The Cost Of Bad IT Economics

By Brian P. Watson  |  Posted 02-11-2008

The Cost Of Bad IT Economics

In times of economic crisis, companies are quick to slash IT costs. With fears of a recession looming over the corporate world, CIOs are facing the axe once again. But no matter how many times CIOs proclaim their strategic value--or the strategic value of their departments--businesses too often view IT as a cost, plain and simple.

IT executives have been rallying against that perception for years, but they're getting little attention. Howard Rubin says it's about time that changed.

An IT benchmarking pioneer and self-proclaimed "metrics arms dealer," Rubin is a former fellow with corporate strategy consultancy Norton, Nolan & Co., where he developed metrics for application portfolios and helped create the balanced business scorecard. He also serves as a senior adviser to Gartner and a research affiliate to the Center for Information Systems Research at MIT Sloan School of Management. A former executive vice president of META Group and professor emeritus of computer science at Hunter College of the City University of New York, Rubin has been an IT adviser to the U.S., Canadian, Indian and other governments.

Rubin says businesses see better results when they make sound IT investments during economic downturns. When they don't, they run the risk of falling behind competitors. And the cost of catching up, he says, can be insurmountable.

But CIOs are as guilty as their bosses in misinterpreting the true value of IT investments. To turn the tables, Rubin says, IT executives must recast the conventional language around IT expenditures and strategy.

Rubin recently spoke with CIO Insight online editor Brian P. Watson about what companies do wrong in valuing their IT investments, and what CIOs must do to change that perception. What follows is an edited transcript of their discussion.

CIO INSIGHT: What's the biggest problem today with the way companies view their IT investments?

Rubin: It's been a long-term problem: Most companies view their IT investment as a cost and therefore they try to minimize the cost.

Corporate leaders always ask me how they can use benchmarks to compare themselves with their peers, and how they can compare against best in class. Best in class, in conventional wisdom, is typically who's doing IT for the least amount of dollars, relative to revenue, relative to operating expense. Best in class sometimes is synonymous with who's the low cost in IT. That's a big problem, because the low cost may not be the best user of IT. When people talk about understanding how to calibrate themselves, they need to redefine best in class in terms of the aspirations of the business. Best in class could be, what's the spending pattern of the companies that are most profitable in our industry the last three years, or what are the spending patterns of the companies that have increased their business performance earnings per share the last three years?

Companies treat IT like a cost and look for outside validation to drive costs down. They really should be looking at the outcome. What should I do with my IT strategy, my IT investment; am I maximizing return? That's better from a business perspective.

Companies understand that IT produces value. But they view IT as a cost because it's so much harder to figure out where the value shows up in terms they can get their hands on. They gravitate to what's tangible, and what's tangible is the budget item.

When you look at annual reports, go to "operating expense." First you find "compensation," and then you find "communications and technology." IT, also through accounting principles, just makes itself look like a cost. The businesses themselves aren't necessarily cost-focused: IT shows up as a cost and finding the value is much more elusive; it's a self-feeding system.

Page 2: Becoming IT Savvy

The Cost Of Bad IT Economics

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But CIOs and IT executives have been making this argument for years. Why aren't they getting any traction?

Rubin: There is no senior executive who will not say technology is critical to the business. But it's viewed as a cost, so the cause and effect of IT investment and business performance hasn't been very visible.

Look at the world of accounting; those principles have been around for thousands of years. IT has only been in the business environment since the 1960s or so. We're looking at something that has only a 40-year history in this big geologic era where business performance, measurement, design and theories have been able to merge. The interesting thing is that when things are in their infancy, you can figure out the costs, but you can't really figure out the dynamics on the other side.

It's only in the past five years that discipline and real good cost accounting--not just by allocations but by bottom-up cost accounting and cost transparency--hit the radar scope in IT organizations. You can't do cause and effect, or even look at the linkages between what you've done and what comes out on the other side and return on any investments, until you can really allocate costs.

It's only in the past five years that people are getting a handle on where the IT dollars are going and can bring it back to a business-product level.

You're suggesting that the people who make those judgments--CEOs, CFOs and other executives--aren't viewing IT as a strategic asset. Are those people creating this perception?

Rubin: Most IT departments do not have effective communication and marketing programs. Again, in business history, these organizations are young, and their strategic value is clouded and not clearly articulated. Most technology people revert and talk about things in technology terms. Having someone at a table for strategic planning when the business is trying to identify how they're going to grow products, grow business, where future revenue is coming from, how they'll launch into new markets ... until you get the special CIO who's able to communicate in business terms and not this technology or that technology, it really doesn't work on the pure side of driving the business forward.

It's also, how does the CIO view the role? It's very complex. If you're hired as the CIO of a major organization and the business manager says, "We understand IT is strategic, and we're hiring you, but you need to control the cost," then boom: What's your mission? Is it creating value? Or controlling cost? Suddenly you have this bipolar existence. CIOs have this complex dilemma of having a lot of visibility through cost, being able to express value through anecdotal instances but limited participation in strategic planning.

Peter Weill at MIT talks about organizations being IT-savvy. Savvy IT organizations understand how IT is a key lever in producing business value, and there's clearly strong communication and the organization is technologically facile.

The CIO's role is obviously to be an effective manager and deal with the cost aspect, but number two, to work with the business to see if you're creating an IT-savvy organization as a whole--a sort of evangelist for technology, in a careful fashion that raises awareness of the interaction of business and technology and business success across the whole place. Eventually, you end up with an organization that has an innate understanding of how technology contributes to the business at a high level and a product level, and the boundary between the technology person and businessperson gradually slips away.

We see more CIOs reporting to CFOs. What impact does that dynamic have on the perception of IT?

Rubin: There are companies whose CIO channel is through strategy, CEO and the business executive table, and those whose CIO channel is through the CFO side. The language they speak depends on what channel they're planted in. If you speak the language of cost, you're condemned ever to deal with reducing cost; when you're on the business strategy side, then you're speaking the language of investments. So the channel controls the language and the interface, and CIOs who are constrained in the cost side need to learn the new language and move themselves across.

In tough economic conditions, companies are concerned about revenue growth. You need to protect revenue, but you also need to control operating expense. IT comes up on the expense radar and is usually whacked. In a time of crisis, companies typically revert to treating IT as a cost, and they put it under the CFO and get into cost-containment mode. They don't pay attention to the fact that, in the average company, IT is 7 percent of operating expense--maybe 15 to 20 percent in financial services--and maybe they want to reduce that. But if you're 7 or 15 percent of operating expense, that means there's 93 to 85 percent of operating expense that isn't IT, and they're squeezing the wrong side of the equation. The business reflex in a crisis is to cut the most visible costs and that's usually IT. The value of IT is visible enough, and they don't understand that when they reduce IT cost, they reduce the possible leverage to get a big multiplier out there.

Page 3: The CIO's Failure?

The Cost Of Bad IT Economics

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Who's at fault for that?

Rubin: That's a failure of the CIO, and it's also a failure of the current metrics that are out there. Most companies will look at calibrating their performance against competitors and say, "Let me look at my technology spending versus revenue, and is it too high or too low." But CIOs don't control revenue. They should look at technology spending versus operating expense to understand if they're under- or overinvested in technology. In a healthy company, spending versus operating expense will rise in terms of IT because as you spend more in IT, you drive operating expenses down faster.

It's an interesting conundrum. One of the key things to managing IT is to have a strong financial perspective on the relationship between IT spending and what it does to business performance, and that's usually visible through the CFO. But if you have this cost-focused view, looking at the wrong metrics and the wrong gauges on your dashboard, you'll never get it right.

So is it more help or hindrance to have CIOs report to CFOs?

Rubin: A CFO can be a very effective partner for the CIO because the CFO has access to the right information. To manage IT investment, you should look at the business and business products, understanding product profitability, future growth plans and product introductions. That's what things are about. You need to slice that down and say, "What's the role of technology that makes us competitive? Does it drive our cost down? Increase our margin? Give us informational effectiveness to do better customer intimacy and match buyer and seller?"

By partnering with the CFO and the right businesspeople--through the CFO, if necessary--the CIO should be able to create a map of the entire enterprise, of all its products, and where the competitive levers are for IT. And the CIO, with the cooperation of the CFO, should be able to see if the investments are going where the bang for the buck is to drive future business performance and do IT investment from the bottom up.

It's going to be a balance between IT optimization--see that IT dollars are spent the right way, get the right value per dollar from staffing to everything else and make sure the dollars are placed right--and building the investment portfolio from the bottom up.

Page 4: The Mission of IT

The Cost Of Bad IT Economics

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So how easily can the transition from cost to strategic investment happen?

Rubin: IT will naturally become a player in strategy once it works on getting the transparency of the product and competitive lever level. The CFO can be a big ally in that. The problem we face in business is that the reflexes are wrong: If you start to cut IT without paying attention to this low-level investment model, you don't know what damage you're doing.

In financial services, out of eight investment banks, three will be spending, the others will be holding or cutting IT spending. The three that spend through the crisis, if they make the right investments, put the others in catch-up mode when they come out of it.

If the companies that spend on IT--those that have the right reflexes and do surgical investments--make the right bets, they'll move ahead. When the guys who choke investment decide to catch up, it'll cost them twice as much. And, by the time they catch up, the other guys will have moved on. So the cost of not investing at the right time and the right price in technology is probably four times the original investment.

What's happening now is, we'll see a tremendous widening of the competitive gap. The guys that cut will pay a price in the future because they may never be able to catch up through traditional means. That means they'll have to sell things, source things, buy capabilities or do things they never thought of.

We're at a beautiful time to be a technology-economics voyeur. You'll start seeing splitting in the various sectors of the companies that use technology and move away, while the others are in cost-cutting mode. If the guys who spend continue to do so effectively, they'll create a gap that's insurmountable for those who haven't. That's the problem with the economy today. In a time where they should be spending their way through a crisis and using IT as the lever, they're cutting IT, and operating expense will go the wrong way, and they'll lose any competitive edge they'd ever had. That's my theory.

There's a difference between companies that treat IT as a cost and companies that treat it as an investment. It's probably worth anywhere from 2 to 5 percentage points in gross profit, which is tremendous. You can really show the cost versus investment mentality showing up in gross profit in multiple years.

The people who treat IT as an investment and are IT-savvy have superior business performances measured by profitability, which turns into earnings per share and all this other good news downstream.

What can CIOs do now?

Rubin: The CIO should campaign and communicate, not against the cost focus, but to align with the business. CIOs should focus on IT investment transparency. They should recast the way they spend into business-facing terms. The first set of terms to replace is development, maintenance and infrastructure--substitute that with run the business, change the business and grow the business. They need to change their language.

They must reach out to the business and work with the businesspeople to identify where the competitive levers are, making sure their investments are fully aligned. CIOs should look inward; they need to focus on the charge of managing costs effectively, which means, from an internal cost-transparency commodity standpoint, they need to be able to answer the questions, "Do we have more or less capacity than we need for a business our size? Do we have the infrastructure we need? Are we paying the right price for the commodity?"

They need to do the yin-yang of cost optimization continuously; drive their people to work at market rates; evaluate sourcing opportunities and places for economic leverages. They need to manage their costs down, and manage their investment out.