Innovation Capacity - Not IT Spend - Matters Most Aug 3, 2005 – By Barry Zellen
For several months two years ago, pundits, analysts and IT vendors sparred
over what then looked to be the essential question concerning IT's future:
'Does IT really matter any longer for competitive advantage?'
Indeed, an intense and passionate debate consumed many business journals,
blogs and IT publications after the illustrious and trend-setting Harvard
Business Review published Nicholas Carr's controversial article on this topic
in May 2003. But in the months since then, this great debate over IT's future
started to fade - with IT continuing to matter, and customers continuing to
make IT purchases, in the hopes of maintaining their competitive advantage -
even if only for a little while longer.
But rather than ask whether IT matters any more, a new report from IT analyst
firm Forrester Research suggests that we need to be much more specific.
Forrester makes the case that our overall IT spend matters much less than the
portion of our IT spend that gets re-invested in new technologies, furthering
along innovation. Indeed, Forrester believes that a company's "innovation
capacity" matters most of all when it comes time to assess that age-old, and
oft-debated question, 'does IT really matter?' Forrester observes that the
economics of IT have long been "rooted in a firm's ability to match finite IT
resources to business needs and requirements" - and a such a CEO should view
a company's IT spend as much more than merely the percentage of revenue his
company's IT spending accounts for. It's Forrester's view that the percentage
of revenue that IT spend accounts for should be "merely the first step in
determining what is an appropriate level and mix of IT spending for achieving
[your] strategic goals." ("Memo To CEOs And CIOs: IT Innovation Capacity -
Not IT Spend - Is What Matters," August 3, 2005.)
>> IT Value Rooted In Innovation Capacity: Indeed, Forrester finds that
in order to fully appreciate IT's ability to deliver business value to the
enterprise, CEOs should keep their focus on what Forrester describes as
"innovation capacity" - which is "the potential for the IT function to
support new products, processes, and opportunities." So while "setting a
firm's IT spending to be a certain percentage of total revenue may make a CEO
comfortable in thinking that IT expenditures are under control," reality is
far more messy and complex - and in this messy and complex reality of IT that
we live in, "that target is meaningless when taken out of the firm's
context," which is "typically composed of factors beyond IT's control."
Forrester believes that CEOs should instead "take a more critical view -
drilling down into the mix of spend allocated to ongoing operations and
maintenance (O&M) versus new IT initiatives." By so doing, CEOs may
better "identify the capacity in which to use IT for business innovation" and
thus "grow that capacity over time." Forrester is confident that "successful
companies will grow their IT innovation capacity by focusing on how IT is
sponsored, operated, and governed," and not limit their view of IT to merely
how big a chunk of company revenue is being forked over for IT spend.
>> Measuring Your Innovation Potential: To fully assess their
"innovation potential," Forrester advises CEOs and CIOs to "look back at the
past three years" and "examine the trend line of innovation capacity" - and
then to "look ahead to the next three years to set a target for what they
want their innovation capacity to be." Forrester explains that "negative
innovation potential" - or a reduction in capacity - is a "recipe for a
variety of unpleasant scenarios, including growing business frustration with
an ever-scarcer IT resource pool, business units' avoidance of the IT
organization, and CEO dissatisfaction with the performance of the CIO."
To derive the most value from their IT spend, Forrester presents several best
practices designed to "help IT change the mix of ongoing maintenance spend to
new spend over time," and in particular advices CEOs and CIOs to "identify
areas for improvement in how the firm links IT to strategy; runs its
operations; and governs relationships."
> IT's Link To Business Strategy: Forrester explains that inside a
company, "accountability and sponsorship tune supply to demand," and as such,
"the mix between ongoing and new spending can only be altered by treating
both capital and ongoing IT expenditures as a consolidated portfolio."
Forrester adds that once expenditures are consolidated, execs "can ratchet
down the amount of maintenance changes to legacy apps, invest in
infrastructure upgrades with lower carrying costs, and decide to introduce
new technologies paid for by these savings." Forrester believes that the
"more effective a firm is at quantifying project benefits, shared
accountability, and the sponsorship for project results, the more likely
subsequent yearly benchmarks of innovation capacity will reveal improvement
compared with the firm's industry as a whole."
> IT's Maturity As A Business Operation: Next, Forrester notes that
"transparency measures progress," and adds that "even with the appropriate
executive oversight and commitment, if IT's house isn't in order, innovation
capacity may shrink over time." If that happens, "IT will then become an
albatross, an organization to be avoided when critical technology innovation
is required." Companies should this aim to improve "how they administer the
portfolio; maintain stable operations; and, like any business, provide
transparency to the measurement of service, results, and improvements."
> IT's Relationship To Business Stakeholders: Lastly, Forrester points out
that "IT is aligned with client expectations," so if IT does not successfully
manage its relationships with stakeholders, "then even if there is capacity
to innovate, the level of trust between IT and business will reduce the
quality of - and even delay - innovation initiatives." Hence Forrester
recommends that execs "make sure that the appropriate governance processes
are in place, that relationships are managed well, and that stakeholders have
a clear understanding of what IT can be and is doing for them." The "skillful
marketing of IT" will thus help companies "with realizing [their] innovation
potential."
>> Having More To Spend On Innovation By Spending Less On O&M:
Forrester observes that innovation capacity is really just "the amount of
available funds that IT can spend on new initiatives in any given year,"
which is "typically total IT spending minus IT spending on ongoing O&M."
Forrester explains that by making savings in ongoing IT O&M, companies
can "free up a constrained resource pool to do new projects and investments"
- driving greater innovation. As such, by looking to innovation capacity,
companies may use that "difference between ongoing IT O&M and total IT
spending as a percentage of total revenue as an indicator of IT's capacity to
support business innovation."
Typically, Forrester adds, IT spending on ongoing O&M is measured as a
percentage of total revenue - and most firms "set a benchmark target to
ensure that the percentage of total revenue spent on ongoing IT support,
maintenance, and infrastructure declines over time." Forrester acknowledges
that "in general, spending less than competitors in this area is good, and
showing downward progress is even better." But Forrester clarifies that
"making the right comparisons is important." For example, Forrester notes
that "manufacturers, retailers, wholesalers, and other goods-selling
companies in which the cost of goods sold represents half or more of revenues
will inevitably have higher levels of IT spending on ongoing O&M than
will services companies with minimal cost of goods sold," while "companies in
financial services - or healthcare - that have invested heavily in technology
to automate business processes will naturally have higher levels of IT
spending on ongoing O&M than those that still have people-and-paper
intensive processes."
>> Financial Services Face Higher IT O&M: Forrester points to the
financial services industry, where IT spending was an average of 8.2% of
total revenue in 2004. While this may sounds "aggressive compared to
industries like telecommunications, which spent 4.3% of total revenue on IT,"
Forrester explains that the financial services industry spends, on average,
6% of total revenue just to "maintain and operate its existing IT systems for
trading, lending, billing, risk management, and customer accounts - leaving
only 2.2% of revenue, approximately 25% of total IT budget, on new work,"
which works out to be "the exact same innovation capacity as telecom. Hence,
Forrester finds that those financial services firms with more than 25% of
their IT budget allocated to new work will thus "have a greater innovation
capacity than their peers do."
>> The New Math Of IT: As a result of this new IT spending math,
Forrester advises execs to examine their innovation capacity and innovation
potential, and if their company "spends only 1.5% of total revenue on new
work, but spends 8% of revenue on IT in total," then their company is
"carrying an ongoing operations burden - especially if competitors are able
to spend 2% or more of total revenues on new initiatives while keeping IT
spending at 8% of total revenue or less." In such a situation, "entry in new
business arenas in the future may find the IT department helpless to
respond."
To remedy this, Forrester advises execs to "set a specific target for
improvement," and explain that "if you project your spend on ongoing
operations over the next several years and its ratio to revenues to be flat
or rising," then "you may be on the road to evaporating innovation capacity
and disappearing IT jobs." Instead, Forrester advises that "pushing that
ratio lower year by year will allow you to shift IT funds from ongoing costs
into new initiatives," and then to "market forthcoming and successful past
projects to build trust." And, as a result, Forrester suspects that you "will
also find that IT may even receive incremental funds for other innovation
projects down the road."
Lastly, Forrester advises execs to "identify tactics for improvement by
examining the overall IT portfolio," and "through inspection of where your
ongoing operations dollars are going," Forrester thinks you'll "see ways to
retire applications that are a resource drain, renegotiate vendor contracts,
consolidate disparate systems, or defer ballooning legacy app maintenance
requests." And by "holistically examining the requested new work - which may
include app upgrades that could be traded off with needed information
security changes" - Forrester expects you'll find "other techniques to boost
innovation capacity."
>> Preparing For The Next Big Thing: Forrester observes that companies
"have been in a period of technology refinement and digestion over the past
few years," and explains that this was "initially as a result of a hysterical
period of overbuying in the '90s" that was "further compounded by an economic
slump and its related downsizing and cost pressures." With that now behind
us, Forrester expects companies will now "finish absorbing the technology
that they already purchased by 2008." So by next year, Forrester anticipates
that companies "will begin to accelerate their investment in new
technologies." As a result, "now is the time to focus on getting current IT
spending under control, freeing up resources for innovation and investment,
just as the firm seizes on the benefits from the next big technology thing."
Innovation Capacity - Not IT Spend - Matters Most
