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Cd 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.com approach 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