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Erp benefits

  1. 1. Info Systems J (2002) 12, 301–320© 2002 Blackwell Science Ltd301Blackwell Science, LtdOxford, UKISJInformation Systems Journal1350-1917Blackwell Science, 200212Original ArticleIntangible benefits valuation in ERP projectsK E Murphy & S J SimonIntangible benefits valuation in ERP projectsKenneth E Murphy* & Steven John Simon†*College of Business Administration, Florida International University, Miami, FL 33199, USA,email: murphyk@fiu.edu, †Stetson School of Business and Economics, Mercer University,Atlanta, GA 30341, USA, email: simon_sj@mercer.eduAbstract. The development, implementation and ownership of information sys-tems, especially large-scale systems such as enterprise resource planning (ERP),has become progressively longer in duration and more cost intensive. As a result,IS managers are being required to justify projects financially based on their return.Historically, information systems have been difficult to quantify in monetary termsbecause of the intangible nature of many of the derived benefits, e.g. improvedcustomer service. Using the case study methodology, this paper examines anattempt by a large computer manufacturer to incorporate intangibles into traditionalcost–benefit analysis in an ERP project. The paper reviews the importance ofintangibles, lists intangible benefits that are important in ERP projects and dem-onstrates the use of a scheme through which they can be incorporated into tradi-tional evaluation techniques.Keywords: IT investment, ERP, intangibles, cost–benefit analysis, case study.INTRODUCTIONManagers responsible for forecasting the return from specific programmes, projects and newinitiatives have experienced a growing awareness of the relevance of success metrics thatelude financial quantification. Intangibles can tip the scale for (or against) the undertaking of aspecific project assuming that they can be properly evaluated. In those cases where financialmeasures of project success are employed, information technology (IT) managers often useonly easily estimable quantitative factors, primarily because these managers are often unableto capture many of the qualitative and intangible benefits that are expected (Farbey et al.,1992). Still, managers are tasked in increasing numbers with quantitatively justifying projectinvestments as ‘cost benefit analysis has assumed a pivotal position in the information systemsrevolution’ (Sassone, 1988).Sircar et al. (2000) discovered that IT investments have a strong positive relationship withsales, assets and equity, but not with net income. They also indicated that spending on IS staffand staff training is positively correlated with firm performance, even more so than computercapital. Analysis suggests that many of the derived benefits from information technology sys-
  2. 2. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320302tems are not accounted for as a result of the methods used to assess IT’s impact on the orga-nization (Cline & Guynes, 2001; Thatcher & Oliver, 2001). The fact that ‘many financialprofessionals believe that intangible assets are relevant to the understanding of a businessfirm’s earning prospects and future cash flows’ (King & Henry, 1999) provides evidence for theargument that intangible evaluation should be included in many project valuation settings. Thisproblem has grown as IT departments have advanced beyond implementing transaction-processing systems with relatively easily quantifiable returns to the implementation of man-agement information, decision support and enterprise resource planning (ERP) systems,which provide returns that are more challenging to quantify. Given the size of IT capital invest-ments and the increasing importance of intangibles in these investments, it is worthwhile toinclude these factors in IT project assessment.This paper provides a case study in which the Personal Computer Company (PCC; the nameis fictional, but the company is real), a manufacturer of personal and business systems, smallservers and laptops, is building the business case for a very large ERP implementation project.PCC routinely uses standard cost–benefit techniques to assess large investments; however, inthis case, PCC includes intangible factors within their financial analysis. It shall be observedthat careful effort was invested into obtaining reasonable financial estimates for the benefit ofimproved user satisfaction on the return on investment measures using a specific quantificationprocedure. It is observed that, even in this rare case in which intangible benefits are incorpo-rated into quantitative analysis, the technique is still limited to classes of intangibles that maybe valued relatively easily.DEFINITION AND RELEVANCE OF THE VALUE OF INTANGIBLESHistorically, the different treatment of tangibles and intangibles can be traced to the distinctionbetween goods and services. As far back as Adam Smith, goods were material and could bestored, whereas services were immaterial and transitory. This transitory nature meant that ser-vices could not be counted as assets, but goods could. Logically, then, items that had beencounted as investment must be tangible. This led to a definition of wealth as material objectsowned by human beings. The concept that tangible, material goods constitute wealth underliesthe national income accounting conventions used to determine asset value, profit, saving andinvestment. This logic fails to consider that many investments in today’s economy are intan-gible and that these investments yield higher profits that translate to greater output and sav-ings. One estimate suggests that an adjustment for R & D alone would raise US GDP roughly1.5% (National Science Foundation, 1998). This estimate suggests that, for many projects, thepayback period would be reduced and the return to the business would become proportionallygreater.The new International Accounting Standard (IAS 38; International Accounting Standards area set of globally accepted guidelines developed by the International Accounting StandardsBoard that seek to unify the way in which accounting information is reported. Additional infor-mation about IAS and the International Accounting Standards Board can be found at http://
  3. 3. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320303www.iasb.org.uk) defines an intangible as an identifiable non-monetary asset without physicalsubstance held for use in the production or supply of goods or services, for rental to others orfor administrative purposes (Bradbury, 2001). It is clear that this definition does not spell out thewide variety of intangibles that may arise in quantitative analyses. Certainly, many investmentsresult in legally recognized intangible assets that can be effectively valued, including copy-rights, e.g. Windows 2000, patents, e.g. Viagra, and improvements in processes and proce-dures for producing existing goods and services. However, how one effectively values thefuzzier assets of intellectual capital, intra- and interorganizational relationships, goodwill, orga-nizational change and brand equity remains an open question.Webster (1994) defines a tangible item as ‘something that is capable of being appraised atan actual or approximate value’. This definition leaves open the question of whether ‘value’refers to monetary worth or some other measure, e.g. customer satisfaction. Remenyi et al.(2000) admitted that there are different definitions of tangible and intangible benefits, andstated that ‘a tangible benefit is one that affects the organization’s bottom line’. This too leavesquestions unanswered for, in general, there is no debate that customer satisfaction (somehow)affects financial measures of performance. According to Hares & Royle (1994), ‘an intangibleis anything that is difficult to measure’. They argue that the boundary between tangible andintangible is fuzzy at best. In this paper, the definition of Remenyi et al. (1993) is used where‘a tangible benefit is one which directly affects the firm’s profitability’. The word ‘directly’ in thedefinition makes drawing a precise line between tangible and intangible benefits challenging;however, it is clear that an activity resulting in direct cost reduction is more tangible than onethat improves customer service. In this framework, quantifiable benefits are differentiated fromtangible benefits in that quantifiable benefits may be measured easily but may or may notdirectly affect a firm’s profitability (see Figure 1 for a framework based on Remenyi et al.,1993).There is evidence that all business disciplines are grappling with the issue of valuing intan-gibles in monetary terms. In finance, the value of reporting has been called into questionbecause the intrinsic value of the firm is much harder to determine for organizations with largenumbers of knowledge workers, high R & D and fast-changing markets. In fact, studies are cur-rently calling the generally accepted accounting principles (GAAP) into question (Condon,1999). GAAP states, for example, that money spent training staff is treated as an expense withno future value, yet businesses understand that the value of a well-trained staff exceeds thetraining expense. The existing accounting system is failing us (Cedar Group, 2001; Henry,2001; Wallis, 2001), suggesting that the value of people and expenses such as R & D are actu-ally assets that are not easily counted and that the old accounting principles are creating avalue gap. The statistics support this view. Additionally, Kennedy (2001) indicated a dualmethod for accounting that incorporates practices that could be adaptable to local regulations,including intangibles. Cooke et al. (2001) suggested that the key issues are the handling of tax-ation where intangibles are often problematic. Ryan & Harrison (2000), in interviews with over50 IT decision-makers, indicated that IT investments elude traditional valuation methodsbecause of hidden costs and benefits. A recent Arthur Andersen study of 20 years of data frommore than 10 000 publicly traded companies indicates that, between 1978 and 1998, the non-
  4. 4. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320304book value of all companies rose from 5% to 72% of market value, which implies that just 28%of value was reflected in the traditional balance sheet (Boulton et al., 2000)Lev & Zarowin (1999) examined three foundational pieces of reported financial information(earnings, cash flow and book value) for thousands of companies and then correlated thosevalues with changes in stock prices. Overall, they found that usefulness of financial informationhas been deteriorating over the past 20 years. They argue that the principal reason is that thecosts associated with change in the form of restructuring and R & D investment are expensedimmediately and that the benefits are experienced later. Easton (1998) presented a similarargument for large and small companies in Australia, stating that correlations between marketmeasures and balance sheet information are spurious. Barth et al. (2000) agreed with the pre-vious findings and suggested that intangible value is rarely accounted for or disclosed (espe-cially for knowledge-intensive companies), so the financial reports reveal less about the valueof some companies than about others.Marketers also understand that organizational performance is increasingly tied to intangibleassets such as customer relationships and brand equity. Lusch & Harvey (1994) observed thatlittle has been done in the past 20 years to project more accurately the true asset base of cor-porations in the global marketplace. They indicate that this failure to understand the contribu-tion of marketing activities to shareholder value continues to diminish the role of marketing incorporate strategy. Anderson & Narus (1996) illustrated how channel management throughcollaboration (an intangible asset) can improve customer service, thus improving customer sat-isfaction (another intangible).Operations managers are also aware of the relevance of intangibles with respect to orga-nizational effectiveness. Saaty (1998) called on quantitative researchers to make a fundamen-tal paradigm shift. According to him, ‘measuring intangibles is the most significant concernfacing anyone who wants to grapple successfully with the mathematics of (problems thatinvolve people and business)’. One of the major challenges for operations managers is in quan-tifying the linkage between product and service quality and economic measures. Athanasso-poulos (1997), for example, measured the quality of service provided in bank branches as oneFigure 1. IT benefits: classification and examples (adapted from Remenyi et al., 1993).
  5. 5. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320305aspect of measuring organizational effectiveness, but failed to link satisfaction with financialperformance. The lack of research linking standard service quality measurements such asSERVQUAL (Parasuraman & Grewal, 2000) to market measures indicates that managers stilldo not have the tools required to quantify the value of customer service properly.In the technology arena, as in the business areas discussed above, many projects deliverbenefits that cannot easily be quantified. These benefits include better information access,improved workflow and interdepartmental co-ordination, and increased customer satisfaction(Emigh, 1999). These are also the features that are listed as key attributes of ERP systems(Mullin, 1999; Davenport, 2000). ERP systems are implemented to integrate transactionsalong and between business processes. Common business processes include order fulfilment,materials management, production planning and execution, procurement and humanresources. ERP systems enable efficient and error-free workflow management and accountingprocesses including in-depth auditing. These systems feature a single database to eliminateredundancy and multiple entry errors, and they provide in-depth reporting functionality. Finally,because of their role as the core transaction system, ERP systems provide information foreffective decision-making on all organizational levels.INTANGIBLES IN IT AND ERP PROJECTSDetermining the intangible benefits derived from information systems implementation has beenan elusive goal of academics and practitioners alike (Davern & Kauffman, 2000). Remenyi &Sherwood-Smith (1999) indicated that there are seven keys ways in which information systemsmay deliver direct benefits to organizations. They also indicated that information systemsdeliver intangible benefits that are not easily assessed. Nandish & Irani (1999) discussed thedifficulty of evaluating IT projects in the dynamic environment, especially when intangibles areinvolved in the evaluation. Tallon et al. (2000) cited a number of studies indicating that eco-nomic and financial measures fail to assess accurately the payoff of IT projects and suggestedthat one means of determining value is through the perception of executives. They focused onthe strategic fit and the contributions of IT projects but indicated that researchers need some-how to capture or represent better the intangible benefits of IT. Giaglis et al. (1999) discussedthe problematic variables associated with qualitative (intangible) benefits in their assessmentof information systems evaluations. Litecky (1981) stated that, despite the perceived impor-tance of intangibles, there has been little if any guidance on the quantification of derived ben-efits. He proposed some assumptions as a precondition to quantifying benefits. First, bothtangible costs and benefits are relatively easy to estimate, whereas intangible benefits arequite difficult to estimate. Secondly, tangible costs are ordinarily much greater than tangiblebenefits, and intangible costs are often insignificant.Parker & Benson (1988) explained that, in order for enterprises to gain competitive advan-tage, the way in which IT is justified financially must change. Classical quantitative techniques,e.g. cost–benefit analysis, are not adequate for the evaluation of IT applications, except whendealing with cost-avoidance issues, which generally occur at the operational level. If these
  6. 6. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320306methodologies are to be expanded, additional measures, such as the perceived value to thebusiness, increased customer satisfaction and the utility of IT in supporting decision-making,must be considered (Katz, 1993). Clark (1992) found little guidance on IT’s contribution to cor-porate profits in the literature, but found firms focused on reliability of service, technical per-formance and business plan support, all items difficult to quantify accurately and express infinancial terms. Other studies found varying measures used for IT assessment including pro-ductivity improvements, user utility, impact on the value chain, business alignment (Wilson,1988), system quality, information quality, system use and user satisfaction (DeLone &McLean, 1992). Accampo (1989) contended that quantitative techniques can be hard to applyto activities in which information is the key commodity. Given that many of the measures foundin the IS literature and listed above to evaluate system success are intangible, traditional meth-ods of project evaluation fall short if these measures cannot be quantified in monetary terms.This problem becomes even more difficult when analysis encompasses changes to businessprocesses and information flows that impact on productivity and decision support.Hares & Royle (1994) indicated that there are four main intangible benefits in IT investment.These are shown in Figure 2. The first is internal improvement or infrastructure investment, andthe second is related to customers. The latter, the customer-oriented intangible benefits, con-sists of those services that the customer sees now and wants in the future and includes cus-tomer service and user satisfaction. The third and fourth sets of intangibles are future orientedand include spotting market trends and the ability to adapt to change.Figure 2. What are the intangibles? (adapted from Hares & Royle, 1994).
  7. 7. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320307Hares & Royle (1994) stated that the first set of ongoing intangible benefits are those con-cerned with internal improvement of company operations or performance. These includechanges in production processes, methods of operations management and changes to pro-duction value and process chains with resulting benefits in increased output or lower produc-tion costs. The second group of ongoing benefits, customer-oriented intangibles, is moredifficult to measure because their effectiveness is determined by external forces. The benefitsof improving customer service are greater retention of customers and customer satisfaction.The third group of intangibles embodies the spotting of new market trends. If new trends canbe anticipated, then technology may be able to transform or create products, processes or ser-vices to gain new sales and market position. The final group of intangible benefits is the abilityto adapt to change. As with the identification of market trends, the benefits derived includeadapting products and services to market trends and the modification of production processes– a critical ability for firms in rapidly changing industries. One way to interpret Hares & Royle’sframework is by observing that intangible benefits are more difficult to measure as the timehorizon over which they are being evaluated becomes longer. A second interpretation is thatexternally oriented factors, e.g. customer perceptions or market forces, are more difficult toassess than internal ones.Irani & Love (2001) proposed a different framework for the challenges associated with cat-egorizing benefits that is based on the work of Harris (1996). In a case study of an MRP IIinvestment, it was observed that, as one moves from strategically oriented IS projects throughtactical to operationally oriented projects, the benefits accrued go from those that are generallyintangible and non-quantitative in nature to more tangible and quantitative ones (see Figure 3for the nature of strategic, tactical and operational benefits). Clemmons (1991) argued that‘evaluation of a system’s development based on potential competitive impact is fundamentallyFigure 3. Nature of strategic, tactical and operational benefits (adapted from Irani & Love, 2001).
  8. 8. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320308different from cost’. According to Kaplan (1986), discounted cash flow and other analyticaltechniques are consistently misused when applied to strategic IT investments. The observa-tions of Clemmons (1991) and Kaplan (1986) are not surprising viewed in the light of the casestudy of Irani & Love (2001). Projects that are strategic are more challenging to value in finan-cial terms than those of an operational nature.ERP system investments are strategic in nature, with the key goal often being to help a com-pany grow in sales, reduce production lead time and improve customer service (Steadman,1999a). In fact, in a survey by Meta Group (Steadman, 1999b), organizations turned up anaverage value of –$1.5 million when quantifiable cost savings and revenue gains were calcu-lated against system implementation and maintenance costs. Improved customer service andrelated intangible benefits such as updated and streamlined technical infrastructure are impor-tant intangible benefits that organizations are often seeking when making these investments.Shang & Seddon (2000) provided a comprehensive framework of the benefits of ERP sys-tems. In their survey of 233 vendor success stories and 34 follow-up phone interviews fromthree major ERP vendors’ web sites, they found that all organizations derived benefits from atleast two of the five categories, and all the vendors’ products had returned customer benefitsin all five categories. Using these ERP benefits and the framework of Remenyi et al. (1993)(Figure 1), one may classify the benefits on a four-point scale as to their degree (low, some,mostly, fully) of tangibility and quantifiability. In Table 1, the ERP benefits are cross-categorizedaccording to this schema.This section introduced the topic of intangibles and related the importance of intangibles andtheir valuation to information systems. Additionally, ERP system valuation was discussed, anda framework for categorizing those benefits introduced. The next section presents the casestudy methodology and argues why it is valid with a brief overview of the importance of usersatisfaction in the IS arena. This is followed by the case of PCC examined in this study.RESEARCH METHODOLOGYCase study is now accepted as a valid research strategy within the IS research community(Klein & Myers, 1999). A series of well-known research investigations (e.g. Sambamurthy &Zmud, 1999; Reich & Kaarst-Brown, 1999) have used the case method to develop and supporta range of IS hypotheses. Case research moves away from rigour towards practicality, whichmay suggest more relevance for practitioners. The natural setting gives case researchers theopportunity to conduct situational and in-depth studies of complex phenomena that is notalways possible because of the restrictions on studies conducted under laboratory conditions.In natural settings, researchers are able to explain more clearly the causal links through real-life interventions, describe the real-life context in which an intervention occurred and explorethose situations in which the intervention being evaluated has no clear, single set of outcomes(Yin, 1990).To ensure the rigour and accuracy of information, the PCC case study used structured andsemi-structured interviews, individual analysis of transcripts, which was later verified by other
  9. 9. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320309researchers and company managers, business case models and briefing information suppliedby the company, and survey information obtained by the company from their suppliers andcustomers. During interviews with company officials, two researchers were always present.Sessions were recorded and transcribed by an independent service and then verified by bothresearchers and the company official (clarifications were made as necessary). Additionally,each researcher took notes during the interview. Those notes were later compared andmatched against the transcript to ensure accuracy. Finally, all the material (including briefingnotes, spreadsheets and business case models) obtained from company officials was inte-grated into the researchers’ notes and transcripts. A follow-on interview was conducted witheach official, who reviewed the information obtained during the initial session, confirmed theresearcher’s opinions and assumptions and answered any additional questions. The com-pany’s business case model was analysed by the researchers and incorporated into their find-ings. This model was reviewed before interviews and provided the basis from whichresearchers developed their questions for the semi-structured interview component.User satisfaction measures focus on a broad range of computer functions (Zoltan & Chapa-nis, 1982). Satisfaction has been used in the MIS literature as a surrogate for system success,especially in situations where use is mandatory. Baroudi & Orlikowski (1988) suggested thatend-user satisfaction can be evaluated in terms of knowledge or the user’s understanding ofthe system and its applications. A number of instruments have been developed for academicTable 1. ERP benefits framework and extent of tangibility and quantifiability (adapted from Shang & Seddon, 2000)Dimensions Subdimensions Tangible? Quantifiable?1. Operational 1.1 Cost reduction Full Full1.2 Cycle time reduction Most Full1.3 Productivity improvement Most Full1.4 Quality improvement Some Most1.5 Customer services improvement Some Most2. Managerial 2.1 Better resource management Some Most2.2 Improved decision-making and planning Some Some2.3 Performance improvement Most Most3. Strategic 3.1 Support business growth Some Full3.2 Support business alliance Low Most3.3 Build business innovations Some Some3.4 Build cost leadership Some Some3.5 Generate product differentiation Some Low3.6 Build external linkages Low Some4. IT Infrastructure 4.1 Build business flexibility for current and future changes Low Low4.2 IT costs reduction Full Full4.3 Increased IT infrastructure capability Some Some5. Organizational 5.1 Support organizational changes Low Low5.2 Facilitate business learning Low Low5.3 Empowerment Low Low5.4 Build common visions Low Low
  10. 10. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320310use in the information systems area (Bailey & Pearson, 1983; Ives et al., 1983; Doll & Torkza-deh, 1988). For this study, the researchers used the customer satisfaction instrument, an inter-nal form developed by the company and in use for a number of years. The form and dataanalysis were presented to the researchers; the company considers this information to be con-fidential and, as a result, only summary information is provided in this study.Although this study is presented as a single case study, during data collection and confir-mation, the researchers interviewed officials and collected data from a variety of levels withinthe organization and across divisions within levels. The ability to gather data from multiplesources allows researchers and managers alike to confirm the accuracy of data as it is col-lected and to extend the depth of the analysis as insights are gained. Additionally, interviewsconducted across organizational levels and functional areas provided the researchers withunique perspectives as to critical criteria towards project milestones and ultimate success. Inessence, this study was more a multiple case study conducted simultaneously within a singleorganization. Although the researchers and, in fact, the organization came to a single conclu-sion, the understanding of the process and contributing factors was strengthened using thetechnique described. Without the multiple data collection criteria, the insights gained in theproject would have been lost.THE CASE OF PERSONAL COMPUTER COMPANYPersonal Computer Company (PCC), a global personal systems hardware manufacturing,sales and distribution organization, had a successful history delivering and implementing awide range of business solutions. In the early 1990s, PCC faced very significant challengesthat included high operating costs, a bloated workforce and many redundancies across theglobe in manufacturing, research and design, which had put the organization in the red. Torevive its profitable legacy, PCC set forth a number of strategic imperatives that included firm-wide cost reduction, reduction of product development and deployment cycle, marketing as asingle global organization and streamlining the relationship between PCC and its customers.One part of implementing the plan for accomplishing these objectives was to put in place theintegrated supply chain that would include procurement, production and order fulfilmentprocesses.In examining the costs of operating the company, among other items, PCC’s corporatemanagement found that IT expenditures were excessive. Like many other multinational orga-nizations, PCC had, over the years, implemented and now operated a large number of non-integrated information systems to support their business throughout the world. Managementfelt that reduction of a number of legacy systems could be achieved through the use of an inte-grated software solution, i.e. an ERP system. To accomplish their goal of reducing costs andintegrating the supply chain, corporate managers established a relationship with a major ERPsolution provider. Although corporate management moved ahead with these new initiatives, theoperating problems, including inventory management and customer satisfaction, at PCC wereonly getting worse.
  11. 11. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320311At the beginning of 1997, managers in charge of re-engineering the supply chain in PCCwere directed to justify the large expenditure that would be required to implement the ERP sys-tem. The scope of the systems implementation project was to bring the ERP solution to theentire division, which included three major production facilities across the globe and variousother smaller facilities. In their published internal documentation, PCC stated that the per-ceived benefits of implementing the ERP system would include:• common processes across the globe;• centralized operations of PCC;• multilanguage and currency capabilities;• better tracking of inventory;• improved utilization of raw materials;• tighter integration of production with sales and distribution;• tax advantages through improved asset management;• removal of a number of existing legacy systems;• improved development and support environment;• real-time functional system enhancement capability.The first three benefits listed were considered strategic to PCC; instead of operating as sep-arate companies in multiple geographies, PCC would now provide a single face to the cus-tomer globally. The next four would benefit operations by providing additional visibility to thesupply chain, which would allow for improved ordering, inventory and demand management.Finally, the last three benefits listed here would significantly reduce costs of the IT function bothin operations and with respect to future system enhancements.Implementing ERP was a corporate initiative at PCC that had begun with the adoption ofSAP in March 1995. Several divisions within the corporation had implementation projectsongoing, and this included one of PCC’s facilities in Latin America. During this project a newleader (from the finance area) was put in charge of the division. He was concerned with theamount of money being spent to implement the ERP system and demanded that the teamassemble a business case for the project. The results would either cause the project to be can-celled or convince the leadership that it should be completely supported. This business casewas created as a joint effort between a finance department and the ERP implementation team.To justify all investments, PCC regularly used a traditional cost–benefit analysis methodol-ogy. To use the cost–benefit analysis methodology, PCC needed to estimate the costs andexpected financial returns over the expected life of the ERP solution. In the analysis, PCC man-agement used three measures to evaluate project return on investment: net present value(NPV) based on discounted cash flow; internal rate of return (IRR); and payback period. Thebusiness case was built assuming a 10-year time horizon and, for acceptance, it would requirea 20% hurdle rate for project acceptance on the IRR.The tangible factors considered in PCC’s business case can be summarized as inventoryreductions, productivity improvements, tax and accounts payable benefits and IT operationscost reductions. The tangible costs included the cost of development and deployment and, forthis, ‘high-end’ costs were used. These expenses were assumed to occur over the first three
  12. 12. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320312years of the 10-year time horizon. The cost of development and deployment was not dis-counted but, instead, expressed in actual terms. The cost of adapting the remaining legacysystems to the systems changes was not included in the business case.To calculate the benefits, very conservative revenue growth and profit margin assumptionswere made, and no benefit was assumed to commence until one year after implementation ateach site. Productivity was measured by the manufacturing output per system user. Produc-tivity in the production process was assumed to increase by 5% in years one and two afterimplementation and 10% per year thereafter. Similar figures (10% and 20%) were used forproductivity improvements in order fulfilment. In the Latin American facility, no productivityimprovements were included, because an earlier version of SAP R/3 was already installed.The benefits associated with inventory were measured as a function of inventory turns–theinverse of the cycle time of an inventory unit. If turns improve, then inventory cycle timedecreases, and the amount of inventory in process will decline. The ERP system was assumedto provide a one-time inventory reduction of 10% that would result from better management ofparts inventories, and this was assumed to occur one year after implementation. The bettermanagement of parts inventories is the result of the availability of real-time information aboutcurrent inventory levels and tighter integration with suppliers.The other benefits included in the case study were IT operations, taxes and an accounts pay-able improvement. IT operations costs were assumed to decline as a result of a reduction inthe number and complexity of systems in operation. Approximately 20 legacy systems wereslated for shut down. Tax benefits were assumed to occur from the more effective managementof assets, i.e. purchasing, which was formerly done by several systems, would now be stream-lined using a single system that would allow for quantity discounts and quicker payment turn-around. During the analysis, management decided not to include the accounts payable benefitin the business case. The cost–benefit estimates resulting from the above assumptions areshown in Table 2.As illustrated in Table 2, the result of the cost–benefit analysis indicates that the project’sreturn on investment is within acceptable parameters of a positive NPV and an IRR of >20%.This alone would allow the project to proceed. PCC, on the other hand, decided to extend thisconservative analysis to include intangible benefits [if the IRR had been below the hurdle rate,intangibles could become the factor(s) that determined project approval]. To accomplish thetask of incorporating the intangible benefit of customer satisfaction (PCC queried their cus-tomers every six months to obtain an internal measure of customer satisfaction. As their cus-tomer satisfaction instrument is proprietary, the researchers were granted access to theTable 2. Cost–benefit analysis (tangibles only) NPV($ millions)/IRRProductivity Inventory IT operations Implementation cost Total* IRR*18.8 49.1 23.4 (73.4) 28.1 39.20%*Tax benefits are included in these figures.
  13. 13. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320313instrument and data but were not allowed to include the instrument because of their non-disclosure agreement) into the financial analysis, a technique that bridges the gap between theintangible and tangible was required. Illustrated in Figure 4, the quantification technique ofHares & Royle (1994) applies a set of steps to convert the intangible benefit into cash flowwhich can be incorporated into the cost–benefit analysis. The steps in Hares & Royle’s pro-cedure include: (1) identify benefits; (2) make the benefits measurable; (3) predict the resultsin physical terms; and (4) evaluate the cash flow resulting from this intangible benefit.Anandarajan & Wen (1999) provided a similar technique for accomplishing the financialquantification of intangible benefits through the use of panels of stakeholders in the develop-ment process. In this technique, panels are queried to assess a probability distribution forfinancial gain or loss associated with tangible and intangible factors. These probability distri-butions are used to run risk analyses on the individual factors and with respect to the overallproject. Tayyari & Kroll (1990) argued that at least some intangible benefits can be quantifiedmore easily (either financially or in some other way) using surrogate indicators that are mea-surable. For example, better levels of customer satisfaction could lead to fewer follow-up calls,which would result in a headcount reduction. Improvements on these quantifiable measurescan be included in the analysis more easily as surrogates for the intangible. Demmel & Askin(1992) presented a hierarchical mathematical modelling approach that normalizes the objec-tives on strategic, tactical and operational levels to the same scale and optimizes to provide aranking of project alternatives. However, this technique does not result in a financial measurethat may easily be used by management for decision-making. Remenyi et al. (2000) stated thatthere are only two ways to put financial value on an intangible benefit –using negotiation orimputation. The negotiation method is the route that PCC chose (detailed below) as themethod that would be viewed as most valid by senior management.The literature suggests that intangibles can be converted into monetary terms through theability to (1) maintain and increase sales; (2) increase prices; (3) reduce costs; and (4) createnew business. Unfortunately, it is very difficult to convert a factor that is initially difficult to mea-sure into a retrievable dollar amount at the bottom of an income statement. The proceduredescribed below had been suggested by Hares & Royle (1994) and is used in this study by boththe researchers and the organization’s managers.The first step of the Hares & Royle procedure to quantify intangible benefits is the identifi-cation of the benefit to be quantified. Two useful sources of information to assist identificationFigure 4. The quantification technique (Hares & Royle, 1994).
  14. 14. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320314include critical success factors (CSFs) and a checklist of intangibles. Long before PCCembarked on their ERP evaluation project, the company’s managers knew that there were seri-ous problems with customer satisfaction, and several of the proposed benefits of the projectlisted related to customer satisfaction. PCC had been monitoring customer satisfaction forsome time using an annual survey with customers and suppliers, which indicated levels of sat-isfaction were down 21% and 15% respectively. Customers, in particular, had indicated thatthey had significantly better relations with PCC’s competition. Realizing that sagging satisfac-tion would soon translate into smaller market share and falling profit margins, senior manage-ment ranked satisfaction improvement as a key goal during system evaluation.The second step is to make the intangible benefits measurable. This consists of re-expressing the benefits described above in more measurable terms. It was opportune thatPCC had been collecting performance metrics and benchmarking the current level of customersatisfaction for some time. The data that PCC was collecting included the satisfaction level withPCC compared with other suppliers of similar products. PCC managers felt strongly that, if cus-tomer satisfaction could increase, then sales revenue would follow and, hence, sales revenuewas the number on which customer satisfaction improvement would be measured.The third step is to predict the benefit in physical terms. This step can be quite difficult withthe possibility of using many methods to convert measures into actual numbers. Reilly (1998)presented three methods to value proprietary technology (the market approach, the costapproach and the income approach), which will be the basis for the framework used here. Themarket approach involves investigating the benefits and costs of comparable projects in otherorganizations. The advantage of this method is that the firm gains from the lessons learnedfrom the past exercise. The disadvantage is that past projects are conducted in alternativebusiness environments, and the method uses backward-looking methodology. PCC hadalready finished a smaller but similar implementation project in another facility in its global net-work, but the customer satisfaction measures used by PCC were company wide so that thebenefits in sales revenue could not be estimated in this way.The cost approach attempts to estimate the benefits and costs of achieving the same func-tionality using alternative technologies, processes or human resources. This approach can beimplemented using a survey of informed stakeholders in the ERP project. Surveys are attrac-tive because (1) the perceptions of the company and customer can be aligned and an agree-ment of monetary equivalence can be attained; and (2) they can be forward-looking, which canlead to proactive actions to increase the value of the project. PCC did not use this approacheither, because the possibility of using another technology was not an option as the corporationhad already adopted SAP.In the income approach, the goal is to find out how much additional income or less cost willresult because of the new technology. In this method, one must obtain estimates from man-agement as to the costs and benefits that will be realized. Senior management whose oper-ations are supported by the project, but who are removed from project responsibility, shouldhave a major role in generating these estimates. The problem with management estimates isthat they are often based on past evidence and are therefore reactive; however, this was theprocess adopted by PCC.
  15. 15. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320315To complete the conversion of customer satisfaction from an intangible to a measurable fac-tor, PCC’s IS department compiled a list of customer-reported system deficiencies from the lastsatisfaction survey. Upon completion of the deficiencies list, IS managers examined eachitem’s performance in the current system and its expected result on the proposed ERP system(see Table 3 for a sample of the items). This procedure established a baseline from which themanagers could project the level of satisfaction improvement once the new system was inplace. Based on these performance improvements, managers throughout PCC and consultedinternal customers projected that, once deployed, the ERP system could improve customersatisfaction by 5% initially and approximately 2% per year thereafter (assuming that expecta-tions were met).The next major task in this analysis was to predict the monetary value to PCC of an increasein customer satisfaction. This step was also accomplished through management interviewsand surveys with PCC’s key customers and suppliers. The managers undertaking this projectwere those most familiar with customers, particularly those in the sales and marketing orga-nizations. The results of interviews with PCC’s internal and external customers suggested that,for each 5% improvement in customer satisfaction, PCC could expect a 1% gain in marketshare. The results, although not quantitative, indicated that customer satisfaction increasescould result in significant market benefits.The final step in the quantification technique is the evaluation in cash flow terms. This is asimple mathematical process with the volumes from the previous steps related to the monetaryvalue of the benefit. It is at this point that the technique can be merged with standard quan-titative techniques and the outcome of the project’s value can be measured. Based on the cashflow resulting from the customer market share improvements, the cost–benefit analysis wasredone and the results appear in Table 4.Table 3. Sample items for customer satisfaction surveyItem Current system Proposed ERP systemEnter pricing data 5–80 days 5 minCommitted ship date 1 day Real timeSchedule orders Overnight Real timeCredit check 15–20 min Real timeEnter order 30 min 5 minInquiry response 15–20 min Real timeShip and bill Overnight Real timeTable 4. Cost–benefit analysis (tangibles and intangibles) NPV($ millions)/IRRProductivity Inventory IT operations User satisfaction Implementation cost Total* IRR*18.8 49.1 23.4 228.7 (73.4) 228.9 124.00%*Tax factors are included in these figures.
  16. 16. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320316DISCUSSIONIn the face of significant threats to the bottom line, Personal Computer Company (PCC) man-agement was asked to justify in economic terms a large and ongoing investment in an ERPsolution. In the first cost–benefit analysis (Table 2), PCC management used estimates of pro-ductivity, inventory and other savings resulting from more effective information systems oper-ations to calculate the net present value (NPV) and internal rate of return (IRR) for the project.The NPV of productivity improvements and inventory reductions resulting from the new systemimplementation were estimated at $18.8 million and $49.1 million, respectively, over the 10-year time horizon used. The NPV for IT operations cost savings was estimated to be $23.4 mil-lion. The total NPV for the project was estimated to $28.1 million. Table 2 shows that the IRRfor this project was estimated to be 39.2%. Using these estimates, the ERP implementationproject appears to meet the hurdle rate criteria set by PCC management.In a subsequent quantitative analysis, many of the same cost and benefit figures were used,and the intangible item of customer satisfaction was included. The assumption made by PCCmanagement was that implementing the ERP system would have a significant and positiveimpact on customer satisfaction and hence improve the quantifiable item market share. Thisview was justified by ongoing customer surveys and data gathered through interviews with cus-tomers and sales managers. When customer satisfaction was factored into the equation, thenew total NPV for the project increased to $228.9 million, with an IRR of 124%.PCC’s senior project managers reported that, at the inception of the project’s evaluation, thecompany’s executive management sought an economic analysis oriented towards bottom-lineproject returns. At the completion of their analysis, the evaluation team reported some of theirconcerns that could potentially affect their analysis. Their concerns included (1) long imple-mentation lead times; (2) large initial investments for hardware and software; (3) increasing fre-quency of changes in technology; and (4) shortages of skilled technically knowledgeablepersonnel and knowledge workers. As a result of the successful evaluation and awareness ofthe related issues listed above, PCC’s executive and senior project managers were better pre-pared to evaluate the project, able to reorganize organizational priorities and view the system’scontribution holistically.As a result of the evaluation and analysis, PCC’s IS department was given approval to con-tinue to implement the ERP application. The implementation of the system, including replace-ment of legacy hardware and software, was conducted on time and on budget. During its firstyear of operation, the ERP system contributed over $225 million in savings and productivityimprovements, resulting in part from reduced IT operations and streamlined production pro-cesses. The results of the tangible and intangible cost–benefit analysis were convincing factorsthat led PCC to the decision to implement the system. Without the numerical results, executivemanagement would not have agreed to continue to move the project forward regardless ofanticipated benefits. Even with the analysis of tangible factors and the quantification of intan-gibles, there are many benefits of a large scale IS project that were not included in the overallbusiness case.
  17. 17. Intangible benefits valuation in ERP projects© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320317Regardless of tangible or intangible benefits, it is progressively more difficult to measuremanagerial, organizational and strategic benefits than infrastructure or operational benefits.This has been an issue of debate since information systems advanced beyond transactionprocessing systems. In particular, with ERP systems, success has been determined basedon the organization’s acceptance of the changes that the system introduces. Publicizedimplementation failures have been caused not because the system failed to perform asdesigned or desired cost savings targets could not be obtained, but as a result of a failure tochange the organization’s culture or in business process redesign (BPR), organizational andstrategic issues. Organizational and managerial classification benefits are not only the mostdifficult to obtain but also the hardest to quantify. As a result, we suggest that future researchefforts focus on the three as yet untapped benefit categories – managerial, organizational andstrategic.The fact that PCC used intangibles in their project evaluation is critical and illustrates thatorganizations are attempting to extend traditional evaluation techniques. The organization andits managers recognized the importance of intangibles such as customer satisfaction and itspotential impact on the bottom line. Despite the limited use of intangibles (operational and costavoidance only), their application provides a basis for advancing our understanding of thesetechniques. Future research should extend this work through devising methods to analyse themeasurement of intangibles that prove hard to quantify over extended periods of time. To assistin the development of improved cost–benefit models and methodology, future endeavoursshould examine and attempt to validate business cases similar to this one. Post hoc exami-nation of a project and its projected numerical targets will assist both academics and practi-tioners in refining models while assisting in studies of the total cost of ownership.CONCLUSIONSuccessful justification of large-scale systems implementation projects often requires financialvaluation, which in turn calls for monetary estimates of the benefits and costs that the projectwill entail. It is clear from the current business case and the literature review that certain antic-ipated benefits from systems projects are more challenging to quantify and attach financialvalue to than others. This dilemma is not restricted to information systems projects; in fact, inevery business, function researchers and practitioners alike have begun to grapple with thosebenefits that are hard to quantify, the intangibles. The growth in importance of intangible factorsparallels the movement from the product- and service-oriented economy to one that is basedon effective decisions, knowledge and collaboration.In this paper, information systems benefits have been classified with respect to severalframeworks: tangible vs. quantitative, temporal, external vs. internal, hierarchical (strategic,tactical, operational), and based on organization factors and technology infrastructure stan-dardization. It has been observed that benefits that are anticipated in the long term, that arestrategic and are oriented organizationally are quite challenging to quantify and value finan-
  18. 18. K E Murphy & S J Simon© 2002 Blackwell Science Ltd, Information Systems Journal 12, 301–320318cially. On the other hand, short-term, operationally oriented and IT infrastructure benefitsrequire relatively less effort to quantify and include in cost–benefit analyses. Paradoxically,ERP projects are often considered to be strategic imperatives, but are usually justified usingoperational factors.The managers at PCC worked hard to present a fair analysis of the financial return of theERP project. In their analysis, they included relatively tangible operational benefits often usedto justify projects, e.g. reduced headcount, reduced inventory costs and increased employeeproductivity. However, PCC managers went one step further by attaching financial value toanticipated improvements in customer service level within the cost–benefit calculations. Cus-tomer service level, although not always considered to be a strategic or long-term benefit, issignificantly more challenging to value financially than operational measures. Its link with thebottom line is not as clear as improvements in customer service and may depend on factorsboth outside the ERP system being evaluated and external to the PCC organization. The pro-cess that PCC followed to include customer service in their analysis demonstrates that intan-gibles can be included in financial calculations with careful consideration.The escalating expense of information systems and their growing importance to organiza-tions have made the justification of projects increasingly critical. This study demonstrated thattraditional cost–benefit analysis can be applied to large-scale information systems projectssuch as infrastructure and ERP. Extending the traditional methodology, the study illustratedhow intangible measures can be used to augment cost–benefit analysis and include what wasonce considered not measurable. This improved analysis provided PCC’s managers with amore accurate and realistic view of the returns expected as a result of undertaking the ERPimplementation.REFERENCESAccampo, P. (1989) Justifying network costs. CIO, 2, 54–57.Anandarajan, A. & Wen, H.J. (1999) Evaluation of informa-tion technology investment. Management Decision, 37,329–337.Anderson, J.C. & Narus, J.A. (1996) Rethinking distribu-tion: adaptive channels. Harvard Business Review, 74,112–122.Athanassopoulos, A. (1997) Service quality and operatingefficiency synergies for management control in the pro-vision of financial services: evidence from Greek bankbranches. European Journal of Operational Research,98, 300–313.Bailey, J.E. & Pearson, S.W. (1983) Developing tools formeasuring and analyzing computer user satisfaction.Management Science, 29, 530–545.Baroudi, J.J. & Orlikowski, W.J. (1988) A short form mea-sure of user information satisfaction: a psychometricevaluation and notes on use. Journal of ManagementInformation Systems, 4, 45–59.Barth, M.E., Kasznik, R. & McNichols, M.F. (2000) Valua-tion-based accounting research: implications for finan-cial reporting and opportunities for future research.Accounting and Finance, 40, 7–32.Boulton, R.E., Libert, B.D. & Samek, S.M. (2000) A busi-ness model for the new economy. Journal of BusinessStrategy, 21, 29–35.Bradbury, M. (2001) Accounting for intangibles. CharteredAccountants Journal of New Zealand, 80, 15–17.Cedar Group (2001) US GAAP’s effect on revenue recog-nition. Accountancy, 128, 98.Clark, T.D. (1992) Corporate systems management: anoverview and research perspective. Communications ofthe ACM, 35, 61–75.
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