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The Metrics Trap. . . And How to Avoid It

The Metrics Trap. . . And How to Avoid It

There is no single metric for determining the right amount of money, the right percentage of revenue, to spend on IT. Even those CIOs who believe that measuring IT spending as a percentage of revenue produces a legitimate benchmark, such as Dow Chemical's David Kepler, consider it a very rough start to a much deeper discussion of IT investment strategy. "My experience is it's relevant to describe about how much you should spend," Kepler says. But, he adds, "it says nothing about how effective your spending is".

The problem most CIOs have to confront is that, in the view of much of the business, IT spending is a big black box. In fact, it's often the company's single largest capital expense and one that promises to grow larger as the world grows ever more digital. "The reason people attack IT over this metric is because they don't appreciate what you're spending and why," says Kepler. Unless CIOs can fill this gap in understanding with a delicate combination of relationship building, education and a series of contextual metrics designed to give businesspeople a sense of IT spending effectiveness, efficiency and value over time, CIOs will see their budgets reduced to a cost to be managed against a vague, often completely irrelevant, constantly sinking average.

Where the Wild Variables Live

The idea of describing and analyzing IT spending in relation to overall revenue has been around for a long time - decades, say some analysts. One can attribute its longevity as a business metric to its simplicity and the ease with which one can make the calculation. It's also easy to get the benchmarking information out of your competitors. No one's giving away any trade secrets by filling out (often anonymously) a survey with their IT spending information.

But it's also a legacy from an earlier era. "The metric is from a time when people viewed IT as a utility rather than as something to provide strategic differentiation," says Scott Holland, senior business adviser for The Hackett Group.

It was, in many ways, a simpler time. In the days when mainframes ruled the earth, IT was more centralized than it is today and, consequently, costs were much easier to calculate. IT back then was basically a handful of really big machines, and the software and staff needed to run them. By comparison, today's Internet and PC-based computing infrastructures are much harder to account for. It's pretty easy for a rogue marketing department, for example, to buy its own servers and software without IT ever knowing. It's much harder to sneak a mainframe past building security. And IT today is a challenge to pigeonhole. For example, should a mobile phone/PDA combination count as IT or telecomms? And does telecomms - traditionally separate from the IT budget - count toward IT spending? Is software depreciated over time or counted as a onetime expense? In all these cases, it depends on the analyst or consultancy doing the counting.

There are so many ways to account for IT that most CIOs dismiss the percentage-of-revenue metric unless it is carefully targeted for their specific industry or industry segment. Yet even in an industry context, the averages can mask huge variations in the sample. Companies at the high end can spend as much as 100 times more than those at the low end, according to CSC Consulting. "If I say that the average age of my two children is 10, do I have an 11-year-old and a 9-year-old, or does my family consist of an 18-year-old and a 2-year-old? It is not enough to know the average. One must also understand the spread of the data," wrote Eugene Lukac, a partner with CSC, in a report about a recent CSC spending survey. Nor does the average account for a company's unique situation; for example, costs will vary wildly between a chemical company with 10 plants spread around the globe and one with three plants, all in New Jersey.

The Battle Over the Numbers

Douglas Novo, former CIO for Venezuelan chemical company Polinter, knows all about these variables. The chemical industry is capital-intensive, dependent on expensive plants and equipment, with low profit margins and unpredictable revenue. That volatile combination means chemical executives are always looking for ways to cut operating costs. To do that, they bring in consultants about every two years to compare their company with its peers and to run the numbers.

In Novo's case, the consultants told him in 1995 that he was spending 1.5 percent of Polinter's revenue, or about 1 percent more than his peers. Novo's response was simple and blunt: "Impossible!" (Indeed, other sources told him that the industry average for the petrochemical sector at that time was about 2 percent.)

What was he to do? The numbers he was being shown didn't jibe with his notion of reality but neither did they come out of thin air.

"There's no equivalent of Generally Accepted Accounting Practices for IT spending," says William Mougayar, VP and service director for Aberdeen Group. "Without some kind of standard for how to account for spending, you can't use percentage of revenue to compare across individual companies. It's too hard to know what's being included and what isn't."

But now Novo was on the defensive. He had to justify $US2 million in spending that suddenly seemed to place him on the wrong side of the chemical industry norm. First, he pushed back against the consultants' findings. He got them to accept the idea that perhaps Polinter only seemed to be spending more than its peers because those companies were failing to take all IT operational and investment costs into consideration. Novo argued that the greater centralization of Polinter's IT operations, as opposed to its competitors, made Polinter's accounting more accurate. And why should he be penalized for his accuracy? But basically it was still Novo's word against the consultants.

So he fought back in a more constructive way: He created his own metrics. He took Polinter's history of IT spending and broke it down as a percentage of revenue, per employee, per employee served by IT, per IT employee and per ton of finished chemical product (a common metric in the industry). "Using historical data is important," Novo says, "because then you can show executives how spending has changed over time and how it responds to changes in the business, such as during bad years when revenues fall."

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