The Value Proposition: Budgeting - the first step to information superiority

IT has become the weapon of choice for competing for markets in the information economy with the assumption IT is a better investment than labour. However, statistics indicate this is not always a good assumption. Proceeding on this assumption raises the question: How much IT is good for you?

Building a budget is the hardest task the CIO performs and it is getting harder as the pace of change in IT accelerates. Should you take last year's budget and add 10 per cent? This will guarantee different projects and departments fight over a fixed pot of money and no one will be able to plan business change effectively. As engineers, we have well-developed methods and metrics for application development, capacity planning and server management, so let's apply some engineering to the IT budget. We can start with a proper assessment of how we are currently spending our budget. If we accept IT as a source of competitive advantage then it follows the right budget must be one that at least matches competitors. But even that may be misleading, since it is only the part of the budget devoted to value generating innovation that is critical to winning new market share. Gartner publishes average IT spending values for industry sectors based on a percentage of revenue. Within each industry sector, however, the Gartner figure is no more than the mean which hides large variations. Analysis carried out by Paul Strassmann shows IT spending as a percentage of revenue varied from one per cent to 10 per cent. He has shown even with an industry sector such as insurance, the average of 3.6 per cent hides a range of values from less than two, to over 20 per cent. The message from this brief look at the percentage of revenue approach is that we need a more sophisticated model. IT budgets need to be based on factors which can be demonstrated to have a statistical relationship to the actual IT spend. Strassmann's extensive database of IT spending data has shown IT budgets are determined more by the way a firm is organised and its business model than by the industry sector in which it is classified. Strassmann shows IT budgets show a simple correlation with a line item on financial statements - the Sales, General and Administrative (SG&A) expense. This line is the most reliable guide as to the total information management costs for a company. IT spending is approximately 10 per cent of SG&A, although some caution is required when using these figures. So, if you are involved in IT budgeting note these three conclusions from Strassmann's work: - Don't use misleading statistics such as percentage of revenue for IT budgeting - Obtain consistent financial figures for information management and cost of goods and use them to analyse IT spending - Relate current and future IT spending to the information management costs of the whole organisation The coefficient of determination for IT spend to SG&A for Strassmann's sample of 468 companies was 73 per cent. Since SG&A appears in most company reports this is a good place to start in your IT spend analysis. What is immediately clear is most of the SG&A expense is taken up with salaries and we can refine our approach by looking at the statistical relationship between the IT spend and the number of information workers in a firm. Information workers will include executive, managerial, professional, technical, sales, administrative, clerical, and service labour. In Strassmann's database the coefficient of determination is higher than that of SG&A at 78 per cent. So if you are looking to reduce the IT budget the first task should be to cut the information workforce by eliminating unnecessary tasks. In Strassmann's database sample, information workers consumed on average $9,200 of IT services per year - 80 per cent of the IT budget. We must conclude therefore that other workers consumed next to no IT budget. The most important thing we learn from this analysis is that IT spend per capita is, like IT spend per revenue, a useless metric. Non-information workers are insignificant consumers of IT, so there is no point in comparing per capita IT spend for a company which outsources manufacturing with a company that employs an army of production workers. In summary: - Obtain figures for the number of information workers before attempting to analyse or predict future IT expenses - Relate IT budgets to the number of information workers and avoid misleading ratios based on total workforce A historical and projected assessment of IT budget as a function of both the information management budget and the number of information workers will provide the first indication as to whether your spending is increasing or decreasing year-on-year. Another extremely critical metric is the percentage of the total budget which is available for new applications and innovation. This so-called 'free money' is an indication of the contribution that IT can make to the competitive edge of the business. Innovative and successful companies report figures of between 20 and 30 per cent of total IT spend. The key to success is to reduce the maintenance and support costs by investing in software components so new systems that don't rapidly become the next 'legacy' can be developed and deployed. Component technologies such as Enterprise Java Beans, CORBA and COM+ all make the assumption that well written and tested components will have a long life and can be re-configured to support a variety of applications over time. Adoption of analytical tools and techniques for the management of IT has been slow. This has been due, in part, to the lack of interest in traditional accounting methods for intangible assets such Knowledge Capital and the reluctance of management to subject their contribution to the company's expenses to the same scrutiny as the cost of goods. Software is the tool by which we can compete in the global economy. Step one is to learn to manage our IT budgets more effectively and to ensure our investments in new systems are measured against tangible returns to the business. In this article we have introduced the first step in the assessment of IT spending. A full discussion of the topics discussed here can be found in Strassmann's definitive work 'The Squandered Computer' which is available at www.butlergroup.com.