Measuring the value of your IT investment.

One need not resort to quantum physics or probabilistic outcomes calculations to better understand the business returns to IT investment. First, be clear about what you're asking the IT investment to do. The measures you select will drive behaviors accordingly.

Last year worldwide business

spent $1 trillion on information technology including hardware, software, and related services, according to the Stamford, CT-based Gartner Group. This number is expected to jump to $1.7 trillion by 2002, representing a 12 percent compound annual growth rate. As is pointed out by A.T. Kearney's Fred Steingraber in the following roundtable, IT spending is replacing real estate as the second largest SG&A item after personnel costs.

One might assume that years of IT investment would show up in improved productivity statistics; but this is not the case. Writing about the productivity dilemma in the Harvard Business Review, Morgan Stanley Dean Witter chief economist Stephen Roach recently observed that "there is not one shred of official evidence that the U.S. economy has broken out of the productivity slowdown that it has been mired in since the 1970s." This is not encouraging even when one allows for the fact that official productivity measures may not adequately capture IT's full impact on output.

Roach believes that the apparent inconsistency lies in the disproportionate role IT has played in recent investment spending. IT's share of capital stock has risen from 13 percent to 20 percent in the last seven years. IT spending has very short product replacement cycles; about 60 percent of annual corporate IT budgets go to frequent upgrades. "In the rules of the productivity game," argues Roach, the net stock of capital determines the technology endowment of the average worker, which matters far more than the gross flow of new machines purchased."

Does this mean that the so-called new economy is built on an illusion? Observers note that productivity measures fail to account for rapid growth in service sector output. Information, not physical assets, is said to be the new economic driver. But how does one measure the value of information, let alone IT's value as a business enabler? Much, of course, depends on the kind of information in question and the uses to which it is put.

In the following roundtable, co-sponsored with A.T. Kearney, CEOs say the value of an IT investment depends on whether it is intended to reduce cost or create new demand. Traditional measures such as ROA may be Useful for project finance, but are useless in capturing the inherent value of information which creates a whole new competitive platform. When buying basics or automating routine tasks, traditional investment valuations may continue to serve their purpose.

Enterprise-wide IT investment, on the other hand, requires different metrics. The urgency to get this right is real. According to the Standish Group, four in 10 large IT projects end in failure and an additional three projects are challenged, meaning that they are either late, over budget, or completed with fewer functions than originally specified.

CEO participants are not surprised by this. In fact, several participants suggest that CEOs think about IT the way they do about marketing: it does nothing for productivity but has the potential to drive shareholder value through innovation.

- J.P. Donlon

WHAT IS INFORMATION WORTH?

Fred G. Steingraber (A.T. Kearney): Most of us can remember 20, 30, 40 years ago, and I suspect well beyond, when we thought measuring return on investment was a pretty simple and straightforward proposition. Investments in hard assets would drive up productivity gains, and there seemed to be plenty of metrics with which to measure this. Whether we worked with paybacks, internal rates of return, discounted cash loads, or simple cost savings, we were able to track these kinds of factors with regard to our ROI.

But with the shift to this digital economy-which is increasingly being called the techonomy - information increasingly be-comes the driver. And while we seem to be able to measure our cost and our investment, measuring the value of information is still a very imprecise function.

So what is the best way to measure the value of investment in information technology? And how do we best use that investment to achieve the goal we're all focused on, creating shareholder value?

The problem is the real value of information comes from how it ultimately helps us create and drive a winning strategy, not just the tactics of driving down cost or improving productivity.

Growth is increasingly identified as a far more powerful driver of shareholder wealth than cost reduction. We have research to demonstrate that the companies with a higher growth rate - even with a 1 to 2 percentage lower EBIT, lower margin - will command premiums of five to seven times those of comparable companies. So true value-creating growth companies do grow revenues and shareholder value above the industry average.

Therefore, to measure our IT investment, perhaps we need to think about pursuing a similar line of reasoning. What value are we asking our IT organizations to deliver? Is it a productivity value or is it an innovation and demand creation value - or is it some of both?

The traditional metrics - we understand them, we're comfortable with them, and we feel we can make good decisions and judgments about them. But they're not going to do the job, to justify, with the benefit of hindsight, the kind of investments we're be'rag asked to make.

One of the things we're going to have to do increasingly is depart from this whole notion of benchmarking against best in industry. If you want to survive and get ahead, you need to look across industries. The concept of lean manufacturing came from manufacturing, but it's being used in the banking industry. And we see examples of this in the transportation and financial industries, where people are taking ideas from the consumer products industry and elsewhere and applying them to their industry. If we don't look at these examples, we're going to be totally blindsided by who some of our competitors are going to be.

James F. Van Houten (Mutual Service Insurance Cos.): Most business schools now are teaching that marketing - which is product design, placing, advertising brand, and entity - is not as important to business success as company positioning within some kind of a competitive structure. IT goes right to the heart of that.

The reason we have these difficulties with IT investment is because company position matters. And if you're in a multi-business firm, you have a number of different positions conceivably for the different businesses you're in. And your IT has to match each one of these.

These generic rules of thumb, that more IT investment is good, less IT investment is bad, that you can't measure by efficiency and those types of things - I think that's wrong-headed. There's no other way to do it. It's like buying a machine for a factory. It's a capital investment, but if you're maintaining infrastructure for payroll, it's a whole different kind of an issue. IT reinforces organization structure and positioning, and if we're successful companies, we're different from our competitors and all those rules of thumb don't work. At least that's my view.

Gian M. Fulgoni (Information Resources): I've heard a lot of different buckets of classifications of the benefits of IT - from cost reduction to demand creation. It seems to me measuring cost reduction is the easier one. And sometimes we get confused because cost reduction not only saves you money you can drop to the bottom line, but if it allows you to price your product lower, you can also stimulate demand.

You measure those two buckets pretty easily with today's metrics. What's really difficult is to measure the benefits of IT in terms of its stimulation of creativity and marketing that allows you to drive demand by coming up with a better product, not a product that you can price lower.

I really struggle in our business, the consumer packaged goods business. I see the Wal-Marts driving their businesses by cost reductions. They figure out a way to use IT to run their business at a much lower cost point and they price it that way and, boom - their sales take off.

But if you were to ask consumer packaged goods manufacturers in the U.S., "are your categories inherently growing because the benefits of IT are stimulating consumer purchasing?" I think you'd get a resounding "no."

Douglas F. Aldrich (A.T. Kearneld): What makes this really different from 1970 is that technology has evolved to a state of lowering the barriers of competition. Before, it was being used to do what we do today but do it better, do it faster, do it cheaper, do it with higher quality, do it with less breakage.

Now I can do things differently. I have got the ability to bypass traditional channels. For example, cable companies are coming out with wide-band broadcasting over your cable line. While you're watching TV, you can talk on the Internet at 1,000 times the speed of your normal telephone dial-up.

The fanatical drive to cost reduction has lost sight of who the end consumer is. Part of what's wrong with supply chain analysis is that you look at the next customer down the chain and the next supplier up the chain, but if you're not examining what you do in the eyes of the end consumer, the digital economy's going to run over you, and your chance of survival's pretty slim.

H. Donald Nelson (United States Cellular): We have a product that we're selling this year called "Prepay," which is where the customer pays up front. You always post-pay for telephone service, but if you put gas in your car, you prepay.

Ten to 15 percent of the customers I've added this year are in that prepay category. I could not have done that without the technology that deducts from the customer's balance for every minute of use they create. I can't do that every time with an operator or a person; I've got to do that with an IT system.

You kind of have to think of IT - at least I do in my business - as the streets and the sewers of your business. You have to have it just run the business. By having better streets and better sewers, I get my financials on the third day after the end of the fiscal month without as much hurry and scurry as I did before.

So now I have time for analysis, I have time for planning. And 80 percent of my IT budget goes for how we're going to increase the size of our business or handle more volume, not for cost reduction.

J.P. Donlon (CE): How do you use those seven or nine days you didn't have before?

Nelson: Analytically, you can use it very, very well. You can use it in pricing. For example, AT&T came out with national pricing and within two weeks, we had an understanding of not only what their system did but how it was affecting us in markets where we compete against AT&T.

James P. Jones (Edward Don & Co.): As all of our jobs have become more complex, we took out the costs. That was phase one of this whole IT thing: how to automate redundant tasks. But as you move up into the revenue side - I think that's why the CEOs got involved.

TO JUSTIFY OR NOT TO JUSTIFY

Steve Barnes (Dade Behring): I'm in the process of making a significant investment to roll out an SAP conversion and my philosophy on IT is that there are really two sides of it: the defensive piece and the offensive piece. What many companies do is they spend too much time on the defensive piece because they set the wrong expectations, they don't do an excellent implementation by having management involved and doing it fast and hard and trying to standardize.

And because of that - we all have limited resources - the defensive piece takes away from the offensive piece. And one of the things we're doing at my company is that we're literally using IT to transform the company.

Now that our defensive piece has gone extremely well, we're able to put a lot of money into a couple of what I would characterize as truly enabling technologies. It's actually that last 20 percent of the investment in IT that actually typically creates 80 percent of the value.

And by being able to get the platform in place, you're able to put your energy in saying, what is the vision, what do we need to do and how can I actually use IT as a competitive weapon? But you can't do that if you set the wrong expectations or you fundamentally mess up the foundation. It's like building a house and spending all your money on the foundation and the structure and not having any money to furnish the place.

Daniel F. Gillis (Software AG Americas): How are you going to measure your significant investment in SAP?

Barnes: I can't really answer the simple question, how can I measure it. I think that you can measure the basics, you can make sure that you feel comfortable with when it's going to get done, how much you're going to spend, how well it's being managed.

One of the real challenges is that it's very hard to really measure and justify a lot of what you're doing. But a lot of it is a necessary evil, so the right thing to do is to make it as positive as you possibly can, minimize the negatives and maximize the positive.

Patrick C. Kelly (PSS/World Medical): I think there is a way to measure it. Seven years ago, we were sort of innovative and automated our sales force using radio frequency to drop off orders. Our salespeople were complaining they wanted to increase their productivity. By increasing their productivity, they could get their orders in quicker and we could deliver them faster, so it made sense.

But before we made that investment, we sat down with panels of customers all over America and we asked them, "what would it mean to you if we automated our sales force?" And they told us: nothing. It absolutely did not bring any value into their mind.

Ultimately, the question was, what would you want from us as a company? And their answers came back as, when your sales rep is in front of me, we want answers. We don't want him having to walk over to call on the telephone and find out what's going on.

Today almost 70 percent of our orders come through radio frequency, instantly printing in our warehouse. But the important thing is, here a sales rep could access information of what was in stock, what the price was and this was what the customer valued.

So ultimately, you've got to say, what value does it bring to give you market reach, and hopefully, you do get productivity out of it.

Recently, our largest competitor came out, same size as us, and said they're spending $80 million to do everything that we're doing. Our total budget over the next year is $20 million to do it. I called our IT people in and said, "what could you do with four times the resources?" And their answer was: nothing more.

So if we can do what we're doing and more for $20 million and they got an $80 million burden, I think we're going to have a competitive advantage while, at the same time, I'm not sure they're going to get a strategic advantage.

Fulgoni: The Internet is particularly effective because it allows you to reach a lot of remote users or sales and marketing folks.

But it's very easy to get confused between these issues. I'll just give you an example. Take e-commerce - and I'm as stunned as everybody else by the valuations, although I'd love to have one [laughter] - but it's almost as if technology is just way ahead of the business side of the equation. Take a look at most of the e-commerce companies. They're not making money. They've latched onto the technology of the Internet to communicate but where they're going to make or lose money is on the physical distribution of the products. And my read of it is that most of them, the more they sell, the more they lose.

Donlon: One big exception is Cisco Systems, which is just putting the pipes in the roads, the infrastructure, and they're making out like bandits.

Fulgoni: The people trying to replace the bricks-and-mortars people, they're offering a potential service, which is to give you, the consumer, the convenience of not having to go to the store, but I'm going to charge you more for it. But I can't yet charge you enough to cover my costs of getting you the products. And that puts another burden on IT to figure out how to get the products there.

Arnie Pollard (CE): In the history of biotech companies, there has been the history of some fantastic valuations going back way more than a decade based purely on guesstimated dreams of the hereafter.

There's going to be an awful lot of high valuations based purely on dreams of the hereafter, and X percent - and probably less than 50 - will actually reap concrete success and the rest will crash and bum.

Fulgoni: I hear you and you're making a very good point. But what worries me is when I translate that to a decision to maybe make a significant investment in SAP - do I want to take that kind of a flyer on my own spending? I don't know.

Gillis: I think there's kind of two kinds of technology buying going on now. One is the infrastructure buy like an SAP buy; you know you need it, but how do you measure it? That's the traditional side of IT.

What's now coming into play, though, is technology that can either change, add to your business, or replace your business, and that's what's causing the anxiety.

George McCown (McCown De Leeuw): The assumption is now imbedded pretty much in American business that it's a given that you've got to have the infrastructure, and it's a given if you get behind, you're going to be at a competitive disadvantage.

Our biggest decisions are: what systems? Because we have a guy, he loves J.D. Edwards. And we have another guy, and he loves some other damned thing you never heard of. And it's some little company and they go broke in the middle of your implementation. [Laughter]

To me, those are the big decisions. I'm not worried about measuring the productivity particularly. I just assume we're going to have to do this to keep it up. The biggest decisions are what system and what flexibilities does it give us for the future? How can we build on it? Are we going to have to go in and rip it out two years from now and put in some other new system when we get a new IT guy who likes some other system? That's the stuff that drives us crazy.

IT'S BLACK-HOLE BUDGET

James M. Deitch (Keystone National Bank): A couple years ago, we went back and invested in some green earth to put a consumer lending system in place that relied on automated underwriting and a whole series of technologies to be able to make decisions fast, and that was the cost mode.

Then we had groups of our associates take a look at what else you could use this for, and they began to get enabled to go out of our geographic footprint and market to a much larger audience in a very narrow way, small markets that otherwise wouldn't be profitable to attack.

And from those, we're able to take an individual project and calculate an IRR or return on equity based upon the investment of not only the technology to enable that particular project, but what the people were going to be able to do in terms of creating customer value, and then how to move some of that underwriting technology horizontally.

On the other hand, the infrastructure cost itself and keeping it current and complying with regulatory mandates, is very, very expensive. And we scratch our heads and say, there's no real easy way to measure this, but without it we can't get that enabling technology on the offensive side.

Aldrich: So the question is, do you need a boiler made of battleship class steel with gold edgings and brass rings and wonderful digital equipment or do you need a basic boiler that will hold water and last five years? The difference between the two is four or five times X cost.

For your basics, you want to spend as little as possible. You don't want to be spending money on maintenance, but on enhancements. You want to shift the budget from blocking and tackling to value-added, because the returns are so much higher even though they're so much harder to measure.

The No. 1 thing in the basics is you've got to be able to manage the projects. Don't spend money on a project that's going to take longer than 18 months. It will not happen. And you guys are the drivers of why it won't happen, if I can be a little critical. There is no mega-project; there is no $75, $80, $100 million project that can withstand, intact, two budget challenges. [Laughter] And 18 months is about as far as you can go without getting challenged a second time. And pretty soon you've got the classic definition of a runaway.

The newspapers are full of projects that are cancelled five years into a two-year implementation cycle. Six months is a good time frame, 12 months is your target, but anything over 12 is questionable.

If you're going to shift your spending from basics into value-add, you kind of have to know where you want to go as a company. It's very, very important, and I alluded to this earlier, where is your value now in the value network? What do you do that in the eyes of the end consumer needs to be done?

Kelly: I agree. If you can't get that project implemented in 18 months, it's lost. So you need a CEO, you need somebody who drives, who has to make the decisions, and it has to be somebody who understands the cycle of your business and the life of your business.

Barry N. Naft (Environmental International): I can't think of a center that's more amenable to change because of information technology in terms of the economy of scale and the distributions of the resources than the service industry.

You see it in banking now. You see that the traditional bank loan officer at your local branch is disappearing, all the financial advisors and the decisions are being centralized in North Carolina or New York or someplace else.

It's an industry that's really amenable to drastic changes in its competitive structure based on information technology and the ability to do things long distance.

Steingraber: What a lot of companies are doing, banks included, is working multiple channels of distribution. The alternate channel of distribution may someday become the main distribution channel, but they're not betting the whole store or business on the alternate channel.

Deitch: We are in the Financial services business, and in terms of distributing our product, we wanted to find folks that were Internet capable and comfortable using it so they could load and access our site and really fundamentally reduce the amount of labor involved with it. We started two years ago and it was 2 percent of our business. Now it's 50 percent of our business, and the number of people involved in it is three.

Jones: It's of paramount importance to be checking these alternative channels. You have to have a finger in each one every now and then. The cost of sales for us keeps escalating as our customers commoditize pricing. There's pressure there, so our sales force naturally calls on the more profitable customer.

So, by accident, we back away from certain markets that you really have to look for alternate channels to get at - whether it's direct mail, target marketing, the Internet. There are just a host of ways getting to those customers. And that's just the marketshare game.

Richard Vissers (CTS): Any time you do something new, it's going to cost money, right? We all know that. We're all talking about products here, but let's look at human resources. We have a fairly tight labor market at the present time, and we just sent some of our accounting business to Canada because we found some people there that could do it for less money and better.

That's one of the advantages, again, of the Internet and IT. So, looking at the total picture, there are many avenues and opportunities today we never had before.

Kelly. We went on the Internet and found out there was no company selling medical supplies cheaply. Even though we have a national sales force, we told our salespeople we were going to start the first Internet-based company selling medical supplies.

Today, if you dial up on the Internet looking for cheap medical supplies, you'll find Thrifty Medical, one of our subsidiaries. So we became an alternate way of selling medical products. Six months later, I can report we will do $1.7 billion in sales this year. But we've sold $43 over the Internet, and we've actually only taken three orders. [Laughter] So even though we're there, our customer is not there. Because in the physician office, typically it's the nurse who buys the product, and she doesn't have time to dial up. But we're there in case they ever wake up and want to go that way.

Aldrich: There's a point that you've got to keep into mind in terms of demographics. The reality is, we haven't hit the tip of the iceberg yet. Today's college freshman has been using PC-based computing since the age of two. For these folks, computers are no more alien devices than your telephone. They do their homework on it, they shop on it, and they do dates on it. When these guys graduate in four years, these are your employees.

These will also be your customers. Right now we're working our way through a huge population of folks to whom computing is still something new. That's not going to be true in three years.

Barnes: It's interesting - if you hear some of the success stories we've talked about, it's not that any of us have figured out some state of the art technology. It's actually more state of the art application of IT. And that's what matters; spend as little as you possibly can on the basics and then be creative to figure out how to exploit what you've got or what other people have.

Streingraber: Another way to think of that is to ask yourself, what is it your customers are trying to accomplish with respect to your product or service. What are their two or three key objectives and how can you, in delivering your product or service, help them achieve their cycle time compression, their cost reduction, take out working capital, whatever the issues are.

And you begin to look at the resources you have, including the technology, and say how can we use it to do that now, to develop a more personal, intimate, longstanding relationship with our customer?

Fulgoni: I would add that when we talk about customers, we should include the customers we sell to as well as the customers internally within the company. The statistic you mentioned was 40 percent of IT initiatives have failed. I think it's interesting to look at where they failed. The most common dimension seems to be where the IT folks don't take into account what the end users within the company really want, and they build these systems that just don't relate to the real value drivers that end users want within the company.

Streingraber: It's going to be increasingly critical to develop an organization that's very comfortable and very facile at being able to work across functions and across processes. That's the key to it. We can't treat it like we treated a lot of the IT stuff back in the '60s, '70s, and '80s - throw it over the wall and let them do it. You have to be involved in it.

The important thing is to figure out what you're really good at and what you're not good at and make sure you've got a good partner in the things you're not good at.

The worst thing a CEO can do - and unfortunately we have a history of doing this in this country - is to become risk-averse, to do things you think have no downside, where you can't make a mistake. The companies that have the most superior long-term financial performance and are the leaders are the ones that take a lot of risk.

If you look at new product development and innovation, there's a ton of risk associated with that stuff, and we don't expect to knock the cover off the ball in 90 percent of the efforts, so you can't expect to do it on a lot of these things.

Van Houten: You really have to be brave. Every one of us has people reporting to us who know more about their functional areas than we do. And that's kind of intended; they're our department heads. But somehow we get into the systems area, and I think we get timid. It's like we're afraid we're going to look stupid. We need to ask the same kinds of aggressive brave questions and not be intimidated by people making these decisions, as we would people who were asking for any other capital investment.

A Who's Who Of Roundtable Participants

Douglas F. Aldrich is managing director of the Global Strategic Information Technology Practice of Chicago-based A.T. Kearney, an international management consulting firm with revenues in excess of $1 billion.

Steve Barnes is president and chief executive of Deerfield, IL-based Dade Behring, A $1.4 billion medical in-vitro diagnostic products company.

James M. Deitch is chairman and chief executive of Keystone National Bank, with $1.2 billion in assets, and of Keystone Financial Mortgage Corp., with $1.7 billion in loans serviced, both based in Lancaster, PA.

Gian M. Fulgoni is president and chief executive of Chicago-based Information Resources, a $456.3 million information services company providing electronic scanner-based business solutions.

Daniel F. Gillis is president and chief executive of Reston, VA-based Software AG Americas (SAGA), a mission-critical enterprise software and services company with annual revenues in excess of $200 million.

James P. Jones is chief financial officer of Edward Don & Co., a $360 million provider of food service equipment and supplies.

Patrick C. Kelly is chairman and chief executive of Jacksonville, FL-based PSS/World Medical, a distributor of medical supplies, equipment, and pharmaceuticals, with more than $1.3 billion in revenues.

George E. McCown is chief executive of McCown De Leeuw & Co., a private venture banking firm that buys and builds middle-market companies in partnership with management teams.

Barry N. Naft is president and chief executive of Potomac, MD-based Environmental International, a private company engaged in the manufacturing of products from recycled waste materials.

H. Donald Nelson is president and chief executive of Chicago-based United States Cellular Corp., and $853 million wireless communications company.

Fred G. Steingraber is chief executive of Chicago-based A.T. Kearney, an international management consulting firm with revenues in excess of $1 billion.

James F. Van Houten is president and chief executive of Arden Hills, MN-based Mutual Service Insurance Cos., an insurance provider with $1.2 billion is assets under management.

Richard Vissers is chief executive of Wilmington, DE-based CTS Corp., a $500 million software company specializing in bulk fare, business-to-business travel.

Thomas C. Wajnert is chairman, president, and chief executive of Tampa, FL-based Payroll Transfers, a $600 million national provider of employee and human resource administration services.