IT STRATEGY - Fanning the flames of IT waste.

Most people are fascinated by gadgets. And for many of them, just keeping a hugely expensive stereo system at home is far more important than listening to music in the most exquisite way. Indeed, the hi-fi experts will tell you that the majority of home systems are set up so badly that simply re-aligning the speakers would do more for the sound than a £500 stylus or a four-figure amplifier. In the home, this kind of wanton expenditure on electronic equipment can be forgiven. But in the age of shareholder value, such profligacy in business is almost unforgivable. Yet according to IT research house Butler Group and its latest associate, corporate technology guru Paul Strassmann, far too many businesses buy in technology which does not add value and may even be destroying the ability of companies to compete. While this may come as no surprise to many FDs, themselves shocked at the ever-escalating cost of IT, what Strassmann and Butler have realised is that the only way to solve this problem is to use a metric which will demonstrate just how well, or badly, companies are managing their information. “We’re trying to get across the fact that return on equity, return on assets, return on capital are out of date metrics (for IT),” says Jonathan Stephenson, principal consultant at Butler Group. “They are all to do with the industrial era, and we seem to be stuck in that mode of reporting. But we’ve really made a move in the economy. There are only a small percentage of companies where capital investment is really important. In 80% of companies the amount that information management costs – the amount you spend shovelling information around and managing your business – is far bigger than the cost of capital ownership.” This argument is revealing on two counts. Firstly, it suggests that companies must start to look at what tangible benefits their spending on information costs has garnered. And secondly, it is a reminder of the importance of focusing not on pure IT spending per se, but on all the costs of managing information, of which the IT budget is merely a subset. To tackle both these problems, Strassmann has devised the “Information Productivity Index”. This appears to be an almost impossibly simply metric: simply take the economic value added of your company (the genuine value created after the cost of capital has been stripped away from profits) and divide it by the information management costs (which are simply the sales, general and administration costs from the annual report, plus spending on R&D). The resulting figure, expressed as a percentage, indicates how well the company’s information resources are being employed to generate shareholder value. Stephenson is comfortable with the simplistic nature of information productivity (IP) scores. “It’s indisputable numbers, whereas if you get people to segment out certain costs and not others, they always juggle them to suit themselves,” he explains. “If you ask companies how much they spend on IT, one will give you the IT manager’s budget, another might add in some of the costs of IT in other departments which they end up hosting – others will introduce lots of other things such as telecoms costs of networks. Strassmann has discovered that any other bottom line figure is troublesome to work with because you don’t get a straight answer. IP may seem crude, but it’s the only thing you can use. There is nothing better.” Naturally, at the macro level, this sort of metric works best in comparison to similar businesses, and ranking companies within a sector this way has been shown to be extremely effective at separating the wheat from the chaff (see box). If you’re spending £1 on information management for every £1 of EVA, while a rival’s costs are only 30p, you may have a problem. But it’s the fact that IP stresses the non-technological aspect of the huge cost of information management that could appeal to FDs the most. “Information management is everything: training your people, sitting in smoke-filled rooms having good ideas, promoting your product, putting up a Web site, paying a designer to paint your graphics. This is all part of information management, and what you spend on a couple of mid-range servers is probably a rather small part of that,” Stephenson points out. Given that IT was supposed to either automate or make redundant many of the information handling jobs formerly undertaken by salaried humans, the measure is all the more relevant. “But you mustn’t always assume that good IP means efficient IT,” warns Stephenson. “It could just be that people have some good ideas and some excellent product lines. It could be that they’ve spent less on IT and more on product development. People don’t rush into stores and buy product because the manufacturer has a good IT system.” So far, at least, Strassmann has fought shy of making recommendations of where IT budgets should be targeted to increase IP, for precisely this reason. Stephenson points out, however, that some general rules about the direction of IT strategy can be learned from looking at whether an IT project is likely to deliver value. “If you just concentrate on the bottom line (information management costs) by automating things that don’t make you any money, like spending £10m on an SAP system, where’s the money coming from?” he asks. “All you’re doing is cutting 10% of your accounting costs – maybe – and I’ve yet to see an SAP site yet where they’ve actually sacked accountants as a result. So they’ve probably saved very little on the bottom line. They’ve spent an awful lot, they’ve got consultants coming in and out trying to patch this very complicated system together, and at the end of the day, what they’ve got for it is an extremely complex piece of infrastructure, some lovely accounting packages. Yet they’ve probably diverted most of their IT budget into it, while they could have been spending on e-commerce – an innovative use of software. So all they’ve done is they’ve sunk more money into automation.” The lesson is that while infrastructure is important, the real value in information spending is found in innovation. “Strassmann isn’t saying that IT is valueless,” Stephenson insists. “He’s saying that throwing large IT budgets into automating and patching up infrastructure without looking outwards into innovative ways of doing business is a waste.” As already mentioned, e-commerce is perhaps the most obvious example of innovative IT spending. When presented with the choice of spending £10m on an SAP implementation or £10m on an e-commerce project, most managers will have no trouble spotting which has the outward-looking focus and prospects for value creation. “The key thing is that if you’re tracking your IP rating and you’re focusing your management team on IP, then they’re more likely to invest their IT budgets and their other management budgets into things that are going to make money and show good returns,” says Stephenson. (Interestingly, the fact that IP is calculated using a figure for EVA ties in closely with this point: EVA creator Stern Stewart would agree that re-focusing management minds on value creation is one of the chief benefits of the metric.) The roots of the IP Index are in Strassmann’s own 25-year quest to find the real value in IT. His career as a chief information officer (that’s IT director this side of the pond) at companies including Kraft and Xerox, and at the US Department of Defence, made it clear to him that there was no correlation between corporate value creation and the quantity of IT spend. Stephenson explains the central problem: “The IT business re-invents itself every four years. And these are expensive cycles. The only people who gain are the IT vendors and the professionals who improve their CVs – the companies get very little. Every time you re-invent these systems, you are simply pushing up the cost of management, and unless you can see a significant return on the top line …” Well, the result is obvious. “Every year the spend on IT goes up. Strassmann describes it as an arms race, and there’s a great deal of keeping up with the Joneses,” Stephenson continues. “There are a lot of boardrooms where people are saying, ‘Here’s my IT budget for the year, how can I possibly know whether this is the right budget or not? Why is it going up 20%?’ That’s what we’re trying to address – how much should you really be budgeting. What the boardroom should be doing to the IT budget is saying, ‘OK, we agree we have to spend this portion keeping the thing operational, but how much are we spending on the innovative stuff? That’s the bit we’re interested in.'” The Butler Group line on information productivity has a very topical hook: the year 2000 problem. The millennium bug happened because programmers didn’t think enough like, well, like FDs when they were writing software. They simply assumed it would become obsolete and the companies for whom they were working would install new systems. This attitude to software, and to hardware and other forms of non-IT information management, prevails today. “This fashion-led IT re-invention has been driven by the software houses, the hardware vendors and people’s CVs. Not enough attention is paid to how IT supports business in creating new revenue streams and new relationships with customers,” stresses Stephenson. “If you’re investing in infrastructure, things like accounting systems or operational systems, people must say, ‘This is a long-term investment, I want it to have some residual value after four years. I can’t write it off because, in four years time, I want a big pot of money to spend on some wonderful new way of doing business. I don’t want to be re-inventing the stuff you’ve just put in.'” The advice is that boards should ensure any new system really is ready for the future (so getting around the computer industry’s mendacious habit of describing its products as “future proof”). Strassmann’s take is that Java, the programming language developed by Sun Microsystems to run on any hardware platform, is the ideal development environment for new corporate applications. But boards should also look at existing information assets and work out whether they even need replacing just yet. “If you’ve got 100 people banging in invoices, then a green-screen terminal and a mainframe is still probably the best way of doing it,” says Stephenson. “The total cost of ownership is minimal compared with giving them a PC with a windows-based client-server SAP system. And that’s the trouble. We’ve conned ourselves into thinking that client-server, object-based systems somehow add numbers up better than mainframes, and they don’t.” While many in the IT industry would argue that modern accounting systems tied in to an e-commerce shop-front will allow really big increases in productivity, Stephenson makes a good point: the time spent installing new systems, training staff and then watching them spend time on non-work-related activities on their PCs actually makes the old green screen world financially appealing. The other point to come out of the IP ranking research is that it highlights the importance of knowledge management. “The accountants are all busy counting the dead things, like property and cars; the banks are all desperate to see on the balance sheet how much money they get back when the company goes bankrupt; and nobody is tracking the value of the knowledge capital, the real money-making capability that’s tied up in people and IT systems,” Stephenson explains. “If 50 people with training and good ideas leave the company, it doesn’t show up on the balance sheet. But if you pension off a bit of plant, it’s on the end of year report.” By looking into the cost and value of information management, Stephenson hopes companies will re-focus from the dead to the live aspects of their business, and direct their IT budgets towards adding value. Avoiding “asset rot”, looking for payback and concentrating on shareholder value are as important in IT as in any other part of the business. UK INFORMATION PRODUCTIVITY FINDINGS Paul Strassmann has undertaken an information productivity (IP) analysis of 1,330 UK companies for Butler Group. Most of those companies have information management costs that are higher than their cost of capital. 600 have a negative IP ratio, which is caused by negative EVA. Among the UK banks Strassmann assessed, it comes as no surprise to see NatWest with a low score (8.5%); its stalkers – Bank of Scotland (43.0%) and Royal Bank of Scotland (19.4%) – performed much better. Butler’s Jonathan Stephenson asks, “What’s the NT roll-out giving NatWest? It’s a typical case of IT infrastructure spend which is patching up internal problems and not looking outwards.” The highest rated firms on the list tend to be investment trusts; all they do is manage information on behalf of clients, and their capital base is tiny so they won’t incur heavy cost-of-capital charges. In this way, Albany Investment Trust, with a ranking of 998%, makes £9.98 in EVA for every £1 it spends on managing information. Surprisingly, capital-intensive British Airways also makes it into the top ten (IP: 847%). There are no other air carriers in the list, so a relative ranking is impossible. Companies assessing their IP need to consider three points: – Negative EVA is bad – improving information management costs and efficiencies can help, but there are many ways to boost EVA. – An IP score on its own is not a brilliant metric – comparison with companies in the same sector is the only way to judge performance, as different industries will have radically different information management needs and capital structures. – Information management isn’t about spending more or less on IT, it’s about spending wisely on value creation.