RISK MANAGEMENT AND ROI
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Transcript of RISK MANAGEMENT AND ROI
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