If you hadn’t noticed, things are changing. Inflation, global supply chain challenges, and rising interest rates, are conspiring to make doing business difficult. For a year or more these short-term pressures have been building. In the last couple of weeks it looks like inflation maybe peaking, and supply chains seems to be sorting themselves out. Central Banks have, however, signaled rates will continue to increase and remain high for some time in order to throttle inflation expectations. In plane speak, Central Banks need to crush demand to save supply.
The End of an Era
But this New Year will be different. It will be different because short- and long-term trends are converging. There are long-term trends that underpin long cycles, and they are crossing a fulcrum. Demographics and labor costs have both provided an ample reservoir for many years, helping to keep global costs down. Globalization helped too with continued opportunities to eke out more margin. The biggest reservoirs are drying up.
There are no cheap labor pools to join the WTO, as China did in 2001. Large, productive economies are greying and demographics are now working against us, and will for many years to come. Working age populations are declining just as retired worker populations grow, with greater longevity than ever. Increasingly profitable and advanced nations also seem more interested in regulating society, than letting society determine its own behavior. The result is public spending and debt has continued to rise inexorably since the Great Depression, and more noticeably since just after the Great Recession of 2000s. If you add the political propensity to seek to regulate for success and social engineering, the trends all point in the same direction. We are at the end of one era and at the beginning of another.
From here on out we can expect interest rates to rise inexorably. There will be times when rates fall back, but the trend now is that long-term, rates will grow. As we have all come to experience low interest rates for 30 years, with all the associated benefits such as low inflation, we will now need to learn to survive with the reverse. So, what does that mean for us?
Something Rotten in the State of Denmark
Another trend that has has been underway for sometime will have an impact on what we all do with IT, digital and AI. Productivity has been unimpressive in many economies for many years. The last big positive swing came about around the time of the dot.com era when IT capability diffused across industries. First IT itself became more productive. Then retail leveraged such capability and re-engineered their business processes and profits. Over time other industries took advantage of business application and cheap storage and compute. But since then the long-term trend with productivity has been slow decline or very low growth.
Despite the dearth of case studies and press stories telling of wonderous tools and technologies, economic growth has not materialized driven by increased productivity. IT has not, it seems, mattered as much as we thought or wanted. Even in today’s digital era, boards of directors and CEOs are wondering where sustainable business value is coming from. And this after multiple years of investments. This is where we need to step up.
The Choices Capital Has
The economic backdrop suggests that the opportunity to make a return on capital investment will change, and likely grow in number and size. As interest rates go up, investing options change. The actual number of options may not change overall. You could, for example, park your capital with a bank, invest in public bonds, a Venture Capitalist, buy some stock, or maybe dabble in some M&A. Or maybe you could invest your capital into a new digital business innovation with a cute new 4-letter acronym. There are options, but there is another angle arguably more important.
Each kind of investment, even each investment, will off a rate of return. It is the difference in rate of return across these options that is key. As differences in return across channels become clearer, capital will shift away from some kinds of investment towards others, as smart investors follow the money. This is a key reason for why lowering interest rates in the last few years didn’t drive capital investment. There were other channels with better rates of return and lower risk.
A year ago, you might have argued for a:
- ERP consolidation
- Cloud migration
- Application and business process automation
- Infrastructure modernization
- AI-driven Customer Experience
- Data-driven or Analytics program
Many of these investments will go along with a justification tied to a strategy, or perhaps an ROI. Investments tied to strategy almost always imply spending money on something in the hope that a benefit or significant return will accrue much later. Our research suggests that most investments do not have any real ROI analysis behind them. And over the long haul, the business impact of strategic investments is questionable at best.
Your Next ROI
In many industries the top one or two firms have maintained their dominant position over the years. Or, through the informal alliance with big government, investments in lobbyists and the regulatory framework continue to keep erstwhile competitors suppressed. The dearth of cheap money, finagled by big governments the world over, even funded M&A deals in the last few years by big business, for what would otherwise have been profitable competitors. These further cements the leaders’ position and further funds big governments’ position.
The Economist Briefing this week nails the challenge. In The New Rules of Investments: When the tide turns, (December 10th, 2022) Raj Mowdy of PWC is quoted, “If you can get 4% on government bonds, is 7% on private assets enough?” This speaks to the challenge for all those that seek to invest in IT and digital. Investments in IT need to both generate sufficient return that exceeds alternatives, and with a degree of reliability such that the difference in return remains attractive. Can you defend a 9% return on an IT strategy or investment with a 60% chance of success against a public debt instrument offering 4% at 90% reliability? What are the other options, their rate of return, and risk element?
And what of those strategies? Investors in IT, digital, AI, and data and analytics, need to master both the short-term and long-term. Shor-term actions are incremental investments with small but real returns. This puts money in the bank and gives you credibility. At the same time, those small investments need to add up or contribute to a longer-term strategy that speaks more to the possible return later. Thus, you build out our organizations’ future state architecture, one outcome at a time. Gone are the days of them 6-months, 5-year detailed, perfect plan. There isn’t one so why bother paying for one? My favorite recent description of this is from Toto Wolf, Mercedes Team Principle. He said, “Strategy is learning by doing.”
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