Research by the Butler Group has revealed there is virtually no
link between profitability and investment in IT. Nick Huber tries
to crack this old chestnut
With company boards eager to trim budgets in response to the
economic slowdown, the last thing IT managers need is research
disputing the link between IT investment and profits.
But that is the central claim from IT research company the Butler
Group, in a report that contradicts conventional wisdom on IT
investment decisions.
The research, which is based on analysis of IT investment by over
1,500 UK companies of all sizes, purports to have overwhelming
evidence to show there is only a random link between how much a
company invests in IT per employee and how much money it makes back
through returns on shareholder equity (ROE).
The findings have rekindled a long-running debate on the financial
value of IT spending and how its contribution to the business can
be measured. The Butler research claims that the per-employee IT
spend of, for example, pharmaceuticals giant Smithkline Beecham,
which has an 86.6% return on investment, is only a fraction of that
of energy services company Centrica, which has a ROE of -36.2%.
The research, which is due to be released in full next month, also
criticises companies for getting locked into an "arms race" of IT
spending without considering how the investment is swelling
profits. It stresses the vital need for a company to be well
managed if is to get a return on IT spending.
Paul Strassmann, the Butler Group associate who conducted the
research said, "Spending money on IT guarantees absolutely nothing.
The absence of a demonstrable relationship between profitability
and IT spending should be seen as evidence that other influences,
such as strategic advantages, competitive positioning and
leadership, are likely to be more decisive than IT."
The research confirms a longstanding problem, according to some
industry experts. How do you quantify the returns on IT investment?
Philip Virgo, strategic advisor to the Institute for the Management
of Information Systems, said, "People have tried to find the
correlation between IT investment and profitability off and on for
more than 20 years."
According to Virgo, Strassmann carried out extensive research on
the same issue 20 years ago, when working in the software industry.
However, with the shadow of a global economic slowdown looming, the
debate over the link between IT spending and profitability is once
again on boardroom agendas. The result, according to Virgo, is that
IT managers are having to work much harder to justify their
departments' budget.
So how can IT professionals justify their IT spending and prove its
contribution to the company bottom line?
Seasoned heads of IT argue that the preliminary Butler research is
simplistic in the way it puts a price tag on IT investment. IT
directors argue that it is difficult to establish a direct
correlation between IT investment and an early financial return on
the investment. Some IT projects may take have a longer pay-back
time.
Margaret Smith, director of business technology and delivery for
financial services provider Legal and General, said, "All our [IT]
investments have a pay back period, whether it's one, two or three
years. The problem is that the pay back does not automatically mean
increased profit."
One non-financial form of pay-back could be ensuring that a company
has the technology to comply with new legislative requirements,
such as data protection.
Smith admitted however, that the research was right to stress the
need for a company to be well managed if IT investment is to pay
off. Much will hinge on justifying any new IT investment before
funds are released.
At Legal & General this cuts both ways so other departments,
such as marketing and sales, will have to justify their case to the
IT department for new technology-related projects.
Another way to measure the value of IT investment is to examine how
IT systems can drive down costs.
Standardisation of IT systems and the way they are used is one way
to boost value for money from IT, according to Virgo. Small
variations on the way systems are implemented pile on the support
costs.
"One organisation had over 90 different implementations of Windows
NT and there was no way of checking them for Y2K compliance," he
said. "The organisation created a single [Y2K-compliant]
implementation and then moved everyone on to it."
To ensure centralised standards are met and costs are kept down IT
managers need to become enforcers.
"You had a time when people were doing their own thing [outside the
IT department] and support costs were spiralling," said Virgo. "The
role of the new generation of IT heads is to police basic
standards."
The corporate intranet is an ideal area to hammer out common
standards - for use of operating systems and protocols - and get a
return on investment.
"There may be a variety of technologies but you can use the same
standards across the corporation," added Virgo.
The Butler Group research has not said anything ground-breaking but
it has spotlighted a crucial issue. Dazzled by the latest
buzz-words and technology many firms have thrown money at IT
without considering what the returns will be.
With an economic slowdown looming IT managers will have to work
harder than ever to show the value of IT to the business.
Measuring return on your IT investment
There are three
main areas where a company can achieve a return on its investment
in IT: profit, cost and standardisation. But putting a price tag on
them has turned out to be more difficult than many companies
expect.
Profit Profit comes from a myriad of factors within
a company, such as leadership from the board, new products and
market conditions.
However, for a particular application, such as a new customer
relationship management product, a company can compare its customer
retention to when before the system was installed. "You need a
clear picture of how many customers you had before and what the
churn rate was," said Nick Griffin, senior partner of management
solutions for accountancy firm Deloitte & Touche.
Lower
Operating Costs This is at the core of most business cases for
installing a new system or technology. Savings often come from
laying off staff and automating manual tasks. Even if unit costs
for IT come down any savings and spare funds are likely to be
absorbed into new and more expensive technology. "When unit costs
come down companies take the benefit by buying faster and more
whizzy applications," said Griffin.
Standardisation As
employees become more IT literate common standards - and lower
support costs - can be more difficult to come by.
Take for example, employees' increasingly powerful desktops. An
employee can bypass company-wide knowledge management systems by
using their e-mail system to store a directory or contacts, or by
using an Excel spreadsheet for financial management tasks.
Although companies agree solid business cases for IT investment
they can loose sight of these goals when implementing the IT
system. Griffin recommends that companies revisit their ROI plan
during and after the IT project. "You need a separate team to test
whether the system has met the business case," he said.
Nick Huber
nick.huber@rbi.co.uk