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The Information Economics Press
P.O. Box 264
New Canaan, Connecticut 06840-0264

Copyright © 2001-2003 Alinean, LLC.
All rights reserved,
including the right of reproduction
in whole or in part in any form.

This publication is designed to provide authoritative
information in regard to the subject matter covered. It is sold
with the understanding that the publisher is not engaged in
rendering a professional consulting service. If advice or other
expert assistance is required, the services of a professional
expert should be sought.

First edition

Manufactured in the United States of America


Section 3: Performance Metrics Every CIO Should Know
3


Contents
Section 3: Performance Metrics Every CIO Should Know

5

Information Productivity®

5

The Need for Information Productivity Metrics

6

Illustrative Example

7

Capital Measures Are Irrelevant for Benchmarking Information Technology

7

The Importance of Multifactor Evaluations

9

The Importance of Measuring Productivity

9

Relevance of Productivity
10

Purpose of Information Productivity Analyses
11

Measuring Information Effectiveness
11

Defining Information Productivity
12

Determining Input
12

Identifying Transaction Costs
13

Economic Value-Added
14

Calculating Economic Value-Added
14

Calculating the Capital Asset Pricing Model, With Risk Premium
16

Risk Free Rate
17

Beta A Measure of Risk
17

Expected Return to Market
18

Capital Asset Pricing Interest Rate
18

Calculating Economic Value-Added
19

EVA Performance
20

Information Productivity Example
21

Transaction Cost vs. Economic Value-Added
22

The Value of Information Productivity Analyses
23

Knowledge Capital
23

The Individual's Point of View
24

The Corporate Point of View
25

Calculating Knowledge Capital
26

Section 3: Performance Metrics Every CIO Should Know
4


How to Grow Knowledge Capital
26

Total Cost of Ownership
27

Appendix A: Glossary
30
Bibliography









52


Section 3: Performance Metrics Every CIO Should Know
5





Section 3: Performance Metrics Every CIO Should Know
Every CIO needs to migrate from the role of the CTO, to become the CFO for IT investments.
Speaking the language of the CFO is an essential success tool for CIOs in this new era of IT
accountability.
The biggest challenge for CIOs is to be able to speak one on one with a CFO not in technical terms,
but in terms of business performance. As prior sections have illustrated, there is no guarantee on
returns from IT spending the gains, if they occur, are delivered through diligent investment
decisions and performance management. But many teams struggle with selecting the metrics to
assess performance measurement and management.

To help meet the demand for benchmarking and value management, this section expands on the
definition, importance and application of five major performance metrics every IT stakeholder
should know, measure and manage:

Information Productivity
Economic Value Add
Knowledge Capital
IT Spending per Capita
Total Cost of Ownership
Information Productivity®
Information Productivity is a great measure of IT performance comparing the impact IT has delivered
with regards to lowering overhead and driving sustainable economic value add.
Correlating IT spending versus a performance metric such as Information Productivity, and then
comparing this measure with other companies can give a great indication as to which companies are
able to derive more or less from their IT investments.
The most frequently quoted indicators for assessing corporate productivity, one of the most
important results of IT investment, rely primarily on capital asset ratios, such as Return-on-Assets
(ROA), Return-on-Investment (ROI) or Return-on-Equity (ROE). Such metrics are not adequate
since capital has ceased to be the most important and scarcest input for a firm. Capital can be now
treated just as another commodity that can be obtained at a competitive price. Information
management has now overtaken capital both in importance as well as in magnitude. Information,
not capital makes the decisive difference in a firms economic performance.
Section 3: Performance Metrics Every CIO Should Know
6



The Need for Information Productivity Metrics
Corporations rarely report about productivity in their annual reports, even though productivity is
frequently touted as one of the firms objectives. Part of the reason is that conventional accounting
is more concerned with the interests of the holders of debt than with the concerns of those who
would like to understand how the company could grow and prosper. The holders of debt like to
know a great deal about the ratios of current assets to current liabilities, debt coverage and book
value. All of these measures represent a bankers view of credit-worthiness in case of failure and
subsequent liquidation of assets.
1
In contrast, the purpose of productivity measurement is to judge
whether a firm is succeeding in the creation of new wealth.

Rare attempts to report on productivity, such as the Forbes annual ranking of corporations, measure
it in terms of revenue per employee. Leading information-age firms, such as IBM, for many years
reported to shareholders and to financial analysts metrics such as revenue per employee as an
indicator that its productivity was increasing even though it was accumulating huge under-utilized
plant capacity while losing market share.

The most frequently used revenue per employee ratio is not only inconclusive but also misleading
for making productivity comparisons. For instance, in a mature industry food processing the
sales per employee for comparable six firms are practically identical:
2



Figure 55: For Similar Revenues/Employee Performance Differs
Although the revenue/employee indicator would suggest comparable performance, by any other
measure (such as Return on Equity or Net Income) the results delivered by employees are different.
The highest-ranking firm in terms of return-on-equity (Allied Domecq, with an ROE of 56%) has a
245% higher ROE than the lowest-ranking firm.

The companies also differ in terms of the net assets employed. For instance, the net assets
(shareholder equity for Coca Cola) per employee are 233% greater than net assets per employee for
Allied Domecq. These firms differ in how many assets they deploy per employee, how their
compensation varies and the extent to which they pursue different policies with regard to purchasing
packaging materials and transportation services from suppliers. To compare the effectiveness of any
of the six firms with roughly equal revenues per employee requires productivity metrics that take
into consideration all of the variables which influence the ability of these firms to create shareholder
wealth.


1
This view has been also called carcass value accounting.
2
FY 2002 results. Standard and Poors Research Insight Database, July, 2003
Section 3: Performance Metrics Every CIO Should Know
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Illustrative Example
Take the case of a paper firm that employs 400 people to produce boxes. It also requires 200
employees in executive, managerial, professional and sales occupations to manage the production,
distribution and selling of its products.

An advanced computer system is installed. The company now requires only 300 workers for
production and only 180 information-processing employees in information-handling jobs. Profits
have increased modestly, but administrative expenses are up to pay for the new computer system.
Inventories have been reduced, but assets and debt are higher than before. Meanwhile, the increased
responsiveness to customers allows the firm to retain its traditional premium prices for boxes,
though a small decline in revenues indicates rising competitive problems.

Do the increased revenues per employee prove that corporate productivity has increased? Does the
reduced inventory-to-sales ratio confirm that information has been successfully traded for assets?
Does the increased overhead ratio defined in terms of head counts give a contrary sign that
information workers are now less productive? Does the increased variety of goods and services
prove that productivity has improved even if it does not show up in any economic results?

None of these single-ratio indicators can prove much. Together they may offer contradictory
findings. To measure corporate productivity requires a composite measure that reflects the
interactions of the resources that are put to use in a modern organization. Unfortunately, most of the
existing composite measures of corporate productivity are unsatisfactory.
Capital Measures Are Irrelevant for Benchmarking Information Technology
It is the principal thesis of this book that the current approach to evaluating the productivity of firms
in terms of ROA (Return on Assets), ROE (Return on Shareholders Equity) or ROI (Return on
Shareholder Investment) for evaluating IT investments is flawed, obsolete and potentially
misleading for the following reasons:

1. Capital is no longer the most important economic input for a modern industrial
corporation to function.

2. The availability of capital from investors has ceased to be the critical resource