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.

Monday, January 28, 2008

IT Effectiveness is Measured by Asset Yield

We tend to consider an IT project successful if it is delivered “on time and on budget.” From an IT governance perspective, however, this doesn’t tell us all that much. At best it is an indicator of basic operational competence, that fundamental project controls are working. At worst it’s a false positive, indicating nothing more than the team was particularly lucky that all assumptions held true, or that their contingency was sufficiently large to absorb the impact of those assumptions that didn’t.

As a measure of IT effectiveness, it is incomplete. The key element missing is whether or not the project met its business objectives. Indeed, measuring systems by their compliance to plan ignores the mission of the project: it focuses on execution, at the exclusion of results. That is, “on time on budget” at best assumes that the business goal was met, at worst abdicates responsibility for it. The objective is to create a business solution, not to simply perform tasks to a forecast.

Business solutions are business investments. These investments are no different from any other use of the firm’s capital. They are made for one reason, and only one reason – to maximise profitability. Sometimes they are initiatives, for example when new systems are developed to support new trading products. Sometimes they are reactionary, driven by the need to comply with a new regulation or respond to competitive market offerings. A firm makes an investment in an IT solution as a way to maximise operational efficiency, and thus EBITDA. If IT application development produces assets which drive EBITDA, we should manage IT projects to maximise asset yield.

Asset yield tells us how effective IT is in its stewardship of the money with which it is entrusted by the firm. With this measure we have a business-oriented way to answer the first governance question: are we getting value for money? This is very powerful. It allows us to take better oversight decisions: we quickly identify where IT is contributing to breakaway results, and where it would be better off putting capital into Treasuries instead of investing in operations because IT is letting the side down. It also improves the day-to-day execution of our different projects: behaviours1 should align with the business goals (the business solution), not an abstraction of the goals (the project plan.) We thus get a simple litmus test to evaluate day to day decisions we take relative to the first governance question: does it improve asset yield?

By focusing on asset yield, we become aware of something else: time-to-market has a greater impact on yield than cost. In the on time on budget world, it’s usually tolerable for a project to be late in delivery if the budget implications are minimal. This is because in most corporations it’s far easier for a manager to be granted additional time (people are on the payroll anyway, so it’s a committed cost), while securing additional budget is nearly impossible (annual expense controls make it difficult to change allocations). The time value of capital is invisible to most managers, and its impact is noticeably absent from project decision making. To wit, rarely do project managers request additional budget to deliver a project ahead of plan because they can maximise business returns.

The fact that the time value of money is invisible to most middle management has disastrous consequences for a firm. An IT asset that is not in production yields no returns. An IT asset will yield more business benefit than it costs to develop; otherwise, the firm wouldn’t invest in it. That means each month of delay depresses yield, while the incremental cost of accelerating delivery can increase yield. Even further, lethargic delivery within budget will yield far less than aggressive delivery in excess of budget.

The converse is also true: the sooner the asset is in production, the greater the yield. Consider a project with an estimated 12 month / $6mm development cost and 17% annual maintenance that will contribute an annualised $30mm in profitability for a firm with an 8% cost of capital. A “big bang” deployment after 12 months yields a return above the firm’s cost of capital, but it is both lower and realised later than if those returns can be partially realised with incremental releases (e.g., at 3 months and 9 months) that provide modest contributions to EBITDA (say, 10% and 30% of the projected impact, respectively). It is also obvious that the disparity between incremental and single-even delivery is amplified in the event of delay.

To be a strategic capability, IT leadership must shift focus away from cost minimisation in favour of time to market. The effort spent in recent years by IT departments to reduce spend is effort misplaced for strategic IT. This is not only because volatile currency markets have made labour arbitrage tactics less effective, but because we’re focused on the wrong end of the equation: whether we’re spending $200 / hour or $20 / hour for a developer, an asset that the business cannot use is of no value. Time, not cost, is the lever IT should be looking to throw. This means IT must capable of delivering in short timeframes and working in greater collaboration with the business partners to produce assets with a high degree of solution fitness. To maximise yield, it is more important to build this capability than it is to source a low-cost capacity.

Making this the business reality isn’t that easy. IT doesn't typically make incremental deliveries, it makes single deliveries following long development lifecycles. Similarly, most business operations are not prepared to deal with training and workflow changes necessary to consume frequent solution deliveries. But do these things, it must. With a rising cost of capital, M&A, stock buyback and startup investments are out of reach. Compounding this, large debt loads coupled with a soft economy will put even more pressure to achieve bottom line results. Investments in operations are now that much more critical to the success – if not the sustainability – of a business. Hustle will be the order of the day, urgency the imperative. Well governed IT is the centerpiece of executing this strategy.

1 There is an important distinction to make here. IT is not a business of assets. It’s a business of people creating assets. We can measure results by focusing on asset yield, but those yields are only achieved by the capability and successful execution of the people we have to achieve them.