Abstract:

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Setting the Stage

Soumitra Dutta, Chair of Business and Technology at INSEAD, surveyed over 200 CFOs in CIOs in Europe and the United States on their approaches to deriving business value from their core software assets. In the knowledge-based economy, the value of intangible assets often exceeds that of traditional physical assets such as plants and machinery. Information and intellectual property are among the most important intangible assets, even though they never appear on the balance sheet. Companies are increasingly recognizing the latent potential value of these intangible assets, and managing them more formally so as to realize this value.

A company’s core software assets embed deep knowledge about its products, services, operating processes and relationships. However, they have traditionally been managed as expenses to be minimized rather than assets which generate future value. Based on his research, the author calls for a new focus on software-based value creation, and introduces some valuation tools and techniques for achieving this goal.

As the backbone of internal processes, software is a dominant force in enabling companies to exploit new distribution channels, create new products, reduce operating costs, and deliver differentiated value-added services to customers. Over three-quarters of CIOs and CFOs surveyed indicated that their core software assets are critical to executing their business strategy.

Unfortunately, significant challenges confound attempts to manage software assets. The scope, size and complexity of software development projects, compounded by the tangled web of legacy systems, challenge most standard management control procedures. As a result, fewer than one-half of CIOs and CFOs fully know the size of their core software asset portfolio, and fewer still feel confident in the data on software cost.

More difficult still is the ability to estimate business value generated by software assets. Categorizing them helps identify the source of potential value. Transactional systems are high-volume systems related to the core business transactions, whose benefits are related to each transaction. Informational systems extract and aggregate data from internal and external systems for decision support. Their value derives from a business outcome linked to a decision made by a human expert. Transformational systems change how knowledge workers interact so as to produce new information of benefit to customers. This value is extremely difficult to estimate, and is dependent on culture, incentives and leadership styles. Ultimately, business value is generated by the integration of people and technology, rather than technology alone, making it harder to quantify in isolation.

The measurement of business value from software assets is widely practiced for new systems. Value assessments include three categories: financial benefits, non-financial benefits, and risk profile. However, executives surveyed expressed frustration that these benefits were not verified post implementation. These same executives were divided on the need to compute value for legacy software assets. Proponents claim that knowing such value helps communicate the overall strategic value of IT to senior executives, and supports strategic decision-making. Opponents express concern about allocating extensive time to counting that could be better spent developing and managing software.

Valuing intangible assets is widely acknowledged to be part art, part science. Valuation experts recommend three approaches commonly used to value other intangible assets, such as intellectual property: cost approach, market transaction approach or income (cash flow) approach. The income-based approach holds the most promise for calculating the business value of core software assets. Estimating cash flows requires an intensive and sometimes costly analysis. However, recent trends in risk assessment require a valuation of software assets as a measure of the operational risk associated with losing them. A risk-based valuation takes a process approach to measuring software asset value.

Researchers at INSEAD propose a novel technique for valuing software asset value that is currently used in market research: conjoint analysis. This technique measures the trade-offs people make in choosing between products or service providers based on component attributes of the product or service. The total value that an individual places on any product is equivalent to the sum of the utility they derive from all the attributes making up the product.

Regardless of the valuation method used, thinking strategically about intangible assets is required to compete effectively in the knowledge economy. The transition from a cost mindset to a business value mindset is significant, and demands a strong partnership between business and IT managers. However, the potential rewards for both are substantial.