InformationWeek 500: Academic Research Yields Actionable Advice
What does the IW 500 data reveal about IT spending's connection to stock prices, outsourcing, and risk? Baylor business professor Kevin Kobelsky's research offers answers.
You Might Be Treating IT Projects As Too Risky
There's a productivity paradox around IT. Companies seem to underinvest in IT, given the extent to which it raises employee productivity. The likely reason: IT is seen as too risky, with the potential to blow up earnings. IT projects can fail or succeed spectacularly and can be devilishly hard to manage, so they increase risk and earnings volatility, much like a big equipment investment.
However, business leaders don't look closely enough at the competing effect that IT spending has on risk--it decreases risk. Because IT provides information that helps executives respond better and more quickly to the ups and downs of business, it lessens the bullwhip effect on earnings, making them less volatile. Which effect dominates depends on three major factors. In some cases, IT is associated with reduced future firm risk.
IT project and budget planners should consider which of these forces will dominate--the risk-increasing or risk-reducing side of IT. Three factors are key to watch. For small firms, undiversified companies, and high-growth businesses, the returns from IT spending are associated with higher risk, yielding the traditional risk-return trade-off. However, for companies that are large or diversified, IT spending and its related returns are associated with lower future firm risk. Low-growth firms also tend to enjoy returns from IT without increasing firm risk.
In estimating ROI for IT projects, companies shouldn't simply assume higher risk when discounting future IT returns. If a company is large or diversified, it should consider discounting IT returns less than other, non-IT projects vying for funds. If it's a low-growth firm, a similar discount rate for IT and non-IT projects should be considered. Otherwise, the company is likely passing on projects that should clear a risk-adjusted ROI hurdle.
"[Large or diversified firms] should consider adding a premium to benefit estimates rather than discounting them. This provides a new approach for valuing IT investments to complement traditional asset valuation and real options theory techniques. IT's coordination capabili-
ties may have a direct impact of reducing operating costs and increasing revenues, but they also have an important risk-reducing impact: the smoothing of income. The value associated with this business risk reduction could be incorporated as an expected outcome."