Prioritizing a Portfolio of Information Technology Investment Projects

Abstract

Japan. He has ten years of management consulting experience and has advised Fortune 500 executives on information technology strategy and systems implementation. SUGATO BAGCHI is a Research Staff Member at the IBM Thomas J. Watson ResearchCenter in Yorktown Heights, New York. His current research interest is in valuation of information technology applications and infrastructure. He is currently working on the development and application of tools and techniques to help potential adopters of emerging technologies quantify the predicted benefits in terms of financial impact. Previously, he worked on knowledge representation frameworks and methodologies for business strategy formulation and on the design and implementation of a business process modeling and simulation tool for multi-enterprise supply chains. He holds a Ph.D. in Computer Science from Vanderbilt University. RYAN SOUGSTAD has seven years of experience in client sales and marketing with the IBM Corporation. He holds an MBA from the University of Texas at Dallas. His research interests center on information technology valuation and portfolio management. He has taught at the National American University in Rapid City, South Dakota, and is currently a doctoral student in Information Systems in the Carlson School of Management at the University of Minnesota ABSTRACT: Although the use of real options for valuation of information technology (IT) investments has been documented, little research has been conducted to examine its relevance for valuing and prioritizing a portfolio of projects. Complexities of IT projects along with the effect of project interdependencies raise several challenges in applying real options for prioritization of IT investments. We examine a large U.S.-based energy utility firm in a deregulated environment that is considering investment in a portfolio of 31 projects to provide a range of Internet-enabled energy services to customers. Using real data on expected project benefits and costs for different competitive scenarios, we develop a nested options model that extends prior research by incorporating the impact of project interdependencies to calculate the option value of all projects. Our nested options model provides a better understanding of project interdependencies on valuation and prioritization decisions, and provides insights Downloaded by [New York University] at 06:58 29 May 2015 34 BARDHAN, BAGCHI, AND SOUGSTAD into the business value of IT infrastructure projects that provide the managerial flexibility to launch future projects. We present a real options portfolio optimization algorithm for dynamic multiperiod portfolio optimization by incorporating the project values based on real options analysis in a portfolio management model with budget constraints.KEY WORDS AND PHRASES: business value, information technology, investment evaluation, net present value, portfolio optimization, real options analysis, sequential investment.THE VALUATION OF INFORMATION TECHNOLOGY (IT) investments is challenging because it is characterized...

Towards a Well-Founded Valuation of Managerial Flexibilities in IT Investment Projects - A Multidisciplinary Literature Review

“…As dcof of ITIPs are usually subject to different risk factors (e.g., unforeseen changing requirements or labor costs), assumption (A2) is also criticized by several authors (e.g., Angelou and Economides 2008; Bardhan et al 2004;Benaroch and Kauffman 1999;Kaufmann and Kumar 2008;Ji 2010;Schwartz and Zozaya-Gorostiza 2003), who make the case for uncertain dcof. Accordingly, several authors suggest that dcof follow GBM similarly to dcif and then apply the Margrabe Model (e.g., Bardhan et al 2004;Dos Santos 1991;Kumar 1996;Kumar 2002;Taudes 1998).…”

“…Accordingly, several authors suggest that dcof follow GBM similarly to dcif and then apply the Margrabe Model (e.g., Bardhan et al 2004;Dos Santos 1991;Kumar 1996;Kumar 2002;Taudes 1998). However, GBM does not seem to be plausible for all types of ITIPs especially if dcof mainly result from the following two sources: cash-outflows for IT infrastructure (e.g., hardware costs) and labor costs (e.g., software developers).…”

“…To value such real options most approaches featuring in the Information Systems (IS) literature use standard financial option pricing models such as the Black-Scholes model (BSM; e.g., Benaroch et al 2006;Heinrich et al 2011;Taudes 1998), the Binomial model (e.g., Kambil et al 1991;Khan et al 2013), or the Margrabe model (e.g., Bardhan et al 2004;Dos Santos 1991). However, these approaches are currently rarely applied by companies since managers are not satisfied with the results given that investment projects are far more complex than financial options.…”

“…To value managerial flexibilities in uncertain Information Technology Investment Projects (ITIPs) such as investments in standard software (e.g., Angelou and Economides 2008;Taudes et al 2000), individual software (e.g., Bardhan et al 2004;Schwartz and Zozaya-Gorostiza 2003), or new technologies (e.g., Benaroch and Kauffman 2000;Ji 2010) 1 , real option analysis (ROA) approaches are considered to be highly relevant by practitioners and researchers (cf., Benaroch et al 2006). To value such real options most approaches featuring in the Information Systems (IS) literature use standard financial option pricing models such as the Black-Scholes model (BSM; e.g., Benaroch et al 2006;Heinrich et al 2011;Taudes 1998), the Binomial model (e.g., Kambil et al 1991;Khan et al 2013), or the Margrabe model (e.g., Bardhan et al 2004;Dos Santos 1991).…”

Decision Support for IT Investment Projects

“…Commonly used net present value analyses tend to undervalue information technology investment projects (ITIPs) such as investments in standard software (e.g., Angelou and Economides 2008;Taudes et al 2000;Wu et al 2009), individual software (e.g., Bardhan et al 2004;Diepold et al 2011;Schwartz and Zozaya-Gorostiza 2003), or new technologies (e.g., Benaroch and Kauffman 2000;Ji 2010), 1 mainly because they neglect managerial flexibilities that can be exploited by project managers (cf., Benaroch et al 2006Benaroch et al , 2010Taudes 1998). In this context, real option analysis (ROA) for the valuation of managerial flexibilities in ITIPs has increasingly caught the attention of practitioners and researchers (cf., Benaroch et al 2006Benaroch et al , 2010.…”