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Noodling Numbers

Noodling Numbers

Reader ROI

Wondering how to best assess the value of IT? This fictitious case study covers:

* Value assessment in an environment of urgency* Selling investment leaps of faith* Allocating costs to achieve maximum business accountability* Partnering with the new CFOLast October, when AusMed (not a real company) CIO David Shepard was feeling particularly paranoid about his new job, he might have viewed this new CFO as some minion of hell, loosed upon the streets of Melbourne's CBD with the singular purpose of hunting him down to torment his living soul. But today a more relaxed, more mature Shepard can see that Scott Brunt is no demon posing as a bespectacled MBA and CPA with a penchant for startling Bill Cosby-style jumpers. In reality Brunt is simply another challenge, a tough-as-nails chief financial officer that AusMed brought in last month to apply more fiscal discipline to the in-progress turnaround.

AusMed CEO Maureen Carleton, who had promoted Shepard nine months ago when she took over the floundering company, was an aggressive proponent of IT as a competitive weapon. At first she'd insisted on keeping spending level, but increasingly ambitious initiatives had blown the budget. Now the company's board was concerned that the promised turnaround payoff had yet to materialise, and it wouldn't be long before stockholders got impatient as well. Enter Mr Brunt, former CFO of a midsize engineering company, on a mission to determine the "value of IT to this business" and to "project, evaluate and audit the return to the bottom line and the shareholders' pockets".

Knowing that value could mean something different to everyone, Shepard probed Brunt for his own definition during their first meaningful one-on-one encounter: a lunch at a Thai restaurant at Shepard's invitation. As he made what seemed to Shepard a showy display of his facility with chopsticks, Brunt explained that he viewed value as a broad pay-off and the ultimate outcome of all the turnaround measures now under way. He saw the value coming from the business initiatives and processes that IT was enabling; he seemed to recognise that technology alone wasn't the creator of value. But at the same time he contended that IT was the most costly component of these initiatives, and therefore there was a special obligation to measure its costs and payback - its ROI and efficiency. What measures did Shepard already have in place? What was AusMed's total cost of ownership? Where were the savings from bringing IT to bear? What business growth was IT delivering for its continually expanding dollar?

All good questions, but Shepard had few good answers. And he couldn't use chopsticks for nuts.

In the past nine months Shepard and everyone else had moved at breakneck speed, planning and implementing initiatives as fast as possible - a worldwide knowledge-sharing intranet, a Web site for consumer sales of homeopathic remedies and the integration of a number of acquisitions. AusMed already had project management guidelines - time and budgetary checkpoints (many of the latter having been missed lately). But there hadn't been time or patience for establishing baseline measures and implementing complex valuation methodologies. There was barely enough time and energy for planning, let alone metrics.

Shepard's appetite deserted him; he'd pushed and poked at his vegetarian Pad Thai, reducing it to an unappealing mush. He was tempted to tell Brunt that if the stockholders were getting anxious about profits, it didn't make a lot of sense to slow down to measure the cents when dollars were more important. He was also tempted to say that since the business units were primarily responsible for value creation, then their leaders should be the ones to measure and audit that value.

But instead of saying these things, Shepard launched into an explanation of the measurement-confounding complexity of any given system. Take the worldwide intranet. It would be tricky to allocate the costs of the intranet's infrastructure, very difficult to factor all the costs of changing the way knowledge workers worked and even harder to quantify the benefits of knowledge sharing to the company. Brunt nodded sympathetically but didn't give a centimetre. He wanted an accounting of AusMed's major existing initiatives and a valuation plan to apply to future endeavours.

In the days that followed, Shepard studied what could be done, talking with his senior IT people and his closest executive peers.

It was clear that all measures of value, and all expressions of that value, had to be in terms of business benefits, either savings or contributions to the bottom line. A proper before-and-after calculation would require Shepard to tediously reconstruct baseline measures of productivity, time to market, expenses for employee travel, and so on, associated with the older processes that had been or were still to be replaced.

AusMed's newest project was a business-to-business e-commerce system to enable just-in-time inventory replenishment with all of its distributors. The system, which had just entered development, would replace the EDI arrangements AusMed had made individually with its largest customers. And it would be scalable to the smaller outlets that had baulked at adopting costly EDI. The new system had seemed like such an obvious strategic win for logistics that no thought of value assessment had been considered. What method could be applied to measure the value of this initiative?

AusMed's CTO, Greg Devlin, raised the idea of the balanced scorecard. Devlin thought the measurement tool could be applied to this and most other IT projects. Still, the effort would take time and resources that were scarce on Shepard's staff. His biggest fear was that he and the IT organisation would be burdened with the whole valuation effort, though the realisation of value would be in the hands of the business unit leaders. How could he make sure they would take accountability and not leave him holding the bag?

Making things worse, the IT budgeting system was hardly conducive to accountability. Shepard was in charge of a central pool for funding, which all the business functions had grudgingly contributed to a year ago. Back then, the IT budget was a sort of emergency fund to get things rolling quickly. A year later, it was clearly time to create a more mature way of financing initiatives. Shepard had discussed chargeback schemes with his external network of CIOs and was drafting a plan for this. But would that ensure a fair accountability for costs and value across the enterprise?

Shepard decided to turn to three outside experts in his worldwide network for some quick coaching - measurement and value guru Howard Rubin, Steve Sheinheit, executive vice president of enterprise systems solutions at The Chase Manhattan Bank, and for that unique CFO perspective, Raghavan (Raj) Rajaji, chief financial officer of Manugistics. Shepard gathered them on a conference call and outlined his precarious situation.

Do the Next Right Thing

Raj Rajaji: David, the first thing you need to do is align yourself with the CFO. Realise that your goals are very similar to his. You should get closer to Brunt and convince him that your contribution to the company is in line with the business's strategic initiatives. Try creating an early win by finding a pet project of his and getting it done quickly. That will show him you understand the issues of the company.

Steve Sheinheit: That's good advice. I'd add that there's a business dialogue that needs to be created. We live in a very complex world, with increased pressures of timing, investment costs and risks. Too often, we want to describe all that complexity to the CEO or CFO. What we're saying is, "Commiserate with me, let me show you how complex and risky this is, and how you really need me". But that's exactly what they don't want to hear. They want simpler messages that they can translate into business terms: One, what's the investment in dollars; and two, what's it going to do for me - not how hard this is for you to do.

Shepard: Oops. I think I've already fallen for that temptation. But wouldn't the pressure of Internet time be one of those simple messages: Can we spare time on valuation exercises when the rest of the world is rushing past us?

Howard Rubin: It's true you can't hold up a project you need next week with three months of analysis. But you can make the measurement fit the time. On the development side you've got to prep your organisation to have new, fast development processes, to put out small chunks of a project quickly. On the valuation side, you've got to impose more of a venture management approach, where you build a continuous value case and keep refining and managing it as you go along.

Shepard: So I'd define and measure value in a project piece-by-piece rather than holding things up getting it all worked out at the start?

Sheinheit: I think that will work for some things, where you define these chunks along the way that will return business value. But some of your major strategic investments will need to be valued holistically because they can't be chunked out. For these, I like to make management an offer they can't refuse. I would say at worst it's a break-even proposition. We think it will be much better, but we won't be able to prove it until later.

Again, Alignment, Again

Shepard: That sounds like our worldwide knowledge-sharing intranet. We launched it about a year ago on a leap of faith that there would be payoff when people started using it in volume. I don't think Brunt is a "leap of faith" type of guy, though. He wants dollars and cents.

Rajaji: It could be that because Brunt is new to the company, he is testing to make sure his CIO is aligned with the business. Once he is comfortable with that, then I think Brunt will start looking more at qualitative measures rather than financial ones. But until he's convinced that you are in step with the business, he's throwing these financial measurement demands at you.

Rubin: The CIO always needs to show that resources are aligned with corporate priorities.

Sheinheit: Absolutely. What are the things that are really important? The CFO is not interested in every project. He wants to know if the IT agenda matches the business agenda. Projects have to move the company into the future, allow it to compete better. The key is to have the IT agenda articulated in a way that the business can understand.

Shepard: I assume that if the CFO perceives that alignment, we can better convince him of the value of these "leap of faith" projects, right?

Rajaji: Yes, but a leap of faith doesn't mean you jump in with no limits, no understanding. You must have measured checkpoints, budget constraints, and so on. A leap of faith just means it's hard to pin down a financial measure of the benefits. But you need to know when it's working or when to pull the plug. Otherwise, it's just a sinkhole.

Sheinheit: Frame the project in the context of what the competition is doing. Sometimes these initiatives are not leaps of faith but defensive manoeuvres. The role of management is to make some bets - some defensive, some offensive.

Rubin: An organisation must view what it's doing as a risk portfolio. The risks could be technology, size, timing or, in cases like we're talking about, the fuzziness of the benefits. If you have a strategic initiative that intuitively makes sense but it's hard to quantify the benefits, put that into the fuzzy-benefits category of risk. That's your framework for it, and the organisation can compare it with the other projects in the portfolio and decide whether it has tolerance for it.

Try Benefits Management

Shepard: Regardless of what kind of project we undertake, Brunt has asked me for a disciplined methodology to apply. Right now we have budget and development milestones and checkpoints. What more benefits-oriented measurement tool can I adopt across the portfolio?

Rubin: There is a concept called benefits management; it's a step-by-step plan for making sure the benefits are realised. Take something like your Internet-based inventory replenishment system, which has external distributor customers. Or maybe your intranet, where the customers are internal. You have to make your CFO and the rest of the executive team realise that there's always some kind of adoption curve for systems that try to change the way people work. You will have to convince customers to switch, so there will be an initial period where they are learning the system but are dubious. Then there is a crossover period where they start using the system. The third phase is where you'll get the financial benefits.

The measures are different at each stage. When people are learning, you're watching how many are going to the training. When you are in the crossover stage, you are tracking use of the system and movement away from redundant systems. And finally, you measure from the benefits perspective. So you have to make the organisation aware of the transitional stages and the different measures of uptake, penetration, proper usage and, finally, the benefits.

Shepard: Even when we get to the benefits stage, for something like knowledge sharing, it's got to be a real challenge to quantify the return to the bottom line.

Rubin: Not really. That return should show up by shortening business cycles, reducing rework. It should also have an impact on innovation rates, especially in the pharmaceutical industry. IBM's knowledge-sharing intranet was measured by amount of use, growth in the user community, products created by that community, how it affected business processes and their innovation rate. When you go to measure, go back and recall what the motivation was for doing this stuff, and apply measurement to those value areas. If you use the balanced scorecard method, some very tangible things should show up.

How to Keep Score

Shepard: I was going to ask you all about the balanced scorecard. It seems like something I can apply to measure just about any kind of value.

Sheinheit: The concept is a good one because it balances traditional financial measures, like ROI and net income, with operational metrics - customer satisfaction, internal business processes and your company's ability to learn and innovate.

Rubin: The balanced scorecard is a good framework to codify the business vision. You can run all aspects of the business through it; it's your basis for understanding the company's value chain.

Rajaji: It's an excellent measure as long as the company is using it for all decision making, not just for IT. You must have consistency within the company for what it's used for and for what the assumptions are behind it. Using it only for IT value would lead to wrong conclusions.

At the same time, you don't want to go to the other extreme and push all the responsibility for using it onto the business units. I've seen that happen, but that's the wrong thing for the CIO to do. That will backfire on you, especially with a new CFO. You're a partner with the business.

Sheinheit: Right. But it's very critical here that in that partnership the business has the lead. IT has the primary responsibility to get a system in on time and on budget. It's the business's primary responsibility to understand how that system manifests itself in lower costs and higher value. IT may take a significant role in how that happens, but this is a clear place where the business must be leading.

Shepard: Pete Lucibelli, our head of sales, likes the balanced scorecard concept. I'm sure I could encourage him to adopt it. But to apply it enterprisewide, we'd need the CEO to back it. And Brunt, obviously. Maybe this is something Brunt can collaborate with us on. He can show us how to use it. That ought to make a new CFO feel comfortable and useful at the same time.

Rajaji: That's good political thinking.

Get Out of the Pool

Shepard: Thanks, but I think I also need to make a big change to our funding mechanism to ensure this partnership with the business. Right now the IT budget is a centralised pool controlled by me. This isn't consistent with the business having a leading stake in value.

Sheinheit: The word "pool" makes it sound like there's no accountability. At Chase, we want to make sure the total cost of ownership is understood within the businesses. We allocate back to the businesses on the basis of actual usage. We want investment in IT to be a business line item, so the business units manage it as they would any other major expense.

Rajaji: New initiatives should definitely be justified and paid for by the business. They should be putting it in their budget, just like any other investment - both the new initiative and what it takes to maintain it.

You shouldn't be getting much resistance from the business leaders in getting IT costs built into their business cases. If a business leader knows it's important, he or she will be willing to pay for it.

Shepard: For new development, I'd agree with you, Raj. But there's been resistance to the idea of allocating infrastructure investments.

Rajaji: Infrastructure is harder. I don't know any business that likes to pay for this. If you've been lax about allocating infrastructure costs to the business units, then you need to educate the leaders that these are the shared costs of doing business, and they need to have enough profitability to offset those costs.

Sheinheit: You can charge back the infrastructure and major new development costs to the business units, but capitalise them over time; that works best for major investments.

That way the businesses don't take that hit up front to their bottom lines. They pay later, once the technology has been implemented, based on who actually ends up using it. Even then, to charge these costs back, you need business buy-in at the highest levels.

The other place you might run into trouble is when people don't understand the potential that costs will escalate over time. You have to get that understanding up front.

Volume growth, new business requirements, ongoing code maintenance and technology replacement are all sources of future expense growth. The business needs to understand the drivers of expense as well as accountability for investments.

Shepard: Thanks guys. You've given me a lot to mull over - ongoing value measurement, benefits management, balanced scorecard, cost allocation and aligning with the CFO. I think I'll have another talk with Mr. Brunt about this, maybe over dinner. This time at a restaurant with forks.

CIO David Shepard, along with the other executives of the fictitious pharmaceutical company AusMed, was introduced to our readers in the October 1999 issue of CIO. To see how Shepard dealt with previous challenges and to learn what advice he received from his real-life coaches, see "Stranger in a Strange Land" Part I, October 1999 and Part II, November 1999 or visit the CIO Web site.

AusMed Pty Ltd

Company: AusMed is a fictional, midsize Victoria-based pharmaceutical company.

Business environment: AusMed is nine months into a turnaround plan based on killing unprofitable alliances, jump-starting product development through new acquisitions and creating new revenue opportunities. Although the company has grown revenue 27 per cent in one year and has increased the number of products in its pipeline by 40 per cent, profit growth has yet to materialise. And IT costs have soared.

Actions: Nine months ago, IT Director David Shepard was promoted to CIO. Now the CEO has filled the vacant post of chief financial officer, and the new CFO, Scott Brunt, is anxious to prove that he can bring fiscal discipline to the turnaround.

Obstacles: Aside from project management checkpoints, AusMed has little experience applying metrics to IT value. The need for speed and a growing sense of urgency heighten the tension under which the CIO and his IT department labour.

Meet the Coaches

RAGHAVAN (RAJ) RAJAJI

As executive vice president and CFO at Manugistics in Washington, DC, Rajaji oversees finance, accounting, planning and investor relations. Previously, he spent four years at BancTec as CFO, and 18 years at Occidental Chemical, where he also rose to the CFO position. Rajaji received a BS from the University of Calcutta, and a master's in business administration, with an emphasis in finance, from Virginia Polytechnic Institute and State University. He currently serves as vice chairman of the Financial Executives Research Foundation, one of North America's leading financial research organisations.

HOWARD A RUBIN

Rubin is a professor and chair of the department of computer science at Hunter College in Pound Ridge, NY. He also is a research fellow at Meta Group in Stamford, Connecticut, and a member of Meta's board. Rubin is an internationally recognised authority in measuring IT performance, the business value of technology and software process. His Worldwide IT Benchmark Project has been recognised as the world's largest IT productivity, quality and performance benchmark database. He is also author of The Software Engineer's Benchmark Handbook and former editor of Information Technology Metrics Strategies.

STEVEN L SHEINHEIT

Sheinheit is executive vice president of enterprise systems solutions at The Chase Manhattan Bank in New York, responsible for enterprise systems and programs including corporate applications, groupware and Internet services, and architecture and standards. He is a member of Chase's management committee and technology governance board. Sheinheit's career spans over 25 years in management of IT in the financial services industry. During the mergers of Manufacturers Hanover Trust, Chemical Bank and Chase, he played key leadership roles in architecting and merging the banks' systems. Sheinheit is a graduate of the Harvard Advanced Management Program and has an MBA in Operations Research from Baruch College.

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