Nick Carr Underestimates the Most Important Parts of IT

By CIOinsight  |  Posted 06-30-2005

Nick Carr Underestimates the Most Important Parts of IT

While philosophic in nature, Nick Carr's hypotheses on the strategic value of IT investments has fueled a two-year debate—which means he's hit upon the very root of the tension that exists between the technology and business camps in most organizations.

Here's where there's truth to his argument: Companies that consistently get the most value from IT investments clearly understand that there are certain cases where tech investments are best managed purely to achieve the lowest TCO (total cost of ownership).

Click here to read Nick Carr's commentary on "The Next IT Revolution."

But in other cases, these same companies realize that spending should be ramped up for specific projects to support the business. Knowing which projects deserve spending and which mandate thrift requires an examination and understanding of both internal and external conditions.

Click here to read the first set of readers' reactions to Carr's CIOInsight article." and here to read the second round.

Every year, Alinean and its analyst partner IDC collect IT spending data from more than 400 companies and apply it to build regression algorithms to estimate spending trends.

We analyze quarterly IT spending and financial performance data for more than 20,000 companies worldwide to identify the companies that are best able to extract value from IT spending. We can then learn from their practices, and understand what differentiates their strategies from those that struggle.

When this IT spending and performance data is analyzed over the past three years—the period since Carr's article first appeared—several interesting trends emerge.

Since 2003, leaders have clearly recognized the changes in the market and have ramped up IT spending. Dig deeper and you can see that they have driven down infrastructure costs and made strategic investments to support transaction optimization, information management and transformation.

In short, they're managing IT investments in such a way as to enable the business to capture all of the potential in improving marketing conditions. They're also managing IT investments in a hierarchy—treating core infrastructure as a commodity while increasing strategic tech investments to support key business goals.

The importance of context cannot be underscored enough. In fact, Carr originally used Alinean's data to support his first suppositions of IT commoditization in his 2003 Harvard Business Review article. But he misinterpreted the research by ignoring the incredibly tight market conditions at the time, and no regard was given to granular IT spending analysis.

Next Page: Putting research lessons to work.

Using Lessons

Here are the highlights of Alinean's most-recent research:

We measure superior financial performance across 150 dimensions, summarized best in the EVA (Economic Value Add) metric—an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk.

In an analysis of the top-performing 200 companies (those with the highest EVA), the leaders consistently prove to be the most frugal in their IT spending as a percentage of revenue, spending on average 0.5 percent less on IT as a percentage of revenue versus the average company.

But placed in context, these leaders are spending increasingly more year after year: 0.82 percent of revenue in 2003, 1.6 percent of revenue in 2004, and 2.8 percent of revenue in 2005. They're making up for frugal cuts in years prior, and are investing rapidly for future growth. As market conditions improve, these agile companies are turning up spending.

Another metric—IT spending per employee—tells another story: Interestingly, leaders spend more per employee on IT than an average company—about $500 more each year, in fact. In these leading companies, IT investments are often made to help the company do more with fewer people or better manage outsourcing initiatives.

Alinean's own ROIT (Return on IT) metric is a ratio of a company's financial performance (EVA) divided by IT spending. ROIT highlights the efficiency of IT spending and its ultimate effectiveness at driving corporate profitability. Leaders have a 426 percent-higher ROIT than the average companies, spending less but getting more from each IT investment.

Inspired by the actions of their top-flight peers, CIOs should be asking a series of forward-looking questions:

1. Is the business facing a period of rapid growth? The degree of frugality in IT budgets should be determined to keep pace with market conditions. Scaling back spending to maintain profitability in lean times—or ramping up spending to capture ripe opportunity—are the mark of a leader.

2. What are the business' most strategic operational and competitive goals? IT dollars spent on initiatives aligned with these goals deliver the most strategic value and highest return. Perhaps this will point to initiatives for automating manual tasks; streamlining interactions' fostering creativity and collaboration; bringing better collection, visualization and application of data to measure the business and drive improved performance; and using information to change the competitive playing field by creating different relationships with suppliers, partners and customers.

3. How mature is the IT organization? Every company must manage IT investments in a hierarchy, where basic levels of IT infrastructure must be solid before more advanced applications can be pursued. Once this infrastructure is in place, however, the company should indeed seek to reduce the cost of ownership as much as possible and manage it as a utility, much as Carr suggests. However, the company that stops here will fall behind the competition.

As CIOs begin thinking about priorities for 2006 IT budgets, now is the time for analyzing business needs and setting goals to support them.

Tom Pisello is the CEO of Orlando-based Alinean, the ROI consultancy helping CIOs, consultants and vendors assess and articulate the business value of IT investments. He can be reached at tpisello@alinean.com.