That's not to say soft measures don't have a place. "These newfangled parameters, like sticky Web pages, were intended to help predict financial business impact of a project," observes Patwardhan of NIIT. In other words, it was felt that assessing the stickiness of a site would lead to certain probabilities of people actually buying from the site, or advertising on the site. But, somewhere along the line, people forgot this and simply stayed with the soft parameters. "As long as one uses the complete logical model for computation and factors in the right probabilities and risk assessment, there is nothing wrong with using soft parameters," Patwardhan says, but "when we forget that the purpose of using soft parameters is to describe the business model and how final financial numbers will get delivered, we have a problem."
To Basket, to Basket
Of course, useful financial metrics do exist, and there's really no reason not to use them. Hughes of BankWest is one CFO who believes in old-fashioned finance. "We stick to our cost of capital pretty rigorously," he says. When assessing IT proposals, he applies net present value (NPV) and payback period, and has adopted a self-styled approach to economic value added (EVA). "EVA has been an evolutionary thing within BankWest," he says. "While we haven't got to the point of saying, 'what is the fundamental EVA of a particular project?', arguably, an NPV combined with a couple of other things, you're sort of doing the same thing anyway." Hughes also looks at earnings per share and absolute profits. "Even though a project might have an NPV that's positive, it might be because five years out it delivers A$30 million (US$16 million), but next year it delivers a loss of A$10 million. So obviously there are P&L issues as well," he says.
There's a good reason why Hughes embraces this grab bag of measures. "The danger is you can choose not to do something just because it doesn't meet a particular measure," he says. "Don't just look at payback period and live and die on that. I'm a strong believer in not using 20 measures, but I think a small basket of metrics is prudent. Your business case assessment might fail on one of them, but pass on four of them — and that's okay," he adds.
This is particularly important when strategic projects are at issue. Discounted cash flow (DCF) techniques such as NPV and internal rate of return (IRR) work well with traditional capital budgeting problems, such as replacement decisions or alternative production methods. Where they fall down is on strategic investments, such as evaluation of new product lines or investment in R&D. Difficulty estimating the discount rate, forecasting the project's cash flows, estimating its impact on cash flows associated with other corporate assets, and estimating its effect on the company's investment opportunities and strategy, can all undermine the integrity of a calculation. What's more, DCF valuations assume the business will follow a predetermined or static plan, which isn't always how things work out.
"We have the usual problems, arguments, debates over the weighted average cost of capital (WACC) calculation," Hughes concedes. "Most accept that our WACC is as good as we can get it, but the issues we have relate to what discount rate should be used when we do an NPV, and for different projects," he says. Hughes says that generally, the organization is consistent in its approach, but also examines what-if scenarios. "This enables us to say, 'if we're wrong here and it's not 12 percent, and we applied 8 percent because of these three reasons, then let's acknowledge that the NPV changes accordingly,'" he explains.
In other words, flexibility is key. An acceptable payback period is determined by the type of project, Hughes says, and depends, fundamentally, on how much of an asset the company thinks it has created. "If we think we've created a 10-year asset, then we can cope with a three-year payback. If we think we've only created a 12-month asset, then we mustn't expect a three-year payback." Recently, for example, BankWest installed enterprise resource planning (ERP) software from U.S.-based Oracle. "An ERP project doesn't need to have payback within six months; it is going to be with us for a long time," Hughes says.
Power Plays
ECnet's Lo admits that at the time, he was nervous about choosing Great Plains Software to run his company's financials. "The company was not very well known in Singapore at the time and we were looking for a company that would be around 'forever'." Then, in late 2000, Great Plains was acquired by Microsoft — a development Lo admits helped him to feel better about his decision. "It's not just that one vendor could go bust. Many others are required to put a solution in place," he says. The backing of Microsoft is a bonus, he says, because of that company's central role in global technology platforms.
Indeed, Broadbent of Gartner says smart organizations are placing much greater emphasis on treating their IT-related investments as a portfolio. This, she explains, means "understanding that each time you make a decision about a particular investment, you don't make it on its own. You have to look at your total portfolio, look at the level of risk to which you are exposed at the moment, look at the organizational stress that is there and ask: How much more change can the organization take?"
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