I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

I work for ThoughtWorks, the global leader in software delivery and consulting.

Thursday, April 30, 2015

Matrix IT Organizations, Part II: The Inmates Are Running the Asylum

A few months ago, we took a look at the pathologies of matrixed organizations: no focus, amateur management, and people waging turf wars to secure power that they can exercise without consequence. The result is stationary organizational inertia, the portrait of a seized-up business.

When non-executives enjoy power without responsibility, the corollary is that executives suffer responsibility without power. The organisation cannot pursue a consistent or coherent strategy, and may find it difficult to take any decisions at all.
-- John Kay, How a proud corporate history can lead to poor governance

Matrices empower petty bosses but disenfranchise organizational leaders. The owner of a product P&L doesn't "own" the people who produce it: executors report to managers in other parts of the organization, are shared with other teams, and may be so over-subscribed they have little time to devote to any one of them. Non-technical product leaders will struggle to navigate business goals to completion through the sea of technical tasks their teams force them to sail in. Knowing their skills and institutional knowledge are in short supply, individual executors and their supervisors get to pick and choose what they work on. The product leader ends up negotiating in all directions - with the people nominally on their team, those people's managers, and their peers struggling with the same organizational dynamic - to secure the time, attention and cooperation of labor. This isn't leadership, this is perpetual pleading, often just to complete the most marginal of tasks.

The chaotic process is vigorously defended by claims of democratic legitimacy, and by reference to the traditions and distinctive values of the organisation. But the democracy is a sham, and the values and traditions [...] encourage a tendency to self-congratulation immune to deficiencies in current performance.
-- Ibid.

Although power rests with people in execution, few will derive any joy from the situation. Whether they have power or not, executors are constantly pulled in multiple directions at the same time. In an organization over-run with demands, people will resort to coping mechanisms. One is process: if they can't control demand they can control the means by which people making demands interact with them, giving them some semblance of "control" over their universe. Another is denial: as Dr. Kay points out, they've lost the ability to recognize that the business context itself is idiotic, yet will take triumph at how well they cope. To wit: revenue is declining, infrastructure is decrepit, quality is poor and we can't make even the most simple of decisions, but my goodness we are so much better at communication since we adopted Scrum. High five!

This is organizational madness, and the inmates are running the asylum.

Companies don't set out to be organized as matrices. They resort to it when revenues fail to keep pace with the costs of doing business. When they do, it suggests that the business is trying to do too many things at the same time. It also suggests that many of the things the business is trying to do don't generate much revenue. Put more simply, the business is distracted by a lot of bad ideas. This isn't a problem of organization or of operations leadership, it's an executive leadership problem twined with weak corporate governance that has failed to keep that executive on a short leash.

I once worked with a private equity-backed firm that had a portfolio of four very different digital media products in different stages of maturity, with limited cross-product synergies. Two were past their peak and in unarrestable decline, one was ex-growth, one was growing. The technology organization - including software development - was shared across all products, with tech costs subsidized by the entire business. The company was unprofitable, dependent on life support from private equity injections. To justify those, the corporate headline was growth, although they tried to make the case that there was a profitability story in some of the lines.

We calculated product-specific P&Ls. These revealed that no product was operationally profitable if it had to carry the burden of its actual tech costs. This was due to product customizations given away by sales as a way of luring in new clients to replace lost ones. The slipshod software that resulted from those freebie customizations came with high running costs; company and customer alike got what was paid for in that unfunded customization.

We also did a revenue analysis. It revealed significant client churn across the lines, and that pricing of the growth business was so anemic that it would never achieve sufficient organic growth to provide the revenue the firm expected. Worse still, this sole growing market was maturing rapidly, creating downward price pressures they could do nothing to combat.

Operations and technology were as described in this and the prior blog: unable to focus, fiefdoms without responsibility, and so forth. Being unable to put a floor under the declining businesses' revenues plus a permanent pricing impairment on the "growth" business meant operations and technology would always be starved for cash. There is no wizardry that would turn this around; it was simply a collection of bad businesses.

The sane alternative was to simplify and focus: dispose of the declining and ex-growth businesses or run them for cash; sell the growth business or acquire competitors to consolidate the industry to achieve scale; and invest in organic development of a new media property. Unfortunately, the CEO saw a portfolio of properties that had thousands of visitors and just enough revenue that he could convince the board to keep the funding taps open, because there had to be a pony in there somewhere.

The options aren't all that great in this situation, which is why professionals aren't attracted to them in the first place. If you're brought in as Chief Executive or part of an executive team with an explicit mandate from the board to make sweeping change, you have a chance. But if you have a weak board overseeing a delusional CEO and a sales force for whom every dollar of revenue is the same, all producing initiatives that require tech and operations to compromise to compensate for a lack of revenue, you're wasting your time: you're in the asylum, and there's no one to hear you scream.

Tuesday, March 31, 2015

Activist Investing in Strategic Software Chapter 1 Excerpt - Why Governance Matters

I've published drafts of the introduction and first 4 chapters of my book, Activist Investing in Strategic Software. I still have some citations to finalize, several visuals to integrate and a lot of editing to do. But the foundation is there. A sample of the book (currently, just the introduction) is available on from the site.

Here's an excerpt from Chapter 1, Why Governance Matters.

* * *

That there are abundant examples of bad governance but few examples of good ones comes as no surprise. What passes for "good" in governance is not all that remarkable. Boards, being the representatives of investors, are expected to be independent, diligent, and uncorruptable. Independent members of corporate boards are assumed to be people of capability and integrity. People in governance roles are expected to discharge their duties competently; meeting expectation is not exceptional. Hence we have few examples of good governance but many examples of bad.

This doesn't help us understand why governance is important.

Poor governance, such as in the cases of Olympus, Hollinger, Madoff, or the United Nation's Oil for Food program, can lead to devastating outcomes that are plain as day after the fact. Yet as we established in the prior section, there are objective characteristics of good governance: set expectations, invest authority, and validate results. And there is research to suggest that the presence of these have a significant impact on bottom-line results.

In a study of 1,500 companies by Harvard professor Paul Gompers, well governed organizations outperformed poorly governed ones by 8.5% annually. “Well governed companies face the same kind of market and competitor risks as everybody else, but the chance of an implosion … by ineffective management is way less.”
-- Gavin Anderson, Chairman, Governance Metrics International

Good governance reduces risk of bad things happening, and there is reason to believe it is a contributing factor to superior performance

Just as a corporation is an investment of capital, so, too, is strategic software. What is true for a company at a macro level should be true at a micro level. The characteristics of good corporate governance should be present in IT governance: an independent board that sets expectations, chooses and changes leadership as necessary, and validates results reported by that leadership.

Saturday, February 28, 2015

Activist Investing in Strategic Software

A few years ago, I felt I had enough experience - and had put enough thought into the subject - to write a book on governance in software development. I had observed that most tech firms and captive IT organizations are largely left to self-govern, and both are pretty light touch about it. I had also observed that governance is widely misunderstood and the term is used in technology in a lot of different ways, almost universally incorrectly. With more ambitious investments being made in software and the success rate of large projects not getting all that much better, the need for better governance was there. Plus, it seemed to me that if IT didn't get its act together soon enough, the CFOs of the world were going to get IT's act together for it, so it also made sense to write it from a bit more of a financial rather than an operations perspective.

The timing was good, too, because the prior decade had given us some very well documented examples of egregiously bad corporate governance, ranging from isolated cases of accounting fraud (Worldcom and Parmalat) to the near-collapse of the banking industry that resulted from so many firms taking too much risk onto their balance sheets, their boards having absolutely no idea they had done so. There was some nascent research suggesting that good governance has a measurably positive impact on business outcomes, and also that "activist investors" - people who force their way onto the board of a company to agitate for change - were by and large net positive to a business. All together, we had great examples of how not to govern as well as behaviors we could use as a standard to define what governance really means - practiced or otherwise - in software development.

Within a couple of years, I had written enough material to compose a draft. Then I took a hiatus from it.

In the years since I wrote the first draft, a tension has developed between advocates of "innovation" and champions of "scale" in software development. In one corner are the enterprise development people who say control over operations yields predictable results. In the other are the lean startup people who say that discipline in execution twined with feedback loops is control enough, so just let people go on voyages of discovery and you'll have far better business results. The control camp claims that innovation is possible in their way because it embraces Agile (evidently, all you need are "innovation sprints"). The lean camp claims they can scale to the size of a large business (which may be true, but they're light on practical details). Both say they can revolutionize business itself.

But both camps take an execution (that is, operations) perspective. Execution is important, but if we're going to make organizational impact, we have to do it from a financial, not an operational, perspective. Operations are cost. Investments are value. To change the business of software, we have to speak the language and act the part of the latter. It doesn't matter how revolutionary or how beneficial a different way of delivering software can be to a company: nothing that comes out of either camp is going to cause the authors of Fundamental Accounting Principles to overhaul their text.

I am once again writing the book. I will publish it iteratively. It is still early days - no cover art, not much of a landing page.

But today, the first draft of the first chapters of my book, Activist Investing in Strategic Software, is available on Leanpub.

Saturday, January 31, 2015

Matrix IT Organizations, Part I: Turtles all the way Down

Multiple layers of authority overlap both horizontally (different people and committees engage with the same issue) and vertically (many decisions are liable to review by some other body). The lack of focus in decision making results in an absence of executive authority; while professional management is subject to random amateur interference. In consequence, able people are not easily attracted to management roles; and so the amateurs view the professionals with often justified and frequently reciprocated contempt.

-- John Kay, How a proud corporate history can lead to poor governance

A business has many sub-organizations. They may be functional (sales, accounting, etc.) or regional (EMEA, Americas, etc.), or specialized (e.g., product). A company may consist of all three: regional sales and marketing teams, working with multiple product teams, all of whom share corporate-level finance and legal. We want the organization structure to balance customer service with operating efficiency: completely autonomous divisions offer high customer service at a cost to our customers or to our profitability, while completely silo'd organizations squeeze every penny of efficiency at a cost to customer service. Competitive customer service at the lowest cost of execution lies somewhere in between these extremes.

Captive IT faces the same challenge as the rest of the business: organize to provide the greatest level of service while containing costs. IT generally organizes around technical roles: we have infrastructure people, database people, helpdesk people, software development people, and so forth. We also have specializations therein: we have ERP developers, who are not the same as our front-end developers, who are not the same as our legacy system developers. And none of them are quite the same as our QA people.

These sub-specializations are fairly well entrenched because career path is generally associated with role, and even specific technologies. For one thing, deeper expertise in a narrow set of technologies will command a higher salary than shallow expertise in a wide range of technologies. For another, a manager is unlikely to promote a promising member of the web development team to be tech lead of an ERP team because the technical knowledge is not transferable.

IT leaders structure their organizational hierarchy with this in mind. For utility functions, this works just fine: provisioning hardware and e-mail accounts is the same no matter who the user is. But in strategic software development, the business domain influences technical implementation, so IT needs tighter alignment with the business. The specialist IT structure is mapped to more granular business customers in a matrix: we form delivery teams to support a business line or a specific product owned by the business, but each team's tech lead reports to a VP of engineering within the tech organization.

Like everybody else, IT is under cost pressure. The greater the pressure, the more likely IT leadership is to make something into a shared service, which translates into fewer people owning multiple responsibilities for multiple teams. Quality assurance, project management, and techops, for example, can provide greater service when paired with a business partner, but become organizations unto themselves (with fewer staff) as a means of creating cost efficiencies.1

From an organizational perspective, this makes things somewhat untidy within IT because we have a matrix (shared services) within a matrix (development teams organized by business line, but reporting up to an engineering leader). If there is a shared service within a shared service, such as DBAs being part of techops, we have a matrix within a matrix within a matrix. It's turtles, all the way down.

Add to this the recent phenomenon of product organizations. A product hierarchy - common but by no means exclusive to tech firms - is chartered to elevate users (people who use the software) and customers (those who pay the bills for those who use the software) in ways that subject matter experts and software engineers are not able to. As the proxy for consumers and buyers, they influence priorities and packages of functionality. But product owners don't necessarily have strong footing in either the business domain or software development. In practice, they act as a referee between SMEs and engineers. At best they're an emerging function clawing at opportunity from a different perspective; at worst they're another level of intermediation in the decision making process.

And so we have the situation described above by John Kay: no small number of people being brought to bear on a problem, but a structural inability to get results.

With no defined power structure, the vacuum is filled by people who turn non-executive roles into a near full-time occupation. [...] Petty politicians enjoy the feeling of being at the centre and jostle for power; the power they seek is not the ability to get things done but the negative power that comes from “no decision without me”. Secrecy about matters of no significance bolsters their sense of self-importance.

-- Ibid.

Instead of better business alignment, we have fragmented ownership and competing priorities and agendas. Matrices create, rather than alleviate, impediments to getting things done.

In Part II, we'll look at executive disenfranchisement in the matrix organization.


1 It's worth noting that the decision to make something a shared service is frequently justified as a means of promoting "best practices". Functions like QA or devops that are fragmented into separate product teams will show inconsistent performance; consolidating them into a single function should, in theory, be a step toward making them more consistent (ignorant of technical, asset or personnel restrictions on that). The irony is that somehow, "best practices" - whatever that's supposed to mean - will compensate for the fact that a critical function is deliberately being starved of investment.

Wednesday, December 31, 2014

The CIO and M&A, Part II

Integrating businesses is no small task.  Established workflows, systems and tools are vigorously defended yet poorly understood.  Fearing for their jobs, people will equate systemic knowledge with job security.  Many in the acquired business will cling to their legacy identity. Organizational politics - and power plays - will alter tactical integration plans.  But it is the business goals that investors signed up for - not the internal special interests - that will determine the fate of the leadership responsible for the integration.  How do we stay focused on these?

Be a business leader, not a technology partner. Technology leadership must be fluent in the broader business context of the integration and be prepared to make decisions on behalf of the business, not just the technology applied to the business.  This means being or bringing in business process analysts to simplify the operations - and with it, the technology - of the business itself.

I wrote last month that most material on the role of IT in M&A are platitudes, and this certainly smacks of one.  But the fact is, this is not something that IT departments have in recent years positioned themselves to do.  The change in moniker from "Information Systems" to "Information Technology" has been a detriment to CIOs: the word "systems" implied responsibilities inclusive of business and technology, whereas the word "technology" suggests it is solely responsible for tech.  As a result, there is less expectation that tech will shape business decisions as much as it will carry them out.  It doesn't help that business analysis skills remain low in captive IT.

M&A gifts captive IT with the opportunity to be the "resident adult" in sorting out intransigent participants in an integration. However, that opportunity exists only if it is prepared to act as a business leader and not merely a technology supplier.

Slowly strangle, don't wholesale replace. Existing systems are complex: they have highly specialized rules that were developed over a number of years, they were developed with very different architectural principles than would be applied today, and the older the underlying technology the scarcer the technological know-how there is to incrementally change them.  This makes it easy to make the case that dueling systems are incompatible with one another, are no less valuable owing to the criticality of the specific edge cases they accommodate, and can only be replaced through a large "enterprise"-scale rewrite.  Thus we have no choice but to maintain the status quo, and only costly and high-risk change can possibly sweep it away.

The headwinds to change blow fiercely; there are always plenty of reasons not to do something.

Unless both organizations have extraordinarily geriatric technology, proposing an enterprise refit will be met with skepticism in the boardroom that will cast doubt on our leadership capability.  Even a big-bang retrofit of one incumbant technology to take the place of another will receive only a grudging endorsement.  Both scenarios also create tactical confusion: should existing systems be modified to meet immediate business needs or do we wait for the big-bang replacement?  And what do we do if that big bang replacment gets delayed?

We avoid this trap by strangling existing software.  In effect, we allow our portfolio of assets to continue to evolve with the business while simultaneously deprecating and retiring them.  We do this gradually, identifying specific functionality that can be integrated and replaced.  We have the practices and technologies today - from continuous integration to feature toggles to branch by abstraction - to make this a matter of will.  It is also palatable to the board because it gives us a means to show how we are structurally reducing our cost of operations in a manner that will support the business in the short-term and sustain it in the long-term, not a slash-and-burn approach that makes it thinner at the cost of making it more sclerotic.

This will mean making some unpleasant decisions. We may have to create new code - a lot of new code - to integrate old code on our way to fully retiring it.  We may have to integrate in unpalatable ways (e.g,. at the database level) where legacy systems do not support modern architectural principles.  And there will be times when the extent of integration will makes our collection of assets very complicated.  This means that our measure of success isn't just getting things deployed, but getting things removed.  To the CIO, the critical measure is a composite "simplicity index" of all IT systems, not "integration progress" in simply making systems work together.

Insist on excellence in engineering.  When the clock is ticking, there will be temptation and pressure to cut corners.  We can create the appearance of integration with quick and dirty solutions, and all that matters in the end is that it works, not how it works.

The phrase "we'll fix it later" probably has the lowest conversion rate of any statement made in business. An implcit expectation in M&A is that we are investing in simplicity and robustness, not complexity and brittleness.  The reality is, we're not going to get money later to pay down technical or operational debt we take on. If the combined landscape has more moving parts and fragmented institutional knowledge than the sum of the parts of the combining companies, we'll have a higher cost of operations and, therefore, have failed.

Investigate, measure, and draw attention to quality of engineering.  Instrument all code, looking specifically for complexity, duplication, testability, and test coverage.  Incentivise good engineering practices and reward teams that make structural and procedural improvements.  Take deliberate action against poor engineering decisions: delay an implementation rather than accept a poor one.  We have to live with the consequences of our decisions; make clear that we have invioable standards of performance.

Nobody is irreplaceable.  Inheriting somebody else's code is never much fun.  We have to deconstruct what other people were thinking at the time they created it, while simultaneously trying to understand the business context that existed at that time versus the context that exists today.  It's much easier to fight for funds to perpetuate a legacy team than it is to take responsibility for cleaning it up.

Two things to remember: it's just code, and the people behind both the code and the business usually don't have as much systemic or contextual knowledge as we project into them that they have.

To the first point, most code is not as algorithmically complex as we are told that it is.  The implementation might be complex, but implementation decisions are generally easy to discern (somebody really liked Java interfaces, so everything is implemented as an interface).  Once we figure that out, it's fairly straightforward to restructure the code and increase test coverage to make it more testable.  This is true for current and legacy languages alike.

To the second point, don't assume that the business leaders have as solid a grip as you'd hope they do as to why they do the things they do.  Some years ago, I was working with a firm to redesign fleet maintenance operations.  The existing suite of software tools were a combination of RPG, Visual Basic, Java and Excel, tied together with a number of manual integration steps.  The business operations leaders could only understand operations in the context that the technology allowed them to do these things.  We had to understand their business operations better than they did to get them to understand the actual value stream.

Do not be held hostage by tribal knowledge or the perception of that tribal knowledge.  Reward people for knowledge sharing and provide career paths for people to move beyond system caretakers to leadership roles that builds on their experience in mission-critical systems and knowledge of how the business itself operates.  Do not be afraid to cut people loose who are obstacles to change, no matter how entrenched they are perceived to be. Best of all, replacing legacy systems will reduce pockets of that knowledge: we start the clock ticking on it the minute we start to retire it.

Put your personal credibility on the line for these things.  A CIO has only as much time as the M&A horizon to create a common culture within the technology organization. Whatever the cultural norms are of the two firms at the start, insisting on engineering excellence, business leadership, and gradual improvement while being willing to accept responsibility for cutting loose tribal knowledge sets a decisive tone of change within an organization.  This creates both a new mission and a new identity for everybody.

Most importantly, we have to make it clear to all and sundry that we are every bit as much on the line for these things as they are.  We will take responsibility for a delay in implementation where quality is sub-standard.  We will develop new leaders in our organization rather than being forced to retain people in existing roles.  Our actions will speak louder than our words.

Nobody is irreplaceable.  If we fail to deliver, we'll find that out to be true for us, too.

Sunday, November 30, 2014

The CIO and M&A, Part I

"It is hard not to be cynical about this. M&A is a great process for creating fees for bankers, and for destroying the value held by shareholders."

-- John Authers, writing in the Financial Times

Industries tend to go through waves of deal-making. Sometimes it is divestiture or separation: sprawling firms that serve different buyers or markets don't achieve much in the way of operating efficiency, and a "conglomerate discount" priced into their equity means there is value that can be released by dividing a firm into multiple businesses. This is something H-P did in the late 1990s, and is about to do again. But usually, deals are acquisitions: competitors merge to gain more power over costs and prices (United Airlines merging with Continental); large firms acquire smaller ones to enhance their core (Yahoo has been on an acquisition tear in recent years), diversify their markets, or simply to prevent a firm from falling into the hands of competitors (Microsoft's acquisition of Skype).

The justification for a merger or acquisition usually involves some quantification of synergistic benefit: the two businesses have so much in common they can achieve greater profitability together far sooner than they would be able to on their own. This can be achieved through sales: Company A and Company B sell complimentary products to the same buyers; a merger of the two would allow for cross selling, resulting in larger and more lucrative sales. It can also be achieved through operating efficiencies: Company A and Company B can operate just as effectively with, say, 70% or less of their combined procurement, finance, accounting, HR and IT organizations.

The expected synergistic benefits to revenue and costs are calculated, then taxed and capitalized, to come up with a hard economic value to doing a deal. This makes them important to the CEOs involved because they help them sell their respective boards - and shareholders - on doing a deal. Their importance increases in direct proportion to the premium an acquirer is willing to pay to buy another firm. Synergies can be substantial: the proposed synergies of the merger between Office Max and Office Depot exceeded the combined market capitalization of the two firms.

* * *

"Most deals fail to create value because the buyer paid too much, or because the acquirer failed in the difficult task of sticking two companies together. Glossy proclamations of new strategic visions often boil down to a prosaic cost-cutting exercise, or into a failure of implementation."

IT is at the center of deal synergy. Obviously, we don't want to pay to maintain multiple e-Commerce sites or pay licensing fees for multiple ERP systems. But redundant IT systems can increase the cost of doing business: if we need people in finance to write custom reports to combine financial reporting across the two businesses, the merger has increased our total cost of operations. We need to combine systems, and do so quickly.

There are plenty of cookie-cutter frameworks for combining businesses, even their technology systems and operations. This also means there are plenty of platitudes to go round: "Involve the CIO as part of the executive team from the start" and "IT doesn't work in isolation". True, but not very helpful. Rubber hits the road in M&A in the actual combination - and reduction - of systems. Platitudes will not change an ugly operating reality.

IT in M&A can be a very messy business. For example, suppose Company A acquires Company B and intends to move Company B - running a highly customized & partially proprietary ERP - over to Company A's similarly customized, but commercial-off-the-shelf, ERP system. Company B has very different business processes and communication channels from Company A. The new divisional leader for that part of the combined company is from Company B and decides he wants those processes applied to the combined business. IT must now make changes to Company A's ERP system and dependent code to accommodate this change, in addition to migrating data. Costs just went up and the consolidation timeline just got longer - and depending on your point of view, it looks like an IT problem.

This also applies to the mundane stuff. For example, IT learns that the data and data structures in Company B don't exactly line up with Company A, so data migration is going to take more effort than originally expected. IT responds by creating data warehouses to house consolidated data so that Finance can run its consolidated reports. Costs just went up, as did operational complexity: those warehouses - and the ETL that refreshes them - have to be maintained and updated.

When companies pay a premium to fair value of net assets for a business they acquire, the excess is recorded on the balance sheet as goodwill. In theory, the value of the combined business should increase as synergies are realized, obviating the need for goodwill. The reality - and core to Mr. Auther's comments above - is that companies have a tendency to pay too much in acquisitions and end up taking a writedown. One study found that between 2003 and 2009, some 4,600 firms wrote-down goodwill due to impairment, amounting to 20% of total recorded goodwill. The study went on to report that there are some serious ramifications to this. For one thing, "the news of goodwill write-off [...] precede[s] CEO resignation and can trigger shareholder lawsuit." For another, "Firms with goodwill write-offs significantly under-perform in future." (Feng Gu, Goodwill and Goodwill Write-off: Economic and Accounting Implications)

So, in a M&A situation, there's a lot on the line for the CIO: you don't want to be the reason the boss loses his job, and you don't want to be a reason why the stock price underperforms. But your operating reality is messy: you're beholden to tribal knowledge of systems you've inherited through the acquisition, you're at the mercy of business decisions that are made for local optimization or simply local convenience, and you're under the gun to enable finance and accounting to create the patina of a combined business for the benefit of the people who approved the deal. As CIO, you'll be under pressure to extend and even bump your payroll to prevent loss of knowledge, create teams to chase business decisions with new software, and take on technical and operational debt to make good on immediate needs.

There is no playbook for this.

Next month, we'll look at how a CIO can square this circle.

Friday, October 31, 2014

Can a Business Rent a Core Capability?

Tech utilities - things that automate administration, enable communication or improve employee productivity - started as a labor expense, became a capital expense, and have now become a rent payment. This final state is an efficient economic relationship for buyer and seller. The buyer has more flattering financial statements and can negotiate for non-core services at a gross level (e.g., a single cost per employee). The seller's income is the rent they can extract from buyers. Utility sellers tend to enjoy monopolistic or oligopolistic market conditions, but there is still room for optimization and even disruption that drives prices down.

But disruptive tech is not a utility. It needs to be developed, and developing it requires a capability in technology (design, coding, testing, etc.) In recent years the trend has been toward renting that capability rather than owning it. This begs a question: can we rent the capability needed to deliver disruptive tech? If today's disruptive tech becomes tomorrow's status quo, doesn't that mean it needs to be part of a firm's core competency?

Two significant factors stand out when considering this question: the state of evolution of the (would-be) disruptive tech, and the extent to which it is genuinely disruptive.

Let's look at the latter part - the extent of disruption - first. New technologies disrupt by creating new behaviours and expectations among its users. In the process, it siphons market share by shifting market participants from one activity to another. Obtaining a book changed from making a trip to a bookstore to an online purchase that triggered a package shipment to an electronic distribution. Social media is a form of entertainment that shifts people's allocation of their leisure time.

Creating new behaviours is more disruptive than being the first to apply technologies established in one market segment into another: streaming video to personal technology on airplanes is interesting, and doubtless it will allow airlines to eliminate in-seat entertainment systems that add weight and burn jet fuel, but it brings established behaviours into a different context. Still, this is more disruptive than developing technologies that mimic existing functionality in the same segment: being late to the game with a "me, too" strategy does not generate much in the way of behaviour change.

With this in mind, let's consider the other dimension, the state of evolution of that technology: is it in research, is it an arms race, or is it a mature solution?

A company investigating a disruptive technology for its potential doesn't have to own the means by which it does that investigation. An exploratory investment is generally developed rapidly and deployed frequently to accelerate the rate of exploration. The differentiating value of effective exploration are speed, adaptability, and the ability to interpret the feedback from the experiment. It may succeed, or be a mild success, or be a complete bust. It's safe to rent as this is a non-operating capability. That a firm does this suggests the firm in question is slow growth and run for efficiency and lacks an R&D capability, but this describes a lot of firms: oil majors have separated into refiners and E&P, and pharma firms have similarly split into generics and growth / R&D firms.

However, a disruptive technology that rapidly gains adoption must become a core competency, and quickly at that. This is a phase when a firm is learning new rules for competition. Firms must learn what works and what doesn't (what we do and don't do), and what matters and what doesn't (what we measure and pay attention to, and what is just a distraction). Successful firms have to rapidly master new business operations under the pressure of scale and growth. Success is equal parts business and tech: the business is changing and the tech is brand new. Renting the tech capability puts a company at a disadvantage because it will not develop core competencies, fundamental skills, communication patterns, and organizational leaders critical to it's "new normal". In a tech arms race, it's not safe to rent.

The extent of disruption determines impacts the feasibility of renting. It is safer to rent capability where the tech follows established patterns. When a firm consumes established technologies to create products and solutions for a specific vertical, there is greater value in the business knowledge because the tech contributes less value to the solution. This makes it safer to rent the tech capability. The less disruptive, the less the risk: there's little point in owning a capability with a mission to mimic somebody else's tech.

Of course, the economics of renting or owning are muddled by other market forces. A start-up compensating employees with equity is not paying market value for its labor and is therefore renting, similar to how a lender owns a house that a borrower lives in. And tech buyers have no choice but to rent tech labor from services firms because of labor scarcity.

A company might have to rent because of prevailing labor market conditions, or because renting gives it a shot-in-the-arm that allows it to catch up when it is caught unprepared by a technology shift. But as Machiavelli counseled, one holds conquered territory with one's own forces, not mercenaries. A company has to own its core.