The Inherent Efficiency of Growth
May 27, 2007 10:15 Filed in:
Technology 3.0
topic Business 3.0
What's the best way to create a more efficient IT organization?
- Implement ITIL?
- Outsource?
- Better align IT goals with business strategy?
- Integrate enterprise processes using web services?
- Focus on growing the skills of your resource pool.
What if there was a better way to provide more services per dollar, one that had nothing to do with your ability to execute as an organization? I am talking about business growth, and the impact running an IT organization at a belt tightening Gap (Limited Brands) vs, heading a similar organization at a rapidly growing Nordstrom.
My analysis provides a surprising and very disheartening result if you are CIO at a company with weak or negative growth. IT departments in growth companies have a significant cost advantage.
Thus if you are right now heads down figuring out how to give your low growth company a cost advantage so it can ... "catch-up" with the industry leaders, you might want to read this article, ... because your job just got a bit tougher.
While attending a CIO Summit in
Redmond last month, I listened as a noted author from MIT explained
the efficiencies of IT organizations at successful companies such
as WalMart and FedEx. He outlined four different types of
organizations and explained how two types were able to deliver more
services per dollar than their competitors. His not entirely
unexpected conclusion was that the success and efficiency of these
organizations at supporting the business strategy of their
companies was primarily a result of their leadership picking a
strategy in the proper quadrant.
I too believe that a well led, mature IT organization will be more successful (i.e. will be able to deliver more business essential services per dollar) than a less well run organization with weaker governance, technology service processes, and/or resource skill. But is success all attributable to leadership and strategy?
I've noticed that there are very few "unsuccessful" IT organizations leading companies, i.e. quickly growing companies at the top of their industry. If you think about it, that is rather odd. Which IT organization is more likely to get lax in their governance procedures, a department with an ever increasing budget or one that has to cut costs year after year? Which is more likely to innovate? ... a CIO who has a budget large enough that he doesn't have to fix what isn't broken, or a CIO that has to choose between people cuts, service costs or better way of doing things?
But IT organizations at growth companies are more efficient. Indeed, at this same event in Redmond, the CIO of the big software company showed in Excel no less, that year after year, his IT organization had become more efficient ... even though his total budget was constantly growing. I sat next to another CIO from a midsize telecommunications firm who watched his presentation with great interest. Here she was always finding herself one step behind, keeping the company running while dramatically cutting absolute costs year after year, yet finding at the end of each year that the new lower number of customers and employees meant her net efficiency was even lower. Obviously, this man who could retire early to his Zune each day while she pondered the potential dollar savings of Dell + Linux, knew something she did not.
That scene lead me to ask the question, "Is there an inherant efficiency in working in a growth company?"
I immediately began to think that this might be so.
I first considered the higher utilization of Software licenses and recalled a particular Enterprise Resource Planning (ERP) system purchase six years ago. When closing that deal, I had asked for additional licenses at no cost (30% more) which had been kindly obliged. My firm was growing rapidly via M&A at the time, so I know the licenses might come in handy. FYI, I also knew that it was always cheapest to negotiate future ERP licenses as part of the first deal. In supplier relationships (like other relationships) it's best to put all your needs on the table before you tie the contractual knot.
Continuing with the example above, if I assume that the initial ERP license & implementation consulting purchase for 2,000 users was consistant with market, then supporting 2,600 users with the same solution would take my net ERP costs per employee well beneath market. I would be more efficient than my peers. Conversely, if I supported only 1,700 users with the same solution, then the cost per employee would be well higher and I would be less efficient than my peers.
Here's the math for my not so hypothetical scenario:
Base ERP System Cost
Assume license, systems and implementation was $1M USD. Annual maintenance averaged $180K. I will exclude depreciation and amortization as the other numbers well illustrate the point.
Cost per user would have been $1,000,000 USD divided by 2000 users or $500 USD. Annual mainenance per user using a similar calculation would be $90.
Growth Scenario
Assume over four years, the company grows at a rapid 9% pace and the number of users rises to 2,600
Cost per user would fall 23% to $385 USD and Annual Maintenance would similarly drop to $69 USD.
Reduction Scenario
Finally, assume over the same four years, the company's growth strategy had failed and instead of growing, company output fell 5% annually and users dropped to 1,700
Cost per user would increase 18% to $588 USD and annual maint would similarly increase to $106 per user.
You might be thinking that the CIO could have aggressively reduced maintenance, reducing the number of licenses each year as the company constricted. Unfortunately, this rarely happens in the real world for several reasons:
A Better Analysis
I spent a weekend working on a more realistic scenario. I wanted to know what would happen to the efficiency of an entire IT organization if you were able to place it into:
To make the scenario work, I had to assume that even the same IT organization would adapt differently when placed in very different situations, I assumed each would change its processes and staff as necessary to adapt to the changing needs of the business.
continued ....
I too believe that a well led, mature IT organization will be more successful (i.e. will be able to deliver more business essential services per dollar) than a less well run organization with weaker governance, technology service processes, and/or resource skill. But is success all attributable to leadership and strategy?
I've noticed that there are very few "unsuccessful" IT organizations leading companies, i.e. quickly growing companies at the top of their industry. If you think about it, that is rather odd. Which IT organization is more likely to get lax in their governance procedures, a department with an ever increasing budget or one that has to cut costs year after year? Which is more likely to innovate? ... a CIO who has a budget large enough that he doesn't have to fix what isn't broken, or a CIO that has to choose between people cuts, service costs or better way of doing things?
But IT organizations at growth companies are more efficient. Indeed, at this same event in Redmond, the CIO of the big software company showed in Excel no less, that year after year, his IT organization had become more efficient ... even though his total budget was constantly growing. I sat next to another CIO from a midsize telecommunications firm who watched his presentation with great interest. Here she was always finding herself one step behind, keeping the company running while dramatically cutting absolute costs year after year, yet finding at the end of each year that the new lower number of customers and employees meant her net efficiency was even lower. Obviously, this man who could retire early to his Zune each day while she pondered the potential dollar savings of Dell + Linux, knew something she did not.
That scene lead me to ask the question, "Is there an inherant efficiency in working in a growth company?"
I immediately began to think that this might be so.
I first considered the higher utilization of Software licenses and recalled a particular Enterprise Resource Planning (ERP) system purchase six years ago. When closing that deal, I had asked for additional licenses at no cost (30% more) which had been kindly obliged. My firm was growing rapidly via M&A at the time, so I know the licenses might come in handy. FYI, I also knew that it was always cheapest to negotiate future ERP licenses as part of the first deal. In supplier relationships (like other relationships) it's best to put all your needs on the table before you tie the contractual knot.
Continuing with the example above, if I assume that the initial ERP license & implementation consulting purchase for 2,000 users was consistant with market, then supporting 2,600 users with the same solution would take my net ERP costs per employee well beneath market. I would be more efficient than my peers. Conversely, if I supported only 1,700 users with the same solution, then the cost per employee would be well higher and I would be less efficient than my peers.
Here's the math for my not so hypothetical scenario:
Base ERP System Cost
Assume license, systems and implementation was $1M USD. Annual maintenance averaged $180K. I will exclude depreciation and amortization as the other numbers well illustrate the point.
Cost per user would have been $1,000,000 USD divided by 2000 users or $500 USD. Annual mainenance per user using a similar calculation would be $90.
Growth Scenario
Assume over four years, the company grows at a rapid 9% pace and the number of users rises to 2,600
Cost per user would fall 23% to $385 USD and Annual Maintenance would similarly drop to $69 USD.
Reduction Scenario
Finally, assume over the same four years, the company's growth strategy had failed and instead of growing, company output fell 5% annually and users dropped to 1,700
Cost per user would increase 18% to $588 USD and annual maint would similarly increase to $106 per user.
You might be thinking that the CIO could have aggressively reduced maintenance, reducing the number of licenses each year as the company constricted. Unfortunately, this rarely happens in the real world for several reasons:
- You incur risk when you reduce licenses under maintenance. This is because if you later need more licenses, the return to maintenance will possibly cost more than what you saved when going off maintenance. Software maintenance contracts wouldn't be profitable if Customers could pay maintenance only when they needed it. As a result software companies engineer severe penalties into maintenance contracts that kick-in when products are taken off and restored to maintenance. For example, if in the example above you reduced maintained licenses to 1,800 after the fourth year and then two years later needed to add 50 licenses, you would have to pay a "catch-up" penalty that includes missed maintenance for two years and an additional fee similar to the now current "retail" price of 50 near licenses.
- Companies rarely accurately forecast reduced output or reduced size
- Reducing the count of licenses under maintenance does not necessarily reduce your maintenance bill. Unless you have specifically negotiated options for reduced maintenance as part of your initial contract, you might find that the quoted price for fewer licenses is not much smaller than the higher quantity original price.
A Better Analysis
I spent a weekend working on a more realistic scenario. I wanted to know what would happen to the efficiency of an entire IT organization if you were able to place it into:
- a company with regular growth over four years,
- a company with flat growth and
- a company that retrenches over the same period.
To make the scenario work, I had to assume that even the same IT organization would adapt differently when placed in very different situations, I assumed each would change its processes and staff as necessary to adapt to the changing needs of the business.
continued ....
|