How Financial Firms Decide on Technology
(Abstract)
The financial services industry is the major investor in information technology(IT) in the US economy the typical bank spends as much as 15 of nonintereste expenses on IT A persistent finding of research into the performance of financial institutions is that performance and efficiency vary widely across institutions Nowhere is this variability more visible than in the outcomes of the IT investment decisions in these institutions This paper presents the results of an empirical investigation of IT investment decision processes in the banking industry The purpose of this investigation is to uncover what if anything can be learned from the IT investment practices of banks that would help in understanding the cause of this variability in performance along with pointing toward management practices that lead to better investment decisions Using PC banking and the development of corporate Internet sites as the case studies for this investigation the paper reports on detailed fieldbased surveys of investment practices in several leading institutions
How Financial Firms Decide on Technology
(Part One)
信息技术金融服务业影响正增加仅仅表现银行15息开支金融服务业运做战略强影响
金融机构长期研究表明机构效率表现决定素中素投资决定理SBS失败例子成功公司少文注重解答问题:
1银行IT投资评估理程?
2IT理程中理实际操作结合?
3IT投资理银行性关系?
10 Introduction
Information technology(IT) is increasingly critical to the operations of financial services firms Today banks spend as much as 15 of noninterest expense on information technology It is estimated that the industry will spend at least 211 billion on IT in 1998 and financial institutions collectively account for the majority of IT investment in the US economy In additon to being a large component of the cost structure information technology has a strong influence on financial firms operatons and strategy Few financial products and services exist that do not utilize computers at some point in the delivery process and a firms'information systems place strong constraints on the type of products offered the degree of customization possible and
the speed at which firms can respond to competitive opportunities or threats
A persistent finding of research into the performance of financial institutions is that performance and efficiency varies widely across institutions even after controlling for factors such as size(scale) product breadth(scope) branching behavior and organizational form(eg stock versus mutual for insurers banks versus saving & loans) Given the central role that technology plays in these institutions at least some of this variation is likely to be due to variations in the use and effectiveness of IT investments While some authors have argued that the value of IT investment has been insignificant particularly in services recent empirical work has suggested that IT investment on average is a productive investment Perhaps more importantly there appears to be substantial variation across firms some firms have very high investments but are poor performers while otheres invest less but appear to be much more successful Brynjolfsson and Hitt found that as much as half the returns to IT investment are due to firm specific factors
One potentially important driver of differences in IT value and of firm performance more broadly is likely to be the decision and management peocessed for IT investments Horror stories of bad IT investment decisions abound Consider the example of the new strategic banking system(SBS) at Banc One(American Banker 1997) Banc One Corp and Electronic Data Systems Corp agreed last year to end their joint development of this retail banking system after spending an estimated 175 million on it As stated in the American Banker article SBSwas just so overwhelming and so complete that by the time they were getting to market it was going to take too long to install the whole thing said Alan Riegler principal in Ernst & Young's financial services management consulting division However not all the stories are negative New IT systems are playing a vital role in reshaping the delivery of financial services For example new computertelephony integration(CTI) technologies are transforming call center operations in financial institutions By investing in technology more and more institutions are moving operations from highcost branch operations to the telephone channelwhere the cost per transaction is onetenth the cost of a teller interaction This IT in
vestment not only reduces the cost of serving existing customers but also extends the reach of the institution beyond its traditional geographic boundaries
In this paper we utilize detailed case studies of six retail banks to investigate several interrelated questions
1What processes do banks utilize to evaluate and manage IT investments
2How well do actual practices align with theoretical arguments about how IT investments should
be managed
3What impact does that management of IT investments have on performance
How Financial Firms Decide on Technology
(Part Two)
For the first question we develop a structured framework for cataloging IT investment practices and then populate this framework using a combination of surveys and semistructured interviews We then compare the results of this exercise with a synthesis of the literature on IT decision making to understanding how practices vary across firms and the extent to which this is consistent with best practices as described in previous literature Finally we will compare these processes to internal and external performance metrics to better understand which sets of practices appear to be most effective
To make these comparisons concrete we examine both the general decision process as well as the specific processes used for two recent IT investment decisions the adoption of computerbased home banking (PC banking) and the development of the corporate web site These decisions were chosen because they were recent and are related but provide some contrast in particular PC banking is a fairly well defined product innovation while the corporate web presence is more of an infrastructure investment which is less welldefined in terms of objectives and business ownership
Overall we find that while some aspects of the decision process are fairly similar across institutions and often conform to best practice as defined by previous literature there are several areas where there is large variation in practice among the banks and between actual and theoretical best practice Most banks have a strong and standardized project management for ongoing systems projects and formal structures for insuring that linemanagers and systems people are in contact at the initiation of technology projects At the same time many banks have relatively weak processes(both formal and informal) for identifying new IT investment opportunities allocating resources across organizational lines and funding exploratory or infrastructure projects
with long term or uncertain payoffs
The reminder of this paper is organized as follows Section 2 describes the previous literature on performance of financial institutions and the effects of IT on performance Section 3 describes the methods and data Section 4 describes the current academic thinking on various components of the decision process and compares that to actual practices at the banks we visited Section 5 describes the results of our indepth study of PC banking projects and the summary Section 6 contains a similar analysis for the Corporate Web Site and discussion and conclusion appear in Section 7
How Financial Firms Decide on Technology
(Part Three)
20 Previous Literature
21 Performance of Financial Institutions
There have been a number of studies that have examined the efficiency of the banking industry andthe role of various factors such as corporate control structure (type of board directors insider stock holdings etc) economies of scale (size) economies of scope (product breadth) and branching strategy see Berger Kashyup and Scalise (1995) and Harker and Zenios (forthcoming) for a review of the banking efficiency literature While there is substantial debate as to the role of these various factors there is one unambiguous result that most of the (in) efficiency of banks is not explained by the factors that have been considered in prior work For example Berger and Mester (1997) estimate that as much as 6590 of the xinefficiency remains unexplained after controlling for known drivers of performance A similar story also appears in insurance where xefficiency varies substantially across firms when size scope product mix distribution strategy and other strategic variables are considered It has been argued that one must get inside the black box of the bank ot consider the role of organizational strategic and technological factors that may be missed in studies that rely heavily on public financial data
22 Information Technology and Business Value
Early studies of the relationship between IT and productivity or other measures of performance were generally unable to determine the value of IT conclusively Loveman (1994) and Strassmann (1990) using different data and analytical methods both found that the performance effects of computers were not statistically significant Barus Kriebel and Mukadopadhyay (1995) using the same data as Loveman found evidence that IT improved some internal performance metrics such as inventory trunover but could not tie these benefits to improvements in bottom line productivity Although these studies had a number of disadvantages (small samples noisy data ) which yielded imprecise measures of IT effects this lack of evidence combined with equally equivocal macroeconomic ananlyses by Steven Roach (1987) implicitly formed the basis for the productivity paradox As Robert Solow (1987) once remarked you can see teh computer age everywhere except in the productivity statistics
More recent work has found that IT investment is a substantial contributor to firm productivity productivity growth and stock market valuation in a sample that contains a wide range of industries Brynjolfsson and Hitt (19941996) and Lichtenberg (1995) found that IT investment had a positive and statistically significant contribution to firm output Brynjolfsson and Yang (1997) found that the market valuation of IT capital was several times that of ordinary capital Brynjolfsson and Hitt also found a strong relationship between IT and productivity growth and taht this relationship grows stronger as longer time periods are considered Collectively these studies suggest that there is no productivity paradox at least when the analysis is performed across industries using firmlevel data The differences between these results and earlier studies is probably due to the use of data taht was recent more comprehensice and more disaggregated (firm level rather than industry or economy level)
Most previous sutdies have considered the effects of technology across firms in multiple industries although a few studies have considered the role of technology in specifically in the banking industry Steiner and Teixiera surveyed the banking industry and argued that while large investments in technology clearly had valuelittle of this value was being captured by the banks themselves most of the benefits were being passed on to customers as a result of intense competition Alpar and Kim examined the cost efficiency of banks overall and found that IT investment was associatied with greater cost efficiency although the effects were less evident when financial ratios were used as the outcome measure Prasad and Harkere examined the relationship between technology investment and performance for 47 retail banks and found positive benefits of investments in IT staff
While these studies show a strong positive contribution of IT investment on average they do not consider how this contribution (or level of investment )varies across firms Brynjolfsson and Hitt found that firm effects can account for as much as half
the contribution of IT found in these earlier studies Recent results suggest that at least part of these differences can be explained by differences in organizational and strategic factors Brynjolfsson and Hitt found that firms that use greater overall IT benefits Bresnehan Brynjolfsson and Hitt found a similar result for firms that have greater levels of skills and those that make greater investments in training and preemployment screening for human capital In addition strategic factors also appear to affect the value of IT Firms that invest in IT to create customer value (eg improve service timeliness convenience variety) have greater performance than firms that invest in IT to reduce costs
While these studies are begining to explore how the performance of IT investment varies across firm particularly due to organizational and strategic factors little attention has been paid to the technology decision making process
How Financial Firms Decide on Technology
(Part Four)
23 IT Investment Decisions
While there is no concise definition of best practice in IT investment decisions there are a number of consistent arguments advanced in the IT management literature that can be synthesized into an understanding of the conventional wisdom
For the pruposes of discussion it is useful to subdivide the process of IT management into seven discrete but interrelated processes The first six processes are oriented around the proposal development and management of IT projects while the last process is about maintaining the capabilities of the IT function and its interrelationships with the rest of the business
1Identification of IT opportunities
2Evaluating opportunities
3Approving IT projects
4The makebuy decision
5Managing IT projects
6Evaluating IT projects
7Manage and Develop the IT Function
This subdivision loosely corresponds to many of the major issues in IT management such as outsourcing line managementIT alignment software project management and evaluating IT investments
In addition this list loosely corresponds to frameworks for the management of IT The primary difference is that this list views the IT management process as managing a stream of projects rather than focusing on the function of the IT de
partment overall or the role of the CIO the typical perspective in the previous literature For example a common framework used to align IT to business starategy the critical success factors(CSF) method include three workshops the first to identify and focus objectives the second to decide and prioritize on systems investment and the third to develop deploy and reevaluate prototype systems Boynton Jacobs and Zmud(1992) identify five critical IT management processes setting strategic direction establishing infrastructure systems scanning technology transferring technology and developing systems Rockart Earl and Ross(1996) propose eight imperatives for the IT organization which can be grouped into managing the ITbusiness relationship building and managing systems and infrastructure managing vendors and creating a high performance IT organization Thus while previous work has subdivided the process in different ways collectively the studies cover all the seven processes we examine
We will discuss each of the individual points in detail below
231 Identificant of Opportunities
Historically the IT function was primarily reactive responding to requests by business units A business unit A business unit manager would identify a need for a new system or a repairenhancement to an existing system and communicate this need to the IT function The IT personnel would then evaluate the idea for technical feasibility and develop a project proposal include an initial determination of resource needs cost and delivery time While this makes effective use of IT personnel in evaluating particular ideas it provides only a limited role for IT personnel to aid in the identification of technologybased business opportunities
For that reason some authors have suggested that the IT function should play a larger role in the identification of technological opportunities For example Davenport and Short (1990) emphasize that IT capabilities should inform business needs as well as the business units placing demandson the IT function Fockart Earl and Ross and Boynton Jacobs and Zmud identify the role of technology scanning and technology education as an important component of a centralized IT department they argue that information systems specialists should be reponsible for evalusting new technologies for business applicability since business units will generally lack the resources or the technological capability to perform these evaluations themselves Moreover central IT is best positioned to educate the end uses to make them good custmers of the central IT group
In the banking industry IT may be able to play an additional role in coordinating technology Because banks and other financial firms are often managed w
ith largely autonomous business units (for example banks are often divided into product lines cash management investmentor along customer segmentswholesale commercial retail) only the central IT function will have a perspective over the porfolio of systems projects and capabilities One critical role in this respect is the provision and development of the shared IT infrastructure (eg central processors networks software standards etc) Often these projects naturally span business units such that the only ral owner is the IT function also they generally tend to be highly technical and thus the natural responsibility would also fall on the IT department
How Financial Firms Decide on Technology
(Part Five)
232 Evaluating Oppoutunities
Once a project is at least initially defined there is a process by which the initial idea is converted into a proposal that can be evaluated by management for approval or rejection of funding
In the last ten years it has become more or less standard practices to develop a business case or business plan for any substantial IT investment (some small maintenance projects are simply done on request) although the content sophistication and formality of this process varied substantially The most typical of these project proposals (assuming a midsize to large project) take the form of a business plan which includes a qualitiative description of the objectives competitive environment a description of the opportunity and in some cases an implementation plan While the form of these plans varies widely there are some general points of comparison
For the qualitative portion the major issue is whether the plan explicitly addresses changes in the business environment or is primarily inward focused For minor systems enhancement projects with no strategic objective (or even major investments that are not strategic such as year 2000 repairs) it makes sense for the plan to focus entirely on internal issues However to the extent that the investment is made for competitive reasons or is likely to spur a reaction from competitors it is important to qualitatively evaluate whether the business environment will remain static and if not examine possible scenarios that are likely to occur The assumption of a static business environment is a common decision bias that can particularly plague strategic IT investments Clemens (1991) terms this the trap of the vanishing status quo
For the quantative financial evaluation most IT evaluation methods have their roots in traditional capital budgeting procedures such as discounted cash flow analysis(DCF) However while these techniques can work well for projects where costs and benefits ar well defined (eg purchasing offthe shelf software in pursuit of operational cost savings) it is increasingly recognized that simple application of DCF approaches is not sufficient for IT investments This is because much of the value of modern IT investments is likely to be difficult to quantify such as revenue enhancements or cost savings through improved customer service product variety or timeliness One commonly used stategy is to value nonquantifiable benefits at zero although this strategy will systematically bias project evaluations to unnecessarily reject projects
Recognizing the limitation of the DCF approach several alternative approaches have been proposed One method is to base tghe case entirely on qualitative analysis unfortunately this approach often leads to hightly subjective judgements and is likely to err on the side of accepting bad projects Kaplan recognizing this problem in the context of evaluating computer integrated manufacturing (CIM) proposed using a variant of DCF a firm calculates the present value of the investment using all the components that can be quantified and then compares this prliminary value to the qualitative list of other benefits and costs In other cases where the evaluation is make difficult because of future uncertainties (eg market growth and acceptance response of competitors ) decision trees or other types of probability based assessment tools may simplify investment decisios Finally for some types of investments or decisions (for example the decision whether to invest immediately or defer) advanced techniques such as real options can be applied
Although this discussion has focused primarily on evaluating the benefit part of the quantitative evaluation there are other difficulties in estimating the cost of IT projects particualarly those involving software development Existing models such as COCOMO of function points estimation are known to improve the ability to predict project length staffing requirements and total costs although they are k own to be systmeatically off by as much as 400 However the accuracy of these estimates can also be improved later in the project when specifications are well defined or by customizing the models to the experience of a particular organization However despite the fact that these tools and approaches are readily available many firms still utilize seat of the pants estimants or lock in schedules and cost estimants before the projects are fully defined
How Financial Firms Decide on Technology
(Part Six)
233 Approving IT Projects
Once a project has been evaluated and a formal project proposal exists there are a variety of mechanisms that are used to determine which projects should be funded Most institutions have some form of committee structure similar to capital budgeting committees which is responsible for evaluating modifying and approving projects
Most of the previous literature on the management of IT has focused on the socalled IT steering committee which is an executive level group often comprised of the heads of business units or their direct reports The objective of this committee is to ensure that IT strategy is aligned with business unit strategy projects are coordinated across business units where there are possible synergies and to educate the business unit managers on the both the actual activities of the IT group and the potential IT opportunities
234 MakeBuy Decisions(Outsourcing)
At the inception of any project a firm has the choice of whether to utilize their internal resources in the IT department (insource) or utilize an outside vendor for any or all of a project(outsourcing) While the market for outsourced services has existed since sale of the first corporate computers the size of the outsourcing market has grown dramatically in recent years and is expected to grow substantially In 1997 the market for information technology outsourcing has been estimated at 265 billion in the US and at 90 billion worldwide Growth estimates of this market range from 15 to 25
In general an outside firm may be advantaged in providing a service previously produced internally because of economies of scale scope or specialization By aggregating demands for multiple clients vendors can smooth variations in demand increasing capacity utilization and reducing risk make investments that trade larger fixed costs for lower variable costs and have stronger incentives to invest in costreducing technology By narrowly focusing on technology they may be better able to attract hire manage and retain high quality personnel due to better ability to tailor management practices career paths and incentive structures to a specific activity The value of these benefis is tempered by explicit and implicit costs of using the market or some intermediate form of governance rather than vertical integration These problems manifest themselves in three types of risk shirking(underperformance in hardtomeasure tasks) poaching (misappropriaiton of shared resources ) and opportunistic renegotiation (exploitation of bargaining disadvantages in ongoing relationships) Some authors have argued that in IT these risks are so severe that outsourcing has overall a poor value proposition However there are a number of very successful agreements
and the growth in the market over the long term suggests that some economic benefits of outsourcing are present
In pratice outsourcing can take many forms and the complexity of these arrangements is increasing The simplest arrangement is the use of contract workers the worker is not employed by the firm but is managed more or less as if they were an employee This pratice is so common in IT that the presence of contract employees is assumed to be a standard feature of IT departments At the next level is selective outsourcing in which a firm outsources particular projects or parts of projects to an outside vendor This is also quite common in software development and technical support activities although any welldefined task could presumably be outsourced in this way Finally the firm may choose to outsource the entire IT function a practice that began in the late 1980s and has continued today
Hitt Lorin M Frei Frances X and Patrick T Harker (1999) How Financial Firms Decide on Technology in BrookingsWharton Papers on Financial Services1999 Litan Robert E and Anthony M Santomero Eds Washington DC Brookings Institution Press
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