RISK MANAGEMENT AND ROI

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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

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Its 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?

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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 ROI
• Provide specific approaches to IT financial risk
  management
• Help 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 companys 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 firms 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 agencys core metric of
  productivity?
• What percent of next years 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 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?

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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 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

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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 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
  organizations 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 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
• Wheres 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
  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
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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 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

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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

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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

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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
Innovation Superstructures
Business Infrastructures
Technology Substructures
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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 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

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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
Investment
Add people, systems, facilities Disruptive,
expensive
1995 2000
NOW 2004
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Business Scaling Down
Investment
Cut people, systems, facilities Disruptive,
expensive
1995 2000
NOW 2004
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Whats next?
Investment
?
?
?
?
1995 2000 NOW
2004
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An example from a superb company
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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
 
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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, risks
• Give clients a real decision to make let them
  choose the trade-offs
• Think ROMI and beachheads