Calculating and using economic value add for energy IT projects can help keep management focused and on track to create shareholder value. Economists frequrently discuss the comparative advantage that strategic commodities such as oil, gas and coal provide a nation. Recent thinking suggests that organizational knowledge may well be the ultimate comparativ advantage,
Calculating and using economic value add for energy IT projects can help keep management focused and on track to create shareholder value. Economists frequrently discuss the comparative advantage that strategic commodities such as oil, gas and coal provide a nation. Recent thinking suggests that organizational knowledge may well be the ultimate comparativ advantage,
Calculating and using economic value add for energy IT projects can help keep management focused and on track to create shareholder value. Economists frequrently discuss the comparative advantage that strategic commodities such as oil, gas and coal provide a nation. Recent thinking suggests that organizational knowledge may well be the ultimate comparativ advantage,
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By Scott M. Shemawelll and
Jerry L. Dake
Calculating and using economic value
add for energy IT projects can help keep
management focused and on track to
creating shareholder value.
conomists frequently discuss the comparative
advantage that strategic commodities such as oil
gas and coal provide a nation. Recent thinking sug:
Jgests that organizational knowledge may well be
tive advant
the ultimate compa wge. Technology has no-
‘economic value; rather, iti the deployment of technology
in conjunction with organizational knowledge where com
parative advantage
Comparative advantage is structural by nature, Structure is
4 macroeconomic function, Within this structural environ:
‘ment, business processes dictate the behavior of the firm with
its structural universe, Al firms have access tothe same set of
software and process knowledge. Indeed, vendors will readily
Ticense intellectual property 10 all industry players. This
process is a leveling activity that ensures that technology and
knowledge are difftsed across a given industry. How an indi
‘dha firm capitalizes om this technology above and beyond
its competitors is the subject of innumerable debate. In the
fi
‘of the fim and quickly adjust to perceived changes
asi, markets constantly measure the economic value
VALUE DEFINED
Value is in the eye of the beholder, and metrics are not
always clearly stated or consistent across the firm, Often one
person's value is another's antivalue. There is one clear
measure of value that most do not understand much less
posit, Economic value add (EVA) isa concept whereby exee-
tives responsible for operations can genuinely add meas:
turable value to the firm, Moreover, corporate governance
level executives who can specifically and directly affect the
debt and equity ratio of the firm, and thus the real value of
the firm, will use the same metric
EVA, term in use for more than 200 years, isa practical
vr energy-markets.comapproach for determining the economic profit that a firm
delivers asa function of the risks it undertakes for any port.
folio of business undertakings. The economic value of the
firm, as opposed to the accounting value, came in to gen-
eral use in the late 1950s with the Miller Modigliani eco
nomic model of the firm,
This model validated the net present valte (NPV)
methodology that many firms use, Interestingly enoul
EVA and NPV provide the same valuation of the enterprise
However, NPV is a stock metric while EVA is flow meas
urement. Therefore, EVA is a useful tool for evaluating
-nt performance presiding over the corporate
multiple accounting periods, whereas NPV is
limited in this regard,
EVA is defined as the net operating profit after tax minus
the cost of capital. Mathematically itis expressed as EVA,
NOPAT ~C% * (TC). NOPAT is net operating profit after ax,
(C% is the percentage cost of capital, andl TC is total capital.
EVA allows management at all levels t0 be held account:
able only for those factors it can control. Metrics based om
EVA criteria can be put in place at all levels of the organiza
tion, EVAdiriven processes meet the test of addressing com:
ponents of
directly affect and thus be held accountable for, andl meas
urement of business (cash) flow and not stock performance,
Value is in the eye of the beholder.
Finally, if the organization is focused on adding eco-
nomic value, it will by definition also add to sharcholder
‘wealth. In the end, the eriteria for the firm's existence is
accomplished. Superior stock performance would be the
expected outcome of robust EVA internal processes leading
to bona fide economic profits for the firm,
VALUE IMPLEMENTED
Every action and every project or procurement that the firm
undertakes should Iiave EVA as a focus. This includes all new
‘implemented proceses, merger or acquisition behavior and any
information technology projects undertaken. Unfortunately this
thas not always been the case, Luckily, the deployment of strate-
sic technologies, such as supply-chain management, augments
‘management's ability to create economic value,
Shareholders concerns alo can be boiled down to three
major trepidations:
increasing the top revenue ine witha good customer ase:
‘reducing the direct cost of operations as well a lower-
ing the indirect cost structure: and
+ dramatically reducing the process/decision cycle time.
‘These three issues are the fundamental drivers of all
process change and all information technology projects.
The history of use of information technology to further
or energy-markets.com
INFORMATIONTECHNOLOGY
‘organizational goals has been mixed. No one can deny the
dramatic changes that have occurred as result ofthe infor-
mation revolution. U.S. Federal Reserve Chairman Alan
Greenspan has praised the value that these technologies
have brought to economic prosperity
Why then does management still tremble at the sound
of the footsteps of yet another IT project? Why after all
these years and literally trillions of dollars in investment is,
itso difficult for information professionals to be on a peer
basis with their operational counterparts? Why is this
almost 400-vearold technology still misunderstood when
the children of the current management erop embrace it
wholeheartedly?
Where isthe end game? Can we expect spending in IT t0
continue to consume an inereasingly larger portion of the
firm's capital and operational spending? How can these
expenditures be accounted for? Finally, do we truly achieve
competitive advantage when everyone is essentially imple-
'menting the sime processes and information stems?
Knowledge is a structural component of the f
such, itis exceedingly hard to duplicate andl isa formidable
barrier to entry. This comparative advantage can be accom-
plished! while using all the basic tools available to others and
implementing them in a manner that is unique and timely
‘Uniqueness in this crowded arena is more than having a
‘lear set of goaland implementing an approach that
the onginization can enjoin. Significant barriers to,
‘entry are established by addressing and renewing bus-
ness processes, such as supply-chain management, with
aa clear set of metres for achieving EVA.
Whether ecommerce, customer relationship manage-
ment, customer information systems or other process
enhancement, the pervasive use of Web-enabled comput-
ing is placing greater demands on the pursuit of value.
These systems are extraordinarily expensive to build and
operate. However, they are critica to the strategie success
of the firm,
Limited value is achieved by simply implementing a host
‘of process and information systems (integrated oF not) that
address portions of the firm’s requirements. Nor should
major, highly sophisticated systems be installed without a
thorough understanding of the expected economic value,
risks, opportunity costs of alternatives not chosen, and, per-
hhaps most importantly, knowledge-based growth and com
parative advantage.
Without a clear goal, the organization is at risk of imple
menting a neverending steam of IT projects and process
‘changes that may cover the shorterm quarterly performance
requirements but never create shareholder wealth. Ml
‘Scott M. Shemellis president and CEO of Real-Time Data Solutions
Ine. sshemwell@worldnetatnet. Jerry L. Dake isa principal in
process and ptrolcwm at IBM. dake@siben.com,
June 2001,
55