Maximising the potential of the new technology through integrating information flows and increasing information availability The redesign of organisational functions, processes and reporting structures Covert resistance to change
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ing investments in IT/IS projects, with examples drawn from the literature. The identification and acknowledgement of these cost implications during an IT/IS deployment could avoid some of the difficulties encountered when using traditional approaches to investment justification. Furthermore, their identification will give companies a better insight into the actual implications and successes of their manufacturing IT/IS investments. However, the lack of widespread use of non-traditional appraisal techniques - analytical and integrated approaches - - as mechanisms for partially addressing some of the 'softer' indirect costs identified in this paper, would suggest a restriction of their application due to their complicated and subjective nature, and, more importantly perhaps, their lack of applicability in manufacturing environments.
Acknowledgements The authors of this paper would like to acknowledge the referees' comments which helped to improve the quality of this paper.
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Sloggy, J. E. (1984) How to justify the cost of an FMS. Tooling and Production 50, 72-75. Small, M. H. and Chen, J. (1995) Investment justification of advanced manufacturing technology: An empirical analysis. Journal of Engineering and Technology Management 12, 27-55. Strassmann, P. (1990) The Business Value of Computers. Information Economic Press, New Canaan, CT, USA. Strassmann, P. (1992) The politics of downsizing. Datamation (15 October) 106-110. Suresh, N. C. and Meredith, J. R. (1985) Justifying multimachine systems: An integrated strategic approach. Journal of Manufacturing Systems 4, 117-134. Swamidass, P. and Waller, M. (1991) A classification of approaches to planning and justifying new manufacturing technologies. Journal of Manufacturing Systems 9, 181-193. Wheatley, M. (1997) Hidden costs of the humble PC. Management Today (January) 52-54. Willcocks, L. (1994) Information Management: The
Evaluation of Information Systems Investments, ed. Willcocks, L. Chapman and Hall, London, UK, pp. 1-27. Willcocks, L. and Lester, S. (1991) Information systems investments: Evaluation at the feasibility stage of projects. Technovation 11, 283-302. Zahir Irani has a BEng (Hons) in Manufacturing Engineering and an MPhil in Manufacturing Systems from the University of Salford, UK. After leaving industry, where he worked for a numberof years in a project managementposition, he joined Brunel University and is now undertaking a PhD in the area of manufacturing information systems. Zahir has retained close links with industry, where he undertakes a number of consultancy roles, and operates as a non-executive director of Velden Engineering (UK) Ltd, advisingon manufacturingand technology strategies. He also has a number of other research interests in the area of business performance improvementwith respect to TQM, BPR, NPI and HRM. Zahir is a visiting research scholar at the Research Institute for Design, Manufacture and Marketing at the Universityof Salford, and has published in a number of internationally refereedjournals and spoken at conferences. He also referees papers for international journals. For further biographical details reference http://www.brunel. ac.uld~empgzni Jean-Noel Ezingeard is a lecturer in Computer Integrated Manufacturing in the
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Departmentof Manufacturing and Engineering Systems at Brnnel University. He is a general engineering graduate from Ecole Centraie de Lille, France. He obtained an MSc in Advanced Manufacturing Systems from Brnnel University in 1991. His PhD research was in the area of manufacturing information and data systems performance measurement and assessment. Dr Ezingeard is a Chartered Engineerand a memberof the Institution of Electrical Engineers, and is a committee memberof its
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Human Computer Integration professional group. His research interests are in the area of management of technology, focusing on manufacturing information and data systems. R.J. Grieve is a Reader in Manufacturing Systems in the Department of Manufacturing and Engineering Systems at Brunel University, UK. He received a BSc degree in Mechanical Engineering from the University of Salford, UK, and a PhD from the University of Manchester Institute of Science and Technology for work concerning the dynamics of the metal cutting process. He is an experienced researcher and consultant in the field of manufacturing processes and materials, industrial robot applications, manufacturing and information system integration and the problems of technology acquisition by industry.
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