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Why TCO is not the best way to evaluate IT investments

Guy Cranswick | July 18, 2014
Measuring enterprise technology purchases in terms of investment ratios to operational revenues is not very sound.

IT investments

For nearly 20 years, IT has attempted to qualify and quantify the cost and value of technology investments.

But IT spending follows different paths depending on the objective and it's very important to distinguish what the word 'investment' means and how it is analysed.

In finance, investment will either overtly or implicitly mean a return, or a yield, such that any money invested will produce an income over the term of the investment and return on capital.

This is how technology investments with new products and public share offerings are valued and analysed. Technology investors in Cisco or a new startup, for example, will determine an investment on the basis of returns.

Enterprise technologies such as ERP applications, infrastructure, desktops and so forth, are applied to large capital investment programs that may or may not produce a direct return.

Obviously these investments produce an indirect return by enabling an organisation to function and allowing divisions of the business to fulfil their jobs.

But, generally, no direct income is derived from enterprise technology investments. Also, they are a depreciated asset, which will not produce a capital return either.

Measuring enterprise technology purchases in terms of investment ratios to operational revenues is not very sound and makes the definition of investment opaque.

These terms, which may be applied and measured accurately, acknowledge that technology is a cost, not necessarily a yield-producing investment.

This distinction in investment is very important because it leads to the dominant analytical techniques for evaluating enterprise technology investments.

Enterprise IT investments are typically assessed from the time of acquisition through to all the additional components of its operational costs and decommissioning. The overview of its total cost of ownership may endure for several years.

This methodology has one clear advantage in that it shows how much an investment will cost, and it can be used to compare different but comparable products. In addition, benchmark costs from similar organisations and technologies are used to empirically validate expenditure in comparative terms.

The value of this procedure is to gain a perspective over the life of an investment and to assess expenditure relative to others.

It's like buying and using a car for several years. The car does not produce a yield, it enables mobility. Its costs per annum can be assessed relative to other cars in the same category, thus a buyer can evaluate relative value in terms of cost, comfort, efficiency, and status.

The expense of the car is an investment in the sense that it is a substantial sum to purchase and operate the vehicle, not that the car produces a yield over its use period.

 

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