Everyone loves a good makeover. Perhaps the CIO could benefit from one. With the help of a 'keen eye' and some...
pointed advice, these embattled executives need to shift focus to what's really the most important criteria for IT and business success.
A recent Empirimetric analysis (contributions to profitability as surveyed by the PIMS Program from the Empirimetric Corporation – 2002) of 3,000 business units from more than 300 corporations found that operating effectiveness (also known as "the ability to run a tight ship") contributes to a company's financial performance just slightly more than luck and random events. Overwhelmingly, success depends on market position: the ability to deliver the right solutions to the right market on a timely basis.
To help drive this market positioning -- which is where the greatest opportunities for success lie -- CIOs must focus on business-oriented goals rather than technological ones.
It's a difficult mindset shift to make, compounded by the intense scrutiny and pressure for IT spending to deliver high value. Although the economy is showing signs of modest recovery, analysts predict IT budgets will remain flat again in 2004. At the same time, demand for IT is increasing, project backlogs are building and business leaders are pressing for migrations, upgrades and new solutions.
Escalating the CIO challenge, IT governance is being transformed from a strategy to make budget planning more efficient and effective to being legislated. The Sarbanes-Oxley Act requires that companies report large material investments to corporate financials, placing most large IT projects such as ERP, data warehousing and intelligence, custom application development, infrastructure upgrades and consolidation under intensified scrutiny.
Economic and legislative realities now mandate targeted goals to define how a CIO contributes to overall business performance. These realities include:
- IT spending results in bottom-line impact
- IT spending drives strategic and competitive advantage
- Individual IT projects deliver measurable results
We recommend a three-step process for a CIO makeover, rooted in reconnaissance to grade past performance, outlining a roadmap for improvement and collaborating with business executives at every stage.
- Step 1: Financial performance
If technology investments truly have a positive impact, the results should be visible in the corporate financials and key financial metrics and ratios -- showing that the company is besting the competition and continually improving performance over time.
These influences should include revenue growth, increased profitability, lower costs of goods sold and operating expenses. For example, the investments in supply chain management should help to improve inventory turns and reduce days sales outstanding overall, as well as show relative improvements compared to the competition.
The most informative competitive benchmarks will measure the company's metrics against named peers in similar industries and geographies, with comparable business models and size.
Competitors' performance information can be obtained from several sources, including annual reports, financial filings and information brokers, as well as specialized benchmarking service and software providers. Typical metrics include important elements and derived ratios from the income statement, balance sheet and cash flow statement.
The metrics a company should use to measure corporate performance is debatable, and can vary greatly by industry. A few commonly used top-level metrics to assess the impact of IT include:
- Revenue, revenue per employee and revenue growth
- Profitability and profitability growth
- Economic value-add (EVA)
- Return on equity
- Return on assets
- Cost of capital
- Days sales outstanding
- Inventory turns
- Working capital productivity
- Cash to assets and liabilities
We also suggest using two specialized metrics, both developed by Paul Strassmann, most recently the CIO of NASA and the former CIO of Xerox and Kraft Foods:
- Information Productivity (IP) -- a measure of the overall impact that IT has on the organization. Assuming that IT investments are made to help reduce overhead (SG&A) and increase profitability, the IP ratio highlights the macro-economic impact of IT, calculated as a productivity ratio of output vs. input: EVA (the output) versus SG&A spending (the input).
- Knowledge Capital -- a measure of a company's sustainable value, calculated as the ratio of overall profitability, EVA, divided by the cost of capital, which highlights how risky the company is perceived to be in the capital funding marketplace -- and an indication of future value devoid of market capitalization volatility and the tumultuous whims of the stock market.
- Step 2: IT spending and TCO
Understanding corporate performance provides only half of the picture; equally important, the CIO must understand which IT investments drive overall performance for the company, and for the competition. Key measurements include IT spending as a percentage of revenue and per employee, as well as the total cost of ownership (TCO), a detailed analysis of IT spending and key performance indicators in various categories.
Finding the IT spending and TCO metrics for competitors is more difficult, but can be obtained from analyst firms, benchmarking specialists and tool providers, or commissioned studies.
- Step 3: Spending versus performance
Once IT spending is assessed, the final step is to correlate the performance of the company and peers with IT spending to gauge the efficiency and effectiveness of spending. This comparison will reveal which companies are spending wisely and achieving great performance, which are investing for the future and which ones are falling behind as spending laggards.
It is essential to place a benchmark in context: Often, there is no direct relationship between IT investments and improved business performance. IT projects are complex, and their success depends on the investments being technically sound, aligned with corporate goals, adopted by the user base and accompanied by changes in business processes and behaviors of employees, supply chain partners and customers.
IT investments can deliver positive business results, and they can be squandered just as easily.
Competitive benchmarking gives the CIO a 360-degree view to prioritize business opportunities, determine if expected results are being achieved and, most importantly, ensure that overall competitive positioning is improving. It helps the CIO move beyond the management of IT projects and the budget to ensure overall information value -- and paves the way for a successful makeover from the CTO to the influential and respected CFO of IT.
Thomas Pisello is the co-founder and CEO of IT ROI and value consultancy Alinean and author of IT Value Chain Management (IEP-- 2003).