RISK MANAGEMENT AND ROI The IT Leadership Financial Conversation Peter G.W. Keen Chairman, Keen Innovations Professor, Delft University The IT Leadership.

RISK MANAGEMENT AND ROI

The IT Leadership Financial Conversation

Peter G.W. KeenChairman, Keen InnovationsProfessor, Delft University

The IT Leadership Development Program,University of Calgary and CIO Summit

September 30, 2004

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It’s all a matter of perspective

Risk is intrinsic to innovationIT is notoriously risky: the only way to avoid risk is to “align” IT with the business as is – safe

projects, cost focusThe IT perspective too often has overlooked, underplayed, dismissed the risk, especially

organizational risk

The issue of IT ROI has been a thirty year tree-killerMethodologies, Spreadsheets, formulaeAnalogous to measuring the ROI of education

What perspective is neededManaging value under conditions of risk and uncertaintyHold the “I”, phase the risk, focus on concrete measures of “R”Build a dialog on managing value not managing IT

Whose perspective?

What perspective?

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The goals for this session

Change forever the way you talk to business managers

Make comfort with and knowledge of corporate finance part of your leadership toolkit

Kill the foolishness of traditional ROIProvide specific approaches to IT financial risk

managementHelp you view outsourcing in a new and more

positive light as co-sourcing

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A quick quiz for private sector students

What is your company’s working capital per unit of revenue?

Its gross margin?SGA per unit of revenue?Revenues per employee?2003 total capital investment budget?What is its weighted average cost of capital?When did you last read your firm’s annual report? What is EVA and does your company use it?

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A tougher quiz for public sector students

What is your agency’s core metric of productivity?

What percent of next year’s total budget is discretionary? Already committed?

What percent of total expenditures are for administration?

What is the maximum level of funding for a proposal for an innovation project?

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A quick quiz for all students

Historically, for every $100 spent on systems development, what is the annual follow-on expenditure for (1) maintenance and (2) enhancement?

What is the average cost of a secure, high volume transactional Web site?

Provide estimates for the following software project outcomes: Early/On-time Delayed CancelledSmall (1K FPs)Medium (10K)Large (100K)What percent of your IT budget goes for really new development?

Operations? User support?What is the typical ratio of IT purchase price to 5 year total

cost?

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Why do the answers matter?

You tell me

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My perspective

The answers matter because they are the language and concerns of executive leadership – if they are not a core part of your own language and concern, what does it mean for you to be a “leader”?

They change your credibilityThey reduce the likelihood of investing in

ventures that are doomed from the very instant the business proposal is approved

They help you direct resources

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Background: The real IT problems

For business executives IT is a real pain:High risk upfront capital investments with

promised but rarely delivered ROILack of business executive control over costs,

targets and risk exposureToo many (expensive) surprisesIT too often operates outside the rest of the

organization’s business rules

Everyone is now a technology “expert”; IT has lost its primary controls of owning the language of discussion

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The IT leadership conversation

The Texarkhana airport testNo one is likely to disagree with anything

you say about IT contributing to strategic business

There is little if anything interesting or surprising to say about technology

Where’s your news?

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Types of IT risk

Technology/Vendor: apply to well-understood and bounded applications via beachheads – not prototypes

Application: use proven technology; avoid organizational and process disruption

Organization/Culture: build real involvement; remember you can never start edn early enough or sustain it long enough -- it is not an add-on

Project Management: limit scale of components; demand client as well as IT disciplines and reviews

Economic: ensure a robust financial model

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IT Cost Risks

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The IT Iceberg

Rule of thumb: 80% of IT costs are hidden below the surface – and a navigation threat

Examples:Education: 20% of development – pay me now or

pay me later (Note: education is not training) Maintenance and non-discretionary enhancement:

60% of development costs, per annum Demand driven by success: storage, support,

telecom capacity

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Software project outcomes

Early/On-time Delayed Cancelled

Small (1K FPs) 61 18 20Medium (10K) 28 24 48Large (100K) 14 21 65

Would you invest in a business with this fifty year risk profile?

FP = function points

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ROI from IT

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ROI from IT

There is none

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ROI from IT

There never will be

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A challenge for the class

Define a formula/method of calculation to show the ROI for your

college education

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The ROI fallacy

IT historically has been a matter of ROR – return on risk - high upfront capital with uncertain benefits:The “I” has to be committed in advanceThe “R” is far off and hypotheticalMost large-scale IT investments fail to

deliver on their promises

60% of large IT developments fail to deliver value for that risk

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Getting value from IT: the accelerating trends

ROMI not ROI: Return on Minimized InvestmentTurn IT into a variable costProcess sourcing – business on demandLink IT to business “imperatives”90/180 day ventures and beachheads

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IT financial payoff targets:

Capital efficiency: Reduce working capital per unit of revenues

Revenue efficiency: Increase gross marginsOperational efficiency: Radically cut overheadOrganizational productivity: increase revenues per

employeeProcess effectiveness: slash cycle time in W3 –

Win-Win-Win processesStaff effectiveness: “beachhead” low cost, low

infrastructure knowledge mobilization

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ROMI

Return on Minimized Investment:Hold the “I”, phase the ”R”Exploit the new innovation architecture

enabled by “Foundational” Web services Focus investment on key business

infrastructures via “imperatives”Build self-integrating modular services Eliminate the high risk, high uncertainty nature

of traditional IT

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The Business/IT “Pyramid”

Technology Substructures

Business Infrastructures

Innovation Superstructures

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Beachheads

Larger than pilots, small enough to deliver in 90-180 days

Focused goal of building momentum for innovation Self-explanatory, self-justifying benefitsHigh centrality: visibility, political credibility, link to

key constituenciesPhase 1 of an “architected” campaignA force for organizational mobilization that balances

speed and flexibility of a small team with scale and rollout capacity that a large project can leverage

Localized enough so that the leader/sponsor can provide oversight and commitment

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Beachhead planning

For each Beachhead:What is the 90 or 180 deliverable? Warning: if it takes

two years, forget it NOW please (FINP)What is the “elevator” pitch about its self-explanatory,

self-justifying benefits? If you need to calculate the hypothetical ROI, FINP

How does this contribute to the economics of the firm? How will it scale and be rolled out across the business?Which leader will sponsor this and put credibility on

the line?What new roles and skills will this help build?What are the incentives for others to pick up on the

beachhead and commit to moving it forward?What is the 8-15 person team it needs?

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Welcome to the Variable Cost Economy

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Business scaling: Up

1995 2000 NOW 2004

Investment

Add people, systems,facilities

Disruptive, expensive

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Business Scaling: Down

1995 2000 NOW 2004

Investment

Cut people, systems,facilities

Disruptive, expensive

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What’s next?

1995 2000 NOW 2004

Investment

??

??

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An example from a superb company

Charles Schwab: Business Charles Schwab: Business ScalingScaling

1995 2000 NOW 2004

Investment

15,100

20,100

26,300

16,100

$150M$199M

$370M

$705M

$301M

$160M

191,000

350,000

115,000

141.000

Transaction per day

Millions of $ of Investments

Employees

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SUPERSTRUCTURES:Priority targets: customer relationships,

supply chain, financial, organizational, operational;

Branding;Innovation paths

Bundling of distinctive capabilitiesvia infrastructure clusters

Process edge – differentiation 

INFRASTRUCTURES:Clusters of services,

Networks of providers and partners; business-, industry- or partnership-focused arrangements;

SUBSTRUCTURES: Highly standardized foundations; “heat, power and light” systems

Automatically interconnected via common interfacesThe Web as electricity;

Largely usage-based variable cost

The new architecture opportunities

Super

Infra

Sub

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Takeaways

Reading recommendations:Subscribe to Forbes Read first 120 pages of Bennett Stewart, The

Quest For Value (EVA)

Learn to write brilliant business proposals Triple the fraction of pages devoted to

financial payoff metrics Highlight, not hide, risksGive clients a real decision to make: let them

choose the trade-offs

Think ROMI and beachheads