In 1986, General Motors' top management became alarmed about
escalating IT costs. To benchmark IT spending against Ford, GM
hired me as a consultant to deliver an IT-to-revenue ratio
comparable to Ford's, whose IT budget was reportedly smaller than
GM's.
It took me a while to convince GM that overall revenue wasn't a
reliable basis for reaching valid conclusions as to whether GM was
overspending or underspending on IT compared with Ford.
In those days, Ford, with less revenue, was outsourcing more of its
production costs than GM was. Therefore, Ford would theoretically
require fewer employees to make a car and consume fewer IT
resources to support its workforce. After adjusting for each
company's employment, salaries, the amount of outsourcing and total
assets under management, I delivered a report that was used to
realign some of GM's IT spending.
During the current economic downturn and IT budget crunch, some
executive will likely come up with a consultant's average
IT-to-revenue ratio for your industry, then ask you to match it.
A comparison of the numbers from the year 2000 for Ford and GM
illustrates how you might want to deal with such a simplistic
challenge.
Ford's and GM's revenues and employment are alike, and therefore,
their IT spending should be close if you apply either a revenue or
spending-per-employee ratio. But their IT budgets are different
because their financial and employment structures are different.
GM's estimated IT expenditures are approximately twice those of
Ford's!
In 2000, GM purchased a larger share of its sub-assemblies, parts,
components and IT than Ford did. Therefore, GM ought to employ
fewer IT resources to manage operations. But that didn't happen
because GM's estimated information costs such as sales, general and
administrative expenses relative to its costs of goods sold are
much larger than Ford's.
This difference is important because IT budgets can be best
explained not by corporate revenues but by other factors, such as
total information costs (which include IT spending), plus the
salaries of all IT users.
Information costs include the purchase of services from
consultants, outsourcing contractors, advertising agencies, law
firms and accountants to support the internal information
workforce.
GM's presumed advantage from its greater reliance on outsourcing is
overwhelmed by a larger information workforce that almost certainly
will generate more demand for IT.
There are other indicators to consider. For instance, what are the
differences in growth rates? Here, GM is at a disadvantage. Ford's
1991-2000 revenue growth was twice that of GM's, but Ford's
information cost to value-added ratio remained level, while GM's
grew 34%. What matters is the difference in profits. As the chart
shows, the automakers reported starkly different profits over a
decade.
Taking into account all the relevant financial indicators, GM's
much higher IT spending is about what I would expect. What is,
then, the "right" IT budget for GM, or any corporation?
That can't be answered by having GM match Ford's spending. The
answer is to define a corporate structure that delivers superior
profits, then realigning IT spending to support that.
Implications: CIOs will be pressed to produce credible benchmarks
to prove that IT costs are either in line with or lower than those
of competitors. The "expected" level of IT expenditures is
determined by factors such as:
- The ratio of information workers to the total workforce
- The composition of the information workforce (such as clerical
vs. professional workers)
- Growth in corporate profits
- Dependency on purchases from suppliers
- The value of assets under management
- The number of PC users supported.
The "right" IT budget, then, is one that's less than those of your
chief competitors, while your firm delivers superior shareholder
returns.
Paul Strassmann has had to defend IT budgets many times in his
career. Contact him at
paul@strassmann.com