Mark McDonald

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Mark P. McDonald
GVP EXP
8 years at Gartner
24 years IT industry

Mark McDonald, Ph.D., is a former group vice president and head of research in Gartner Executive Programs. He is the co-author of The Social Organization with Anthony Bradley. Read Full Bio

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#10 IT financials require improvement — twelve things every business leader should know about IT

by Mark P. McDonald  |  April 13, 2009  |  3 Comments

“Everything I need to know about a company I can tell from its financials.”  This statement is foundational to modern management.  While we can debate the efficacy of financials as a way of knowing what is really going on in a company, financial is the language most people use to understand the business, its contribution and its performance.  Executives applying a financial view to IT need to recognize that the current state of IT financials requires improvement.

For more than 30 years the fundamentals of IT finance have been about spending money.  IT financials have been based on making decisions about investment expenditures and operating budgets.  This expenditure-based view permeates executive impressions of IT “it costs too much, what are we getting for our money, how much should we spend on IT?”  These are all questions asked repeatedly in the last 12 -24 months as executives seek to understand IT. 

These questions ask half a question – the cost and spending little to no time on the other half – the return or value generated.  The observation that executives look at IT finances from one perspective indicates that IT financials require improvement.

Expenditure dominates IT management thinking.  CIOs admit that they look to fully fund their internal resources as they are creating their IT budget. They can think of generating value once they know their current resource base is secure. 

  • IT project management is expenditure driven based on a concern for managing ‘on time, on budget, with quality.”  Going over budget is seen as a sign of bad management regardless of the value created.
  • IT portfolio management that categorizes IT spends as either strategic, managerial, transaction or infrastructure.  The stability of the spend per category illustrates the limitations of expenditure based finance.  Because while these ratios remain remarkably stable over the past 10 years, IT has transformed the business through the Internet, Y2K, Monetary unification, ERP, etc.
  • CIOs implement various ‘chargeback’ mechanisms in an attempt to manage demand for IT services and solutions by making the cost of IT more visible to business executives.  The track record of chargeback is mixed at best, with executives responding predictably when they see IT costs – “what am I paying for?  How can I pay less?” 
  • CIOs and IT executives bemoan the fact that the average IT budget spends 2/3rd of its resource on current operations.  They believe that the IT budget should spend more on transformation when their counterparts in the business have 90+% of their budgets dedicated to operations.

Look at the terms used in these cases; they are expenditure based with little to say regarding the return the CIO is expected to gain from these investments. 

Now before we take the CIO to task, its important to remember executives responsible for other business groups are not immune to this view.  They too, tend to separate the budgets they manage from the revenues they generate.  The only difference with IT is that it does not have a revenue side making it expenditure dominated making it a cost center that is minimized rather than a resource that is leveraged.

I am not suggesting that we return to the idea that “IT is a revenue center,” or “Running IT as a business.”  These approaches have had even less success than ‘chargeback’ in most circumstances.  But its clear that executives need to know that judging IT by its finances tells only part of the story and often the least interesting part.

So What?

Rather than giving IT a dubious revenue stream, executives should know that IT financials tell only half the story – the expenditure half.  Executives, including the CIO will need to work to re-formulate IT finance as current models and obsessions place an unbalanced emphasis on expenditure that limits both the enterprise and the IT organization. 

CIOs are fond of saying that “There are not IT projects, only business projects.”  That is true, but when it comes to a financial view of those projects too often it looks like IT is spending the money rather than being jointly responsible to achieve the business results.

Executives should take a broader view of IT than what can be communicated via IT financials. Such a view extends IT’s contribution to the results, outcomes and impact of the expenditures rather than the expenditures themselves.  For example do your executives or yourselves know the answers to the following questions:

  • What is the total business value of IT investment projects for the current year?  What are the major balance sheet and performance measures that are expected to change in the year based on these investments?
  • What is the net present value of these benefits streams?  How will that value come online by month, by quarter?  How does this year’s value stream match to last year’s value stream?
  • What are the operational, management and other structural changes required to achieve that value stream, beyond IT? 
  • How is IT investing in its own operations to lower the cost of computing, storage and communications while raising its capacity, quality and reach?

Executives need ways of thinking about IT’s contribution in leveraging operational resources and enterprise performance.  Operational leverage can be measured in many ways including the number of accounts, products, customers, revenues etc.  These are good places to start because IT creates leverage in these areas. 

IT leverage is best illustrated over time and in response to changes in business volumes.  So the answers to the questions below are often expressed in per unit measures with a trend line over time.  In that way, executives can see how enterprise performance changes over time and ratios improve.  Executives can better understand those sources of leverage by asking the following questions:

  • What is the ratio of personnel to revenue over the last five years?  How has that ratio changed?  What about the ratio of customers to personnel?
  • How much working capital is required to support a million dollars of sales growth? or how much capital is locked up in the balance sheet when sales drop by a million dollars?
  • How many products are you supporting in the marketplace and what is their revenue trend?  What systems are required to support those products?
  • How many channels do we use to market, sell and serve customers?  What is the sales volume in these channels, the average cost to serve and how are these figures trending?
  • What is the relationship of IT spend to transaction volumes? 

IT financials require improvement as they only tell half the story.  While CIOs have demonstrated the ability to manage cost, they are doing so at the expense of business innovation, transformation and making deep changes in the way the enterprise works.  Executives who often want more from IT can get that ‘more’ in part by changing the way they think of IT finances and measure IT success and performance.

3 Comments »

Category: 12 things business should know about IT CFO CIO Economy     Tags: , , ,

3 responses so far ↓

  • 1 ben kahn   April 19, 2009 at 2:27 am

    This approach only goes so far

    In my view, it misses the key point that it is much easier to construct cost-benefit analysis for “tactical” changes than for “strategic” ones. Good financials are helpful in clarifying justifications for one-hit improvements, such as a global version upgrade to a specific technology, also for programmes made up of a number of such independent initiatives.

    It is significantly harder to put financial metrics to programmes which are made up of multiple initiatives with inter-dependent pieces, the benefits of which may apply across multiple financial units.

    Many corporates are stuck with antiquated technology stacks, not because there is no compelling case for investment in, say, migration to SOA, but rather because their financial methodology is inadequate to successfully express the cost case to the board.

  • 2 Mark McDonald   April 22, 2009 at 7:33 am

    Ben

    I understand your view about the cost-benefit analysis of tactical vs strategic changes. But IT and Finance professionals have to find a better way of thinking about IT finances as the current model is creaking and cracking — first at the big companies and soon with the cloud to many more companies.

    I agree that its hard to put financial metrics into multiple initiatives, particularly if you take an initiative based view — thinking of how we spend the money first and making each project “wash its face.” I believe that way of thinking is losing its relevance as the business itself already operates with a set of financial metrics

    Your final point is important to keep in mind — technologies will rarely or grudgingly make their cost cases, but its time to find a new way to think of IT finance as other investments are made on a different basis.

  • 3 12 Things every business needs to know about IT.   July 11, 2011 at 6:16 am

    [...] #10 – IT financials require improvement. Effective enterprises right now are looking for better alternatives to funding IT given its horizontal #1 and hybrid #2 nature.  Allocating IT budgets, chargeback, project Roy’s are all methods that are nearing the end of their useful life.  Check this space for future innovations. [...]