Two decades of research by Howard Rubin, president at Rubin Systems, reveals two key concepts that can enable CIOs to see whether their IT investments are really adding up.
He found that measuring IT spend against two factors – operating expense and net revenue – is a more accurate gauge of IT effectiveness than the metric of measuring solely against net revenue.
In addition, Rubin discovered that enterprises spending slightly more than their peers tend to have better business results. But after a certain point, that extra spending does no good. Rubin calls the sweet spot of extra but not exorbitant spending “optimal IT intensity.” He calculates IT intensity by comparing the IT spend to both the operating expense and net revenue, and has developed IT intensity curves that help CIOs see if they are under-investing, investing an optimal amount or over-investing.
“Now we can understand in an actionable way where we are under-investing and [where we’re] perhaps over-investing,” says Jim Noble, managing director of global infrastructure solutions at Merrill Lynch.
“We realised we needed a better comparison to be able to evaluate spending on a more holistic basis,” adds John Comisky, vice president of services operations at Verizon.
“The discipline of going through something like this provides a great deal of credibility with the senior management and at the board level,” notes Rob Leeming, chief administrative officer for IT infrastructure at financial services provider UBS..
These IT leaders note, however, that it will be a few years before they know how well Rubin’s theories play out in practice. And the numbers don’t provide insight on how to get the most bang for your IT buck, just that slightly higher spending correlates to better business results. There is, it seems, still an art to IT investment, not just maths.
Benchmarking yourself against past investments and the investments of your peers is nothing new. But historically, the available data was hard to use for anything more than the highest-level comparisons. “Even then, the benchmarks were pretty worthless,” says Merrill Lynch’s Noble. And the data was insufficiently detailed to allow companies to compare specific aspects of their IT spending versus that of other companies. “There was a danger of comparing apples to oranges,” Noble says.
But Noble believes that the two decades of benchmarking by Rubin, who is also research associate at MIT’s Centre of Information Systems Research, has created a database for the financial services sector that allows finer-grained comparisons, a key step to understanding real trends over time and distinctions between competitors.
Rubin’s own analysis of IT spending compared to a company’s financial performance made him question the traditional measure of IT ROI, typically arrived at by dividing the IT spend into net revenue. The assumption behind that measurement was that net revenue should rise proportionally to the IT spend. Consequently, if revenue did not rise with a higher spend, the investment should be adjusted accordingly. Or more simply, the IT spend should be limited to a set percentage of net revenue. But such a calculation, in Rubin’s view, ignores periods of investment and market change, which is why he suspects it hasn’t correlated well with business results.
Rubin therefore began experimenting with other calculations and found that IT spending as a measure of business success correlated much better to another factor: operating expenses.
How to find the sweet spot
Further research showed Rubin that comparing IT spending to operating expense in order to measure IT’s impact on business performance was not the answer to determining whether the right amount of money was being invested in technology. It turns out that calculating the relationship between the IT spend as a percentage of operating expenses and the spend as a percentage of net revenue is what a CIO needs to do to arrive at an optimal IT investment for his business. Rubin believes this is true because the triangulation that occurs when these two calculations are used can better account for the interplay between IT investment (operational expenses) and fiscal reality (net revenue) and thereby provides a dynamic measurement for an intrinsically dynamic environment.
That triangulation led to Rubin’s IT intensity concept, which is that there is a sweet spot for technology spending. For most enterprises, that means spending more as both a percentage of operating expenses and of net revenue than they are now doing. “The objective analysis shows that spending wisely and applying IT intensity analysis can get you more return,” says David Howe, North American vice president for benchmarking at Gartner.
But the research does not mean the sky’s the limit. Rubin’s calculations show that technology investments hit a saturation point after which no further business value is obtained. For example, he found no examples of any type of financial institution outperforming its peers by spending more than 14.1 per cent of operating expenses on technology – essentially demonstrating that for banks there’s a ceiling for IT investments. For the subcategory of investment banks, that ceiling was 13.1 per cent. For spending as a percentage of net revenue, the figures were 9.1 and 8.2 per cent.
Rubin has created IT intensity charts for more than a dozen industries based on historical IT spending and their financial results. All show the same basic IT intensity curve and the sweet spot at its apex, although the curve itself differs from industry to industry.
That makes sense, says Howe, because business models and degree of dependence on IT to deliver business functions vary across industries.
The art of IT investing
While Rubin’s research provides a way for CIOs to calibrate their spending to optimise the chances for business success, it doesn’t guarantee that success. That’s because, Rubin notes, the wise selection of technology initiatives (in other words, IT strategy) and good execution are always critical to gaining positive results. And that’s where the art comes in. CIOs who can do the maths but fail the art will not be able to use any extra money they pry out of their CEOs to improve business performance or create new value.
Even effective, artful CIOs will get different results from similar spending. “Companies will drive to different results based on how they answer the questions the data poses,” says Grande Bucca, managing director for investment banking, research, legal and compliance technology at Merrill Lynch. “We look at our investments against our business goals, and we can change the order of them or their emphasis based on that assessment.”
At Verizon “we now have a more in-depth viewpoint about our spend that lets us lower the cost of maintenance and infrastructure while at the same time improving the quality of services,” says Comisky. “This lets you spend on the efforts you think are better for productivity.”
Separate research at the BTM Institute, an industry think tank, reinforces the idea that smart technology management is essential to getting the desired return on IT investments. Its research shows that companies that treat IT as a driver of business growth get better financial performance and “that doesn’t necessarily mean they’re spending more on technology,” says Faisal Hoque, the institute’s chairman.
Other research shows that companies that have managed the complexity of their IT by building well-conceived systems rather than throwing a lot of technology at the wall to see what sticks get higher value from their IT spend, notes Bob Zukis, partner at PricewaterhouseCoopers.
At the end of the day, there’s no magic formula to justify IT budgets, no wand to wave that guarantees that real business value will pop out of the technology investment hat. But good CIOs shouldn’t be looking for magic, says Rubin. They should be using their skills in the science and art of IT to manage technology as the critical investment it is.
“The CIO,” concludes Rubin, “is a fund manager who needs to get the right return on his investment for the risk assumed – and who must make sure his portfolio is managed well.”
Galen Gruman can be contacted at [email protected]