ROI STRATEGIES
Return on IT analysis proves that IT does matter
Tom Pisello, Founder and CEO of Alinean, the IT Value Experts
10.27.2004
Rating: -5.00- (out of 5)
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Nick Carr's argument that IT initiatives are no longer a source of corporate competitive advantage is both right and wrong. True, many IT purchases are commoditized buys that don't lift an organization past its peers. But the fundamental mistake in Carr's thesis is that all IT investments are a commodity, and should therefore be cut because they don't drive business value.
Alinean's analysis of 2004 IT spending across more than 5,000 companies clearly disproves Carr's theory, showing that on average, companies that spend more on IT achieve greater bottom-line benefits. The key to ROIT™ (Return on IT) success: minimizing commodity purchases and investing more in innovation, which has proven to generate significant competitive advantage.¹
Simply put: value isn't derived from how much companies spend on IT, but from how IT dollars are invested and managed.
Nick Carr's recent comments contain a litany of flawed logic:
- "IT is shifting from a potential source of competitive advantage to just a cost of doing business."
Averaging best and worst performers across all market sectors, companies spend 65 percent of IT budgets on ongoing operations and support, and 25 percent on migration and upgrades to existing infrastructure and applications. These expenses, which Carr correctly calls "a cost of doing business," drain 90 percent of the IT budget. But the remaining 10 percent sliver matters most; this is where companies' strategic technology investments achieve competitive gain.
Top performers find ways to reduce the commoditized 90 percent and spend more on inventive IT projects that align with business goals and deliver bottom-line value. Typical areas of cost cutting occur in hardware consolidation, standardization, managed services, selective outsourcing and utility computing.
- "My argument is not that you don't need IT or that it's not important, but that it doesn't matter strategically and doesn't provide one company with a way to distinguish itself in any meaningful way from its competition."
Were this statement true, all boats would rise and fall with the tide. However, the ROIT evidence of thousands of public companies shows that businesses achieve both positive and negative returns from their IT spending, regardless of the amount invested. In short, a company that spends more does not necessarily obtain higher returns or additional competitive advantage.
So while some leaders are clearly frugal, an under-spending company is just as likely to get poor results. Similarly, spending more on IT could lead the company to good results, but can also just as easily be squandered. A demonstrable competitive edge exists, and it goes not to those who spend the most or least, but those who invest in innovation, and manage those investments wisely.
- "I think longer term trends toward the greater standardization of IT and toward rapid price declines of IT components have also influenced executives in leading them to move away from the cutting edge and look for cheaper ways to get the capabilities they need."
Carr correctly notes that during the downturn, companies sensibly adopted frugal spending practices. Those agile enough to reduce total cost of ownership (TCO) of IT spending and other overhead expenses the most generally out-performed peers.
But for the long term, 2004 data reveals that companies agile enough to increase IT spending derive the greatest value, as they capitalize on the recovering economy and new market opportunities.
Case in point: IT spending for the top 20 highest-performing companies has nearly doubled over the past year, rising from a frugal 0.82 percent of revenue to 1.6 percent of revenue. The lowest-performing companies still spend more than the top performers, but maintain a frugal approach, cutting investments from 2.72 percent of revenue in 2003 to 2.6 percent of revenue in 2004.
- "Focus on cost management, risk management and the capabilities your company needs with the reliability and the low cost that will itself distinguish you from perhaps less frugal competitors."
Cost management and risk management alone are counter-intuitive to the facts. Alinean's statistical analysis of IT spending and shareholder value for 5,000 companies shows a modest correlation of 0.64, meaning that companies that spend more on IT today are outperforming their peers.²
Looking at specific industries (the recommended approach for companies to compare themselves to competitors), results show that 40 percent of sectors have a significant positive correlation (greater than 50 percent) between IT spending and performance. Others, meanwhile, show no correlation or even a negative correlation.
This insightful breakdown demonstrates the risk of blindly following one strategy. Companies must not only understand the market conditions for top performers, but also base strategy on how IT spending generates bottom-line value in their sector.
Conclusion: IT does matter
Alinean's ROIT analysis proves that IT does matter. Nick Carr is right to call for a lowered TCO of many IT investments. But narrowly viewing all technology as commodities ignores the reality that innovation spurs competitive advantage, and companies that increase pioneering purchases will likely surpass the competition.
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.
¹ ROIT is a metric developed by Alinean to measure the efficiency and effectiveness of IT spending when comparing companies in a peer group. The formula for ROIT is EVA / IT Spending, where EVA® is a Stern-Stewart metric for corporate profitability, and IT Spending is the total IT spending for the organization including formal IT, business unit IT (20-30 percent of total spending for a typical company) and shadow IT spending (consuming from 5 to 15 percent of the total spending for some organizations).
² Correlation results are based on calculating the correlation coefficient, the relationship between any two sets of key metrics for a select set of organizations or the entire database. The analysis utilized the CORREL worksheet function in Excel to compare the two results and generate the correlation coefficient.
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