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20 January 2009

IT opportunity cost in a downturn

By Andrew Clifford

Understanding opportunity cost can help you make the case for increasing some types of IT investment during an economic downturn.

Opportunity cost is a measure of the value of the next best alternative to a course of action. For example, if I am at a restaurant and I have to choose between the steak and the chicken, part of the "cost" of the steak is that I can not eat the chicken.

Opportunity cost is important in IT because IT skills have historically been in short supply. There are lots of things we could do, but we have not had the people to do them all. To give a common example, we often have to choose between deploying people on a major new project or deploying them on improving the systems that we already have.

Looking at IT in isolation, and in simple cost/benefit terms, the return on investment in improving current systems is often high. For example, a small amount of work on improving performance can greatly reduce running costs, and pay for itself in a few months, thus improving the organisation's profits. There are many such improvement that we could make, such as technology standardisation, simplification, consolidation, performance, documentation, any of which can significantly reduce costs.

However, the opportunity costs of these types of improvement can be huge, because it can mean missing out on the value of major new projects, including the political value of being seen to be contributing to the organisation. For this reason, we have often avoided investment in these types of improvements in the past.

In a downturn or a recession, the cost calculations change. The simple cost/benefit of system improvement stays much the same, but the opportunity cost is greatly reduced because there is much less benefit in major projects.

We could explain this simplistically by saying that we might as well do maintenance because we haven't got anything better to do. We could spin it better: investments in IT improvements provide a good return on investment at a time when there are few other opportunities for improving profits.

We often miss this. In a downturn, many organisations follow a tragic line of reasoning. They see that the IT department is mostly involved in major projects. When major projects dry up, they make arbitrary cuts in the IT department, rather than redeploying some of those people in reducing the cost base of IT.

Would this approach to justifying IT investment work? I certainly think it is worth pursuing. In the past IT has been really good at supporting big projects, and has focussed on this more than the internal efficiencies of IT. When there are fewer projects, there is still value in making IT smaller, simpler, cheaper, better understood, and a better basis for the recovery when it comes. This is not just a nice to have to keep the staff busy, but a really worthwhile investment for the organisation.

Next week I will consider some of the practicalities of making the case for IT investment in a downturn.

Next: Justifying IT in a recession

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