IT Value Methodologies: Do They Work?
- 18 December, 2007 11:50
For the CIO, it's the question that never goes away: Can value methodologies really prove IT's worth to the business? Three experts weigh in on whether this is the impossible dream.
Director, Mercer Oliver Wyman, a consultancy with a focus on financial services and risk management.
IT is not one thing. It is a complex array of services, some of which are indistinguishable from the business capabilities they enable
First, as a factor of production, any direct correlation between IT spending and bottom-line results is highly elusive. Several academic studies bear this out. One employed competitive economics to speculate that higher returns from IT encourage other firms to enter and drive down profits. Another concluded IT had become a strategic necessity, not a source of competitive advantage and therefore not measurable as such. A third found that higher productivity and consumer value — in fact attributable to IT — did not translate into measurable business profits because they tended to be competed away or passed on to customers.
Our own client work in financial services also suggests that IT spend is not really a distinguishable driver of bank performance today because scale and capability benefits are dwarfed by inefficiencies, cost of complexity and other costs associated with realizing revenue. In other words, looking at relative IT spending does not tell you whether a bank is an advanced or an inefficient consumer of IT.
That's the economic theory. Then there's the nature of IT itself. IT is not one thing. It is a complex array of services, some of which are indistinguishable from the business capabilities they enable, such as trading. Others are more like utilities. How do you go about valuing the electricity or water your business consumes?
In the case of business application development, leading practitioners associate the IT portion of their projects with the business portion and do a combined investment case. In the case of IT infrastructure, companies look for cost efficiency, reliability and scale. Very few have a methodology that combines the two, allowing them to value IT investments both in terms of deployment and operations over their lifecycle.
IT valuation techniques have not kept up with the pace of change in technology and management. In IT, strategic planning cycles have sped up and become more iterative. The dotcom era ushered in a place-your-bets and launch-and-learn culture. The "atomization" of technology (many more subcomponents and vendors) also means that no IT department can afford to supply or even be competent in every technology. At the same time, companies don't want to be locked into a single vendor or approach, with no endgame in sight. They want to avoid creating the legacy environment of the future.
Page BreakAll of this puts a big premium on the options value of IT, meaning that many IT investments today are made on the basis of business or technical flexibility (customization value), or better quality decisions (information value), or to preserve future options and hedge bets (portfolio value). Traditional IT valuation is focused on cost, service quality, and enabling productivity and revenue, and it does a poor job reflecting this increasingly critical aspect of IT investment. There have been considerable advances in real options value as applied to IT. However, these valuation techniques are not developed to the point where they are readily adopted by businesses.
IT practice leader, The Hackett Group, a strategic advisory firm that provides best-practice research, benchmarking and business transformation services to improve performance across SG&A and supply chain activities.
It is possible for IT to drive significant value. But this value comes in places where CIOs don't generally look for it.
The best place for IT to look when developing a value methodology is in other parts of the business. Top performing companies use IT to improve both efficiency and effectiveness in key back-office areas such as corporate finance, procurement operations and human resources. IT helps these areas reduce overall costs, redeploy resources and provide greater strategic value to their organizations.
For example, our research shows that world-class IT organizations now spend $US9024 per end user, 7 percent more than typical companies. But with the help of improved technology, world-class finance organizations spend 45 percent less than those at typical companies; world-class procurement organizations spend 25 percent less; and world-class HR organizations spend 13 percent less. The net result? By achieving world-class performance in these four key areas, companies can reduce SG&A costs by $60 million per billion of revenue. This is a powerful value proposition. And optimizing the performance of IT is critical to realizing these benefits in other SG&A functions.
One powerful starting point we've seen for companies looking to generate IT value is a comprehensive back-office benchmark that captures detailed data across the enterprise on spending, staffing and other key metrics on a function-by-function level in IT and in finance, procurement, HR and other areas.
One global Fortune 100 company we work with did precisely this, with the goal of reducing SG&A costs. What they discovered was that transactional costs and staffing levels were exceptionally high in several areas, including finance and HR. The level of automation in these areas was also unusually low. So they embarked on a multimillion-dollar project designed to consolidate their worldwide operations on a single ERP system, and use this system to automate transactional activities.
Page BreakThe completed system helped them reduce their transactional costs in finance and HR. Savings in these areas paid for the ERP project in about three years. After that, the annual SG&A savings went directly to improving the company's bottom line.
There are also direct correlations between IT effectiveness and improved effectiveness in finance, procurement and HR. This is enabled in part by the automation of basic transactional activities, which drives down headcount, reduces error rates and improves cycle times. Staff can spend less time on transactional activities and more time on analysis and other value-added activities. For instance, at the Fortune 100 company, the new system enabled finance staff to spend less time "racking and stacking" data, and it became easier for them to do forecasting, planning and other analysis activities. As a result, finance staff could provide much greater strategic value to their organization.
But IT doesn't just help staff in the back office find time to do more strategic analysis. It actually improves the accuracy of the analysis process. The best IT organizations focus heavily on designing systems that offer "one version of the truth" and then make these systems easily accessible. This dramatically simplifies activities such as enterprise performance management, supply chain optimization and financial simulations.
To drive the maximum value from IT, companies should focus on five best-practice areas. Do careful reward-risk analysis to identify where technology investment can reap the greatest rewards. Consolidate and standardize, reducing IT complexity wherever possible. Rather than focus on minimizing cost, seek to maximize value at the lowest achievable cost. Outsource selectively and use outsourcing as a tool to improve effectiveness rather than efficiency. Finally, the best IT organizations work with functional leaders to ensure that technology is implemented in conjunction with best practices and process redesign.
Senior vice president and director, Boston Consulting Group which specializes in general management and international strategy.
It is easy for CIOs to focus on critical projects to deliver value. The real challenge, however, is to step back and ask, "How are we adding value to the business?"
Effective CIOs first focus on where and how they are creating business value and making the key decisions transparent to both the business and the IT organization. Then they execute the plan to deliver the results in partnership with the business.
For example, I work with a CIO who produces an annual report that shares what the business has accomplished with IT's support. It also talks about where they will jointly focus their effort and dollars for next year. As with any good annual report, it discusses the financials: spend versus budget, benefits of previous projects versus plan, cost-saving initiatives versus plan, etc. It also discusses what they're doing to prepare for the future from an architecture and technology standpoint. It has been extremely well-received, and this is in a non-high-tech company.
Another challenge CIOs face as they strive to prove IT's value is what to count as the benefits of a project and how to ensure these benefits are achieved. Everyone focuses on the hard benefits, which is important. However, articulating the softer benefits that support key business strategies (which many times cross-functional silos) is also critical. This is especially challenging for CIOs who report to the CFO. But making transparent the hard and soft benefits to the senior team is the best way to make good business decisions.
Many CIOs also now group projects into "programs," a simple concept that can have powerful benefits. Focusing your development and business resources on a small number of programs makes it easier to communicate and more effective to measure benefits across business units.
Associate Staff Writer CG Lynch can be reached at firstname.lastname@example.org.