META Trend: Leading Global 2000 organizations will dominate their markets through engaged, active governance (e.g., senior management participation versus policy lists), process, and architecture (business, information, application, and technology). Highly distributed organizations will grow in number through 2005 and be increasingly pressured to deploy governance processes to mitigate inherent cultural conflict. By 2007, innovation leaders will implement tightly linked, yet loosely coupled, horizontal integrating processes, enterprise information management, and a collaborative culture.
Throughout the 1990s, the ratio of IT spend to business revenues increased, though revenues for some organizations were increasing by 20% or more. Even in organizations where revenues were increasing 30%+, IT costs were often increasing by 50%+, resulting in IT spend going from 2%-3% to 3%-6% (or more) of revenues. From 1995-2000, our research shows that the IT cost/revenue ratio increased by 50%, on average, across all industries. This trend was driven by the following:
- Frenzied efforts to continue dizzying revenue growth rates, often based on marginal business cases – and the hope that IT investments would yield a breakthrough competitive advantage (e.g., innovation)Publicized cases of IT-infused business process improvements that yielded significant revenue/employee increases (e.g., Fed Ex’s “self-service” package tracking using the Internet; Internet stock trading; front-office and customer service in the banking industry)Business awareness of IT issues (e.g., the airline magazine syndrome)
Throughout 2001/02, the slowing economy drove organizations to review IT budgets and previous investments with intense scrutiny, focusing on cutting costs. During 2003/04, firms will continue applying increasingly sophisticated portfolio management disciplines to manage projects and assets across the business and the IT organization. By 2005/06, leading organizations will have evolved their portfolio disciplines to accurately expose truly life-cycle costs, consequences, and value to business leaders. Ultimately, these business leaders must be the ones who manage IT demand. This requires the CIO to have a clear communication line to the CEO, CFO, COO, or at least a line-of-business president to elucidate the costs that might be incurred as a result of user demand.
Business-Area Ratios of Costs to Revenues Are Key
Funding models must evolve. Leading organizations will hold businesspeople accountable for productivity increases in their areas, rather than simply focusing on IT project budgets and operational costs. For example, it does not make sense to expect IT costs to decline as a result of deploying a new human resources (HR) application; rather, the HR department’s costs should decrease as a percentage of revenue due to productivity improvements (or the level of service or regulatory compliance should be significantly improved). In the case of an enterprise resource planning (ERP) deployment, the focus should be on the ERP-related IT project and operational costs being offset by improving the ratio of manufacturing costs to revenues, or improving cycle times or quality. For sales force automation, the ratio of the cost of sales to revenues should improve – ideally, because salespeople are more productive, thus increasing the revenue per sales representative or customer through cross-selling, up-selling, or shortening sales cycle times.
These types of ratios are the key metrics for IT leaders to focus on, and figuring out how to capture and communicate them accurately is a key IT organization imperative. If costs:revenues are increased in one business area, such as IT, a commensurate decrease needs to take place in another business area, unless business leaders have decided to change the ratios or margins of the business due to a strategic initiative (e.g., improving quality, complying with regulations, shortening cycle times). Promises of revenue increases are only valid if profits remain the same or improve, unless business leaders are willing to accept market share gains as justification for changing the profitability model of the company.
Handling Frenzied Efforts, Marginal Business Cases, and Airline Magazine Syndrome
Although current cost-cutting efforts have severely curtailed IT spending, the issues that drove the excesses of the 1990s continue to exist. Leading CIOs will develop a consistent set of disciplines to ensure that the mistakes of the past are not repeated.
The key to controlling frenzied efforts – and avoiding ill-advised bets on IT investments yielding a business breakthrough – is for the CIO to gain the attention of the highest-level CxO who will listen, and explain the true costs of the revenue-generating effort and how the costs might impact strategic ratios if the initiative fails. The CIO must then get out of the way, as the senior vice president of sales or some divisional vice president pleads the case. This highlights how portfolio management must evolve, eventually enabling the analysis of benefits, costs, and risks of investments across the business rather than simply within the IT organization.
The way CIOs can avoid inappropriate IT investments due to public success stories and vendor marketing is to be as involved as possible in explaining what can be achieved using IT as well as what it will cost. Also, CIOs must insist on organizational readiness assessments being conducted to determine whether the organization can/will adopt a new IT-infused process. In this case, the IT organization must be at least a trusted advisor to overcome line-of-business politics and avoid “wild goose chases.”
When it comes to business executives reading airline magazines and questioning why the IT organization is not pursuing the latest great idea, the key is for CIOs to understand “technomics” – the real economics of new technology and integration. Technomics not only comprises upfront acquisition costs, but also extends total-cost-of-ownership concepts. These include how costs change as bleeding-edge technologies commoditize and skill sets become cheaper and widely available, through to technologies becoming legacy when skill sets become rare and maintenance costs rise. The need to comply with the Financial Accounting Standards Board’s recommended approach to “Accounting for Asset Retirement Obligations” (FASB 143) further highlights the need for business leaders to understand the big picture of IT costs, as well as the benefits and impacts on other parts of the business.
Managing Supply and Demand, Instead of Fixating on Managing Supply
Long term, leading IT organizations will evolve beyond the near-term fixation on controlling costs by controlling supply. Once most cost savings have been squeezed out of suppliers and IT inventory has been rationalized, the next challenge is to work with business executives to identify the user behaviors that drive the most business value versus those that simply drive costs. Leading CIOs will enlist business leaders to help shape user behavior through a combination of policies, pricing, retuned service-level agreements, and marketing. In the most successful organizations, the business leaders themselves will be the role models for how IT should be leveraged, and they will regularly ask their staff questions that focus on driving user behavior toward maximum business value-add.
Business Impact: For business leaders, understanding the implications of user demand for IT on costs, benefits, and risks across the business is the first step in managing costs long term. The next step is identifying and driving behaviors with true business value-add while constraining user actions that simply drive IT volumes and costs without adding value.
Bottom Line: IT leaders must enable business executives to be the ultimate managers of IT demand by effectively communicating benefits, costs, and risks to business leaders.