Managing Information Technology Investments: A Capability-based Real Options Approach

Investments in IT have become a dominant part of the capital budgets of many organizations. While the costs seem readily identifiable, many of the benefits are elusive. As a result decision makers are faced with difficult questions: How should IT investments be designed and managed to ensure alignment with corporate strategy? How should such investments be prospectively justified? What more (than technology) is needed to realize the full potential of IT? What are the risk implications of these investments? How can the value of IT investments be managed over time? In this paper we develop a formal and practical methodology to evaluate information technology infrastructure investments. Our research provides a novel way of thinking about the elusive benefits of IT and proposes a new way of managing such investments. We recognize that the design and justification of technology investments must begin with the set of desired business capabilities that unfolds from the overall business goals of the firm. Investments are broadly defined as the physical assets (e.g., technology), the human capital (e.g., training) and the organizational structures (e.g., partnerships) that are needed to transform today’s business capabilities into those desired for the future. By investing in capabilities, an organization acquires options that enable management to react to changing business conditions by altering the timing, scale, and configuration of follow-on investments. Such actions modify the risk-return pattern of the investment outcomes. These options have significant value for the organization and can be estimated using a modified version of the techniques used to value financial options. Implementing this approach requires periodic monitoring, re-evaluation, and redesign of investment programs. Hence, investment decisions are not simply made once and handed over to project managers for execution, but rather, investments are managed over time. This shift from a project management to an investment management view requires that firms put in place a capability to enact an investment management process with requisite measurement metrics, monitoring schemes, and decision making authority. Finally, we illustrate the proposed investment management approach by analyzing how a Canadian mortgage banking firm leveraged imaging technology to build several important business capabilities. Further, we validate this approach by performing the analysis at a Research Center workshop whose participants were CIOs from large corporations. The results of this analysis are presented in the paper.