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RISK MANAGEMENT AND ROI

RISK MANAGEMENT AND ROI. The IT Leadership Financial Conversation Peter G.W. Keen Chairman, Keen Innovations Professor, Delft University The IT Leadership Development Program, University of Calgary and CIO Summit September 30, 2004. It’s all a matter of perspective.

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RISK MANAGEMENT AND ROI

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  1. RISK MANAGEMENT AND ROI The IT Leadership Financial Conversation Peter G.W. Keen Chairman, Keen Innovations Professor, Delft University The IT Leadership Development Program, University of Calgary and CIO Summit September 30, 2004

  2. It’s all a matter of perspective • Risk is intrinsic to innovation • IT is notoriously risky: the only way to avoid risk is to “align” IT with the business as is – safe projects, cost focus • The IT perspective too often has overlooked, underplayed, dismissed the risk, especially organizational risk • The issue of IT ROI has been a thirty year tree-killer • Methodologies, Spreadsheets, formulae • Analogous to measuring the ROI of education • What perspective is needed • Managing value under conditions of risk and uncertainty • Hold the “I”, phase the risk, focus on concrete measures of “R” • Build a dialog on managing value not managing IT • Whose perspective? • What perspective?

  3. 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 ROI • Provide specific approaches to IT financial risk management • Help you view outsourcing in a new and more positive light as co-sourcing

  4. 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?

  5. 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?

  6. 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 Cancelled • Small (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?

  7. Why do the answers matter? • You tell me

  8. 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 credibility • They reduce the likelihood of investing in ventures that are doomed from the very instant the business proposal is approved • They help you direct resources

  9. Background: The real IT problems • For business executives IT is a real pain: • High risk upfront capital investments with promised but rarely delivered ROI • Lack of business executive control over costs, targets and risk exposure • Too many (expensive) surprises • IT 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

  10. The IT leadership conversation • The Texarkhana airport test • No 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?

  11. 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

  12. IT Cost Risks

  13. 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

  14. Software project outcomes • Early/On-time Delayed Cancelled • Small (1K FPs) 61 18 20 • Medium (10K) 28 24 48 • Large (100K) 14 21 65 • Would you invest in a business with this fifty year risk profile? FP = function points

  15. ROI from IT

  16. ROI from IT • There is none

  17. ROI from IT • There never will be

  18. A challenge for the class • Define a formula/method of calculation to show the ROI for your college education

  19. 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 advance • The “R” is far off and hypothetical • Most large-scale IT investments fail to deliver on their promises • 60% of large IT developments fail to deliver value for that risk

  20. Getting value from IT: the accelerating trends • ROMI not ROI: Return on Minimized Investment • Turn IT into a variable cost • Process sourcing – business on demand • Link IT to business “imperatives” • 90/180 day ventures and beachheads

  21. IT financial payoff targets: • Capital efficiency: Reduce working capital per unit of revenues • Revenue efficiency: Increase gross margins • Operational efficiency: Radically cut overhead • Organizational productivity: increase revenues per employee • Process effectiveness: slash cycle time in W3 – Win-Win-Win processes • Staff effectiveness: “beachhead” low cost, low infrastructure knowledge mobilization

  22. 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

  23. The Business/IT “Pyramid” Innovation Superstructures Business Infrastructures Technology Substructures

  24. Larger than pilots, small enough to deliver in 90-180 days Focused goal of building momentum for innovation Self-explanatory, self-justifying benefits High centrality: visibility, political credibility, link to key constituencies Phase 1 of an “architected” campaign A 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 Beachheads

  25. 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?

  26. Welcome to the Variable Cost Economy

  27. Business scaling: Up Investment Add people, systems, facilities Disruptive, expensive 1995 2000 NOW 2004

  28. Business Scaling: Down Investment Cut people, systems, facilities Disruptive, expensive 1995 2000 NOW 2004

  29. What’s next? Investment ? ? ? ? 1995 2000 NOW 2004

  30. An example from a superb company

  31. The new architecture opportunities SUPERSTRUCTURES: Priority targets: customer relationships, supply chain, financial, organizational, operational; Branding; Innovation paths Bundling of distinctive capabilities via infrastructure clusters Process edge – differentiation Super Infra Sub 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 interfaces The Web as electricity; Largely usage-based variable cost

  32. 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, risks • Give clients a real decision to make: let them choose the trade-offs • Think ROMI and beachheads

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