Portfolio Theory Approach For Selecting and Managing IT Projects

Abstract

Effective IT planning remains a key issue for managers who seek to maximize the return on their investments in information systems. Managing the risks associated with investments in IT represents an important, but understudied, aspect of the IT planning process. Recognizing that individual projects carry different levels of risk, it has been suggested that managers adopt a portfolio approach toward investments in IT. Under such an approach, individual projects would be evaluated not just on their own merits but on the basis of their contribution to the overall risk of an organization's IT project portfolio. While the portfolio approach has intuitive appeal, it has been criticized for failing to provide a more direct linkage between the concepts of risk and return. In this paper, we draw upon financial portfolio theory to extend and explore the concept of a portfolio approach to managing IT project risk. In particular, we present a model that assesses an individual project in terms of its contribution to the overall risk of the IT project portfolio. The properties of the model are then examined using a simple two-project portfolio. A simulation using the model illustrates how an IT manager can take maximal advantage of the effect of diversification by selecting projects that are negatively correlated. In short, the paper demonstrates how to manage the risk/return tradeoff through careful selection of IT projects and appropriate allocation of resources among these projects.