Capital spending is coming back with a vengeance and so will waste—shareholders beware.

“I wouldn’t give a fig for the simplicity on this side of complexity; I would give my right arm for the simplicity on the far side of complexity.”

-O. W. Holmes

Here We Go Again

Capital spending is coming back with a vengeance and so will waste—shareholders beware.

Barry Sheehy

It’s official: capital spending on technology, which accounts for nearly half of all business investment in this country, is making a comeback. Tech spending in 2004 will hit levels not seen since 2000. Sales of semiconductors, always a leading indicator, are expected to climb 17 percent this year.

This surge in investments presents us with a paradox. On one hand, it is good for the economy and bodes well for future improvements in productivity and value creation. On the other, this surge in spending will likely signal a return to many of the bad habits that characterized investment spending in the bubble leading to waste, rework, late and over-budget projects, and plenty of outright failures. At the height of the bubble we were writing off $100 billion in technology investments every year. How quickly we forget.

During the spending spree of the late 1990s, more than half of all technology related investments failed to deliver promised value, came in late, or went over budget — many suffered all three afflictions. Even those that did come in on budget usually did so because the original estimates allowed for enormous waste. It was not unusual for churn (useless work or useful work repeated more often than necessary) to consume 30 cents of every project dollar. Back then, 35 percent of the average business investment portfolio was tied up in low value/no value investments. But here is the rub: despite this mess, technology investment in the 1990s laid the groundwork for the fastest improvement in productivity the United States has seen in 40 years. Just think what might have happened if we had got our act together!

This time around, it may not be quite as bad as it was in the 1990s.  Portfolios have been under such scrutiny over the last few years that most low value investments have been squeezed out. We also have learned to be wary of leading (bleeding-edge) technology or doing things in-house that are best done outside. We have learned the value of breaking projects into smaller chunks and gaining greater business ownership of technology investments. A few organizations (emphasis on “few”) have even set up more disciplined investment management and optimization processes. But even these prudential efforts will come under pressure as the investment cycle heats up and the “animal spirits” of business leaders grow impatient queuing up at designated investment gates.

The truth is that many fundamental issues that cause wasteful technology investment remain unaddressed and have lain dormant, waiting for the next spending cycle to re-emerge. Chief among the issues is a misunderstanding of the very nature of the problem; this is not primarily a technology problem but rather a manifestation of weaknesses in the larger management system. The solution lies in redefining how we think about and manage business investment involving technology. Today, it is nearly impossible to create value without involving technology to some degree. Consequently, the tech and business components of the investment must be managed as a whole. Separating the tech part from the larger business investment to be managed in isolation, guarantees you’re about to waste a lot of shareholder money.

NOT TRACKING THE RIGHT THINGS

Most business leaders recognize the theoretical need to be more involved in managing their technology portfolio investments, but they lack the tools for effective control including appropriate metrics, investment optimization processes, risk management tools and governance models.

Let’s examine the latter—governance. One of the most disturbing patterns to emerge from the last decade is the steady decline in the ability of teams to manage down risks even after the source(s) are clearly identified. This happens when project teams lack the power, influence and levers to fix the problem. Paralysis occurs because technology investments have grown more complex and pan-corporate in nature (Customer Relationship management is a good example) and require strong horizontal governance across functions and business lines. Too often, these horizontal links are weak because governance models are rooted in existing vertical businesses or functional silos. This results in the bulk of the mandate and the project staff coming from a single business line—while the true breakthrough power of the investment lies in making linkages horizontally across the organization.

Sounds easy to fix?  Well it’s not, because power flows vertically through most organizations, and any investment lacking support from an existing business or function stands little chance of success. But at the same time, this essential support can bring with it an outdated governance model. So long as the investment is aimed primarily at the narrow interests of the vertical business unit, everything works fine.  However, if the aim is pan-corporate and, thus, horizontal in nature, problems in governance soon surface.  The team may find flaws in the value proposition, distribution assumptions, marketing plans or partner dependencies that fall beyond their purview. In short, they know what’s wrong but haven’t the power to fix it—at least not easily. It’s a sort of Catch 22 for technology investment.

And the problem becomes exponentially difficult to fix the longer it goes unaddressed. Once the spending machine starts up, commitments are made, and careers and egos are put on the line, it is hard to change course. Like the Titanic heading toward the iceberg, the momentum is enormous and there is not enough (governance) rudder to change course before the inevitable collision.

The root of the problem is that our governance doctrines and protocols are outdated. They are one generation behind the horizontal challenges they now face. This is a classic case of doctrinal and structural obsolescence.  

THE WAY OUT

The solution is to update our doctrines for managing investments involving technology. The first step is to tighten up front-end portfolio management and investment optimization by insisting on better business model planning. It is not unusual in examining business portfolios to find as many as one third of investments with weak business cases. Sound outrageous?  Well, sadly, it’s too often the norm. Don’t believe it? Just take a long hard look at your own portfolio and see what you find. The second step is to subject important investments —pick a cut-off point at say above $1 or 2 million—to rigorous risk assessment.  Make mitigation of the identified risks compulsory for continued funding, and track progress. Next, build an end-to-end investment management process that measures front-end business case assumptions against risk scoring and mitigation and back end performance. Creating such a closed loop is, from a technical perspective, easily done yet hardly a company in America does it well today.

The elements of the solution are not hard to sequence:

• Build an up-front investment optimization system to ensure more money is allocated in the right areas—from a strategy and ROI perspective. If nothing else, this tighter filtering process will ensure more investments have strong business cases.
•  Ensure that important investments are subject to disciplined risk assessment, employing up-to-date risk modeling. (The best models are built around the organization’s own unique pattern of execution pathologies).
• Establish a closed loop tracking system to compare front-end business case projections with risk assessment scores (and corrective actions) and backend delivery performance. In short, a system that tells you the following: what was promised, what risks were identified, what was done about them, what was delivered in the end…and, oh yes, what was learned along the way.

Incorporating this information, it is possible to set and track aggressive investment efficiency improvement goals measured in terms of ROI and PTI. It is also possible to track the cost of achieving each incremental dollar of revenue or profit. You can then set targets for improving the number of investments that actually achieve their original projections (on time, on budget, on scope and on value). Given the huge dollars involved, even a small improvement of one or two percentage points a year, compounded over several years, would produce huge returns. Finally, the availability of such investment efficiency metrics creates a learning loop of incalculable value. This tells the organization not only how well it has done, but also why.

THE NEXT WAVE OF MARGIN IMPROVEMENT

This tracking of investment efficiency in technology-intensive investment represents the next frontier in margin improvement. Today, with the advent of large-scale outsourcing and the use of component architecture, we are finally beginning to see ROI improvements on fixed technology investment—something that would have been thought impossible seven or eight years ago. Now, attention is turning to new technology investment. And the numbers justify this attention—just look at your own capital budget for next year.

What makes all this tricky is that the return on technology investment is not controlled entirely by the technology community. The success or failure of new technology spending, like all new business investment,  is primarily influenced by business factors. Governance, market planning, value propositions and competitive environment are greater sources of risk to technology spending than any failure of the “black box,” by a factor of more than four to one. The problem is that many business leaders still think their technology organization is the problem, when really it is the surrounding management system. So, while the next frontier is in sight, it is yet a long way off. This is why a new generation of metrics and tools is so important—without new metrics and tools, it will be difficult to penetrate the wall of myth and misunderstanding surrounding the true nature of the problem. In this case, not only are facts friendly, they are essential to achieving simplicity on the far side of complexity.

This next generation of metrics and tools can be easily built. All the necessary tools exist. It is only a matter of will…and, yes, leadership. The incremental effort and cost of putting in place the necessary processes are small. All it takes is for the CEO to insist on them.

Business leaders armed with better tools and better information will invariably make better decisions, the impact of which will find their way to the bottom line in one form or another. Margin improvement is where to look for it first.

The opposite is equally true. Many a CEO, puzzling over a decline in margins or an erosion in competitive position, need look no further than the track record of his or her investment portfolio over the past several years to see one source of the problem. If too much money is being consumed in churn, if the return on investments is suboptimal, if too many low-value projects are funded and too many high-value projects under-perform, then sooner or later, the incremental cost of earning the next new dollar is going to rise—and margins will erode.

So, two cheers for the recovery in capital spending!  But let’s save the third cheer until we see just how much we have learned from the past and how prepared management teams are to address the challenge of improving investment efficiency.  Until then, buyer (in this case shareholder) beware.