Developing a Practical Financial Model to redefine

Information Technology from a Cost Centre to a

Benefit Enabling Centre
Naresh Kurada, M.Sc.E.E. , P.Eng., M.B.A., Member, IEEE & ISACA

Abstract In large enterprises with multiple products and

services, IT is often vertically integrated as a corporate function
and investment in Information Technology infrastructure and
resources appear in the general ledger and balance sheet as costs
and depreciation with steep values. Here, they are viewed in the
light of a cost centre. Further, compounding this unenthusiastic
view is the misalignment between IT objectives and core business
goals [1]. Therefore, the Information Systems Audit and Control
Association (ISACA) in its valIT framework proposes the value
proposition of IT, and brings to the forefront that investment in
IT should be managed as a portfolio of investments that is
aligned with the business objectives[2]. This view can be further
enhanced when investment in IT is treated as a benefit enabler
that is aligned with the business requirements. However, for a
business to derive the full benefit of IT, the two views have to be
harmonized, mutually appreciated and fully understood. And as
managers and stewards of IT resources, the onus here lies on the
latter to quantify and categorize benefits of investment in IT in
economic terms (financial modeling) by reframing the value
proposition questions. In other words quantifying future benefits
in preset value terms to evaluate IT infrastructure and redefine
IT from a cost centre to benefit centre.
Index TermsBusiness economics, Finance, Information
technology, Strategy

I. INTRODUCTION

nterprises use the Information component of IT to

create value for their shareholders and stakeholders rather
than the Technology component itself. In other words, the
Technology component is only a delivery mechanism for the
organization to make better business decisions and for
consumers to transact on goods and services offered by the
enterprise. Although, organizations understand that better
information is a source of competitive advantage and built into
the business model and the strategic imperative of business
continuity planning, they view investment in Information
Technology similar to any other investments that the
enterprise makes to acquire assets. Here they ask two very
basic questions
1.) What is the cost of the investment?
2.) What are the financial and non-financial benefits of
adopting the proposed Information Technology infrastructure
that can improve on the cost of doing business?
The above two questions are centered on the value proposition
[2, 6] of acquiring and developing the IT infrastructure.
Therefore, as managers of IT, it becomes extremely important
to understand that Information Technology serves as a means

c
978-1-4244-6039-7/10/$26.00 2010
IEEE

to an end the end being fulfilling the business goals of the

enterprise [3] and articulate more than just the obvious cost
savings realized by IT. Alternatively, modeling future IT
benefits, that is in tune with the business requirements of the
organization. Furthermore, it also means that organizations
can expect the delivery of the financial and non-financial
benefits of IT when they direct IT resources and build
processes to monitor IT resources. In other words an
alignment between IT and business has to occur to derive
competitive advantage of IT [7, 8].
However, to model future realizable benefits of IT, a
framework has to be created that categorizes the benefits in
financial (dollar) terms and not just the outlay of direct
operating expenses (DOE) of IT. This paper proposes a
framework to that end and aids in creating a business case
using well established business and financial tools.
II. ALTERNATIVE STRATEGIC TOOLS TO ACQUIRE
INFORMATION TECHNOLOGY INFRASTRUCTURE

The value proposition derived by investment in IT is no

different from any other investment and is therefore governed
by a set of similar strategic tools available to the organization
to acquire them [9]. These tools are the following
1.) Licensing and leasing
Licensing and leasing in effect operate in a similar
fashion which is effectively a legal agreement to use the
software or hardware for a period of time. The term License
is often associated with software while the term Lease is
associated with hardware. The advantage is that it relieves the
organization the need to develop a full range of
complementary resources and capabilities particularly those
involved with support and operation. However, the inherent
risk is, the success is totally dependent on the commitment and
effectiveness of the license and falls into the category of risk
acceptance by the organization.
2.) Outsourcing, Strategic Alliance and Joint Venture
Outsourcing is often a legal agreement with another firm to
perform a certain function of the total function of total
objectives of deploying the IT infrastructure. While Strategic
Alliance and Joint Ventures operate similar to Outsourcing
they are often not legally bound. Here, the benefit is the
pooling of resources and capabilities of more than one firm to
reduce investment costs with intention of transferring the risk
of investment loss amongst them to achieve a mutually
inclusive or exclusive goal.

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3.) Internal Commercialization / Build in house

Internal Commercialization is process of developing the
technology within the organization when the organization has
the necessary resources and capabilities to deliver an IT
solution. The benefit is that the organization has the
opportunity and flexibility to develop what is exactly
required and mitigate the risk of failure.
Strategic Tools to Acquire Information
Technology Infrastructure
Decision
Factors

Investment

Licensing/L
easing

Outsourcing
/ Strategic
Alliance/
Joint
Venture

Internal
Commercialization/
Build in house

Deployment
Dependant

Deployment
Dependant

Deployment
Dependant

Benefit

Less
constraint on
resources

Risk

Risk due to
customizatio
n constrains
Risk
Acceptance

Cost of
Resource
Requirement

Low

Permits
pooling of
resources
and
capabilities
of more than
one firm
Risk of
Dependence
on Suppliers/
partners
Risk
Transferring
Medium to
Substantial

Flexibility of
Developing what is
actually required

Risk Mitigation

Substantial

Fig 1. Alternative strategic tools to acquire information technology

infrastructure [9]

The table above illustrates the Strategic tools and mechanisms

that organizations have at their disposal to evaluate the value
propositions of Information Technology. Although, the
strategic tools fall in the three categories, the decision factors
are not limited to the cost associated with the above listed
alternatives but depend heavily on the resources and
capabilities that the organization wants achieve as a part of its
strategic business imperatives without compromising on
governance and compliance obligations. Further, the path to
achieve the organizations goals can include one or a
combination of the above alternatives.
III. THE VALUE PROPOSITION OF IT AND QUANTIFYING

Information Technology infrastructure, the mechanism of

information delivery can be directly attributed to
Information Technology where IT is used to achieve
automation that capitalizes on the economies of scale and on
the economies of scope from the supply side of technology
while improve user efficiencies from the demand side of
technology. Therefore it is safe to say that these are value
propositions of IT [9, 10]. In other words these are the benefits
of IT.
Economies of scale is the process of reducing the long term
unit cost of ownership of individual products or services by
grouping together similar products or services [10]. Likewise,
economies of scope exist whenever there are cost savings from
using a single resource in multiple activities carried out in
combination rather than carrying out those activities
independently [9]. In both economies of scale and economies
of scope the objective is optimal utilization of IT infrastructure
and resources by sharing the fixed costs. Although more often
than not the distinction between economies of scale and
economies of scope applied to IT is a source of ambiguity, a
little examination reveals that the software component of IT
fits well into the definition of economies of scope while the
hardware (physical) component fits well into the definition of
economies of scale.
The process of categorizing the benefits of Information
Technology along economies of scale, economies of scope and
improved user efficiencies is very important not only for
financial modeling but also to better understand the full range
of benefits and is analogous to the idea that costs are better
understood when broken down to unit costs.
This process of categorizing the benefits of Information
Technology gets better clarity and coherence through the
Fishbone Analysis diagram [12] where the components of
Information Technology Delivery mechanism are listed along
the skeleton of the fishbone as illustrated in the diagram
below. Here the skeleton of the fishbone skeleton consists of
the three categories of economies of scale, economies of scope
and improved user efficiencies while the components such as
communication network devices, application servers and
security devices are listed along them. The intention
throughout, is to categorize a completely exhaustive list of
cost savings (benefits) of Information Technology without
double counting in economic terms.

BENEFITS

The process of quantifying the value proposition of investing

in IT infrastructure is a process that needs articulation and
understanding of what the business requirements are and how
IT will be used to fulfill those requirements. Logically, they
can often be classified into two broad categories of financial
benefits and non financial benefits.
Although, the non financial benefits such as brand equity,
reputation and business model cannot be directly attributed to

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2010 IEEE/IFIP Network Operations and Management Symposium Workshops

becomes necessary to replace the revenue generated with the

benefits of IT-i.e. the automation realized by capitalizing on
the economies of scale, the economies of scope and improving
user efficiencies to create a financial model.
Further emphasis of the capital budgeting process and
calculating the present value of future benefits of IT is only
one part and must involve deducting the upfront costs incurred
as a result of work effort to design and build the infrastructure
along with the capital cost of the infrastructure to derive the
Net Present Value (NPV) to represent the value in dollar terms
of how much value is created today or added to the
organization by undertaking an investment. This logically
suggest greater the NPV, greater the value. With these
concepts, the spreadsheet for capital budgeting is as illustrated
in the figure below.

Fig2. Adaptation of the Fishbone (Ishikawa) diagram to categorize the

benefits of IT [12]

In the process described above and as illustrated in Fig 2, the

fishbone analysis forms the novelty of financial modeling and
a clear departure from the other approaches of lumping
benefits of IT into non quantifiable entity. Therefore, it is the
key to articulating the financial benefits of IT quantifiable
terms with the following reframed approach of
1.) What are the quantifiable cost saving benefits realized
by optimizing IT resources along the economies of
scale/scope?
2.) What are the quantifiable cost saving benefits realized
by optimizing IT resources to improve user efficiencies?
IV. FINANCIAL MODELING TO ARTICULATE INFORMATION
TECHNOLOGY BENEFITS

So far it has been established that organizations consider

investments in Information Technology similar to investments
in other assets and it is possible to categorize the benefits of
Information Technology along the lines of economies of scale,
economies of scope and improving user efficiencies. Further,
it also implies that the standard financial practices of capital
budgeting can be applied to quantify these future benefits in
preset value terms to evaluate the attractiveness of IT
infrastructure and resource investments [4, 13].
Now, the process of Capital Budgeting begins with the ceteris
paribus assumption that organizations invest to reap higher
rewards and if an organization grows at a rate of r then
compounding and time value of money concepts can be
applied to calculate the present value of future returns when
investments are made .However, the point of interest in
valuation of future returns over a period of time is to make
sound logical assumptions to model the variable income (cash
flow) calculated by deducting costs from revenue generated
for each period over the entire period of time and is referred as
Discounted Cash Flow (DCF). At this juncture and in order to
develop the financial model based on the DCF technique, it

Fig3. Constructing a financial model using DCF [13]

It must be noted that, the term r in the DCF formula is rate

of return and any reasonable value can be used, however, it is
only prudent to use the Weighted Average Cost of Capital
(WACC) as it takes into account the risk free rate, the cost of
debt and the cost of equity that is, all the available financial
tools an organization has to raise capital and is in line with the
idea of IT investments for business requirements [13]. Further,

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the number of years must be equal to the number of years the

IT asset has useful value and could be either the lifecycle of
the technology or the number years the IT asset can be
depreciated.
In conclusion, and perhaps the biggest advantage of the
process of capital budgeting is that, it sets the stage for
financial due diligence through sensitivity analysis to
determine the appropriate level of the Strategic alternatives
available to the organization as discussed in section II.
V. A NOTE ON COSTS
Control Objectives for Information and related technologies
(COBIT) defines the business requirements for information
and information delivery as Effectiveness, Efficiency,
Confidentiality, Integrity, Availability, Compliance and
Reliability [5]. And it can be effortlessly observed that these
requirements are qualitative descriptors and their
manifestation depend on qualitative description of the
components of IT such as connectivity networks and
applications while falling in the realm of stability, availability,
interoperability and security. Apart from these business
requirements, there are the additional major strategic
imperatives of business continuity and reducing the cost of
ownership which weigh heavily into planning and
implementing IT solutions. Further, additional discretion must
be exercised to identify the functions of IT such as
development, maintenance, governance and compliance that
are vertically integrated into organization to avoid double
counting as costs. For example if the organization has a team
of database developers as a part of the IT function then the
costs associated with database development must not be
considered as a cost. Lastly, but not the least costs in the
Figure 3 such as Licensing and Leasing are also referred to as
Direct Operating Expenses.

Fig4. The benefit enabler framework for IT

VII. CREATING A FINANCIAL MODEL THROUGH A SCENARIO

ILLUSTRATION

VI. THE BENEFIT ENABLER FRAMEWORK FOR IT

From the above discussion, it becomes evident that the process
of redefining IT from a Cost Centre to that of a Benefit
Enabler Centre begins with understanding of what the
business requirements are and how can the benefits of IT in
terms of economies of scale, economies of scope and
improved user efficiencies be used to deliver on the business
requirements by answering the value proposition questions.
Once these are defined and understood then the process of
financial modeling rests on articulating them in dollar terms
with the perspective that organizations invest in assets today to
realize future benefits. And it is here that the principles of
capital budgeting is used to expressive them in terms of Net
Present Value. This process is illustrated figure 4.

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Fig5. The architecture of an Employee Compensation System without

virtualization

Scenario I
In order to demonstrate the application of
the framework consider a scenario where a large
organization has four separate applications and the individual
applications are related to employee work assignment
information, project time keeping, service delivery application
(ITIL) and employee variable compensation (bonus). Each of
these applications consists of a backend database and a front
end user interface. Currently, an employee has to logon to
each of these applications individually and input repetitive
information and there is no flow of data from one application
to the next dependant application to derive useful and

2010 IEEE/IFIP Network Operations and Management Symposium Workshops

consistent information without manual intervention and

human discretion to transfer data between the applications.
This manual transfer is a plausible risk to not only maintain
the integrity of the work-performance and compensation
relationship but also poses a threat to dynamically transfer
data to accounting systems Furthermore, there is lost
productivity while increasing aggravation amongst the users of
these systems. This scenario is illustrated in Fig 5.

In addition to the cost savings benefit, there are improved

User Efficiencies producing cost savings in terms of work
time saved on per employee. Here an assumption is made that
the organization consists of 10,000 employees, costing $20 per
hour ,working 49 weeks per year and on an average a user will
have to spend at least 10 minutes per/day logging into 4
separate systems to enter often duplicating information to keep
records current. Thus the Annual Cost Saving Benefit of IT
realized by improved user efficiency is
10 minutes x 5 days / week x 49 work weeks x 10,000
Employees x $20 / hr (Average hourly wage)
= $ 8,166,666.67
Finally, the last step of the framework is to apply capital
budgeting principles with an assumption of using the rate of
return to calculate the Net Present Value (NPV) is 10% which
is equal to the WACC of the organization. And the time period
is equal to 3 years which is equal to the period when the asset
has almost been fully depreciated. With these assumptions the
Net present value i.e. the value of the project today realizing
future benefits is as shown below.

Fig6. The architecture of an Employee Compensation System with

virtualization

Therefore, the business objective is to create a single intuitive

and ergonomic user application interface with a single
authenticated sign-on conceived by marrying the strengths of
the existing systems. This is conceptualized by integrating the
backend individual databases with the information and
information delivery criteria assumptions of Effectiveness,
Efficiency, Confidentiality, Integrity and Availability and is as
illustrated in fig 6. Now, that the business requirement has
been understood and the next step is to propose IT solution to
integrate 4 the separate back-end databases on a blade server
chassis with a single-front end employee portal. The
assumption at this stage is upfront cost of development and
deployment of $1,000,000 and includes the cost of hardware
and software.
Subsequently, the framework calls for identification and
categorizing the benefits of IT and it becomes evident that
economies of scope is derived by utilizing server virtualization
software and integrating the four separate databases into one
database by using RDBMS techniques and the cost of
ownership is reduced to one quarter of the existing solution.
Further, for the purpose of this analysis the assumption of the
cost of ownership including software licensing and hardware
leasing (including the telecommunication network) is reduced
to $10,000 from $40,000 per year i.e. $30,000 in cost savings
(benefits) will be realized as a result of the proposed IT
solution. Further, an additional assumption is made to exclude
the vertically integrated Corporate IT support and
maintenance.

.
Fig7. Constructing a financial model using DCF to illustrate the scenario
1

Although, the above scenario is an illustration and the

calculation of the NPV exposes considerable benefits, it
brings to the forefront the benefits of financial modeling to
redefine IT from a cost centre to a benefit enabling centre with
the projected estimate of adding $19,359,028.31 to the
organization over a period of 3 years. The process of applying
the Benefit Enabler Framework For IT demonstrates a

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structure to decompose the benefits of IT in dollar terms and

aids the development of a business case for investments in IT.

telecommunications costs which organizations try to reduce by

capitalizing on by developing and deploying automation tools.

Scenario II
Consider the network architecture of a
Demilitarized Zone (DMZ) where a corporations internal
network connects to the internet. The DMZ consists distinctly
of two layers - the web layer and application layer. The
architecture is as illustrated in the figure below and consists of
a router and firewall for each of the layers.

Now, to quantify the Benefits in $Terms, let us assume that

the initial capital investment for a single router is $50,000 &
for a firewall is $60,000. Therefore the total initial cost for the
original architecture as in Fig 8 is $220,000 and with
virtualization as in Figure 9 is $110,000.
The benefit of deploying virtualization on data communication
router and firewall equipment from 4 devices to 2 results
savings of $110,000 which can be applied into the calculation
of the Net Present Value (NPV).
Now, let us assume the cost for vendor maintenance support
for a router is $10,000 and $15,000 annually. Therefore the
cost savings realized by capitalizing on virtualization is indeed
the savings due to the economies of scale by reducing the
number of devices from 4 to 2.

Fig8. The network architecture of a Demilitarized Zone (DMZ) without

virtualization

Further, if we assume that the OAM per device is $2000, then

the OAM is reduced by $4000 which can be appropriated as a
benefit of IT as a result of economies of scale. The last step of
the frame work calls for using the Capital Budgeting and we
use the same assumption and values as in scenario I i.e. 10%
rate of return with a time period of 3 years.

However, the advances in virtualization allow the router and

firewall to be virtualized by running virtualization software
such as Ciscos Virtual Routing and Forwarding (VRF) and
Check Point VSX respectively[14,15]. The virtualized
architecture is as illustrated in figure 9.

Fig9. The network architecture of a Demilitarized Zone (DMZ) with

virtualization

To put this into context and apply the frame work - the
business objective is to reduce the foot print and reduce the
cost of ownership of IT infrastructure with an emphasis on of
Effectiveness, Efficiency, Confidentiality, Integrity and
Availability. Here, the benefit of IT is achieved by capitalizing
on the Economies of Scale provided by virtualization and
reducing the number of physical devices from 4 to 2. A little
foresight will reveal that there are no achievable improved
user efficiencies. However, there are economies of scope for
Operation, Maintenance & Administration (OAM) of the
devices .Further, it is widely accepted that these OAM
activities form a major component of all data&

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Fig10. Constructing a financial model using DCF to illustrate the

scenario II

Although, the net cash flow, DCF & NPV over the 3 year
period is zero, it must be noted that the scenario presented is
for an even number of devices (i.e. 2:1 device virtualization)
and the calculations will even out. However, if scenario
presented 3:1 device virtualization the calculations of cash
flow, DCF & NPV would have been very much positive.
Never the less, the observation and the exercise of IT

2010 IEEE/IFIP Network Operations and Management Symposium Workshops

governance of aligning IT with the business is to focus on the

benefits of IT i.e. virtualization to reduce the cost of
ownership & IT foot print.

[6]

The point of interest in both the scenarios is that improved

user efficiencies, economies of scale & scope are treated as
revenue - in other words, cost savings provided by IT and
therefore the benefits of IT. Further, this systematic approach
highlights the ease and the opportunity for sensitivity analysis
focused on financial due diligence such as break even analysis
and evaluating the composition of strategic alternatives. For
example in the first scenario when the not so obvious but the
intuitive awareness of Benefits of IT due improved user
efficiencies is not taken into account in the calculation, the
NPV becomes negative and a sound enough reason to not
proceed with the project.

[7]
[8]
[9]
[10]
[11]
[12]
[13]

VIII. CONCLUSION
The individual components of the framework that will enable
investments in IT to be viewed as a benefits enabler are not
new. However, the novelty of the above described framework
is combining the individual elements of the framework and
breaking down individual elements of benefits of IT into
improved user efficiencies, economies of scale & scope by
using the fishbone analysis allows stewards IT to form a
compelling and quantifiable business case for investment in
IT. The process will lead to better understanding of future
benefits which is in line with the idea, costs are better
understood when broken down to unit costs. This return to
basics approach reveals the obvious and not so obvious
benefits and sets the stage to apply the common business
practice for financial modeling using the principles of capital
budgeting while quantifying in dollar terms the present value
of the future worthiness of an asset. The Benefit Enabler
framework of IT is intended to serve managers of IT as a
financially adept tool that will advance the articulation of
redefining IT from a cost centre to that of a Benefit Enabler
Centre by not only viewing investments in IT enthusiastically
but also demystifying the value proposition of IT.
Furthermore, it will give the stewards of IT business tools to
evaluate commercially available financial management tools.
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ABOUT THE AUTHOR

Naresh Kurada obtained his B.Eng. in Instrumentation
Engineering from Bangalore University, India in 1996 and
started working as an Instrument Engineer in Kuwait. He left
for Canada in 1998 and expanded his career into Data
Communications. In 2004 he obtained his Master of Sciences
in Electrical Engineering with an emphasis in
Telecommunications from the University of Texas at
Arlington and completed his MBA at the Schulich School of
Business - York University in 2008. He has over 9 years of
experience in Data Communications infrastructure
development for the Financial Services Industry. He has
worked for Bank of Montreal and currently works for the
Canadian Imperial Bank of Commerce (CIBC) in Canada.
He is a registered Professional Engineer in Ontario, and a
Member of the Institute of Electrical and Electronics
Engineers (IEEE) and Information Systems Audit and Control
Association (ISACA). Naresh serves in the IEEE Toronto
Section in the Capacity of Newsletter Editor and has published
a paper in the IEEE Canadian Review.

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