IT Value Metrics: How to Communicate ROI to the Business

CIOs are always faced with pressure to justify their IT expenditures. Now, new research can help correlate those IT dollars spent with business value accrued.

1 2 3 4 5 Page 4
Page 4 of 5

New Math: The Practice

Benchmarking yourself against previous investments and the investments of your peers is nothing new. But historically, the available data was hard to use for anything more than the highest-level comparisons. “Even then, the benchmarks were pretty worthless,” says Merrill Lynch’s Noble. And the data was insufficiently detailed to allow companies to compare specific aspects of their IT spending versus that of other companies. “There was a danger of comparing apples to oranges,” Noble says.

But Noble believes that Rubin’s two decades of benchmarking has created a database for the financial services sector that allows finer grained comparisons, a key step to understanding real trends over time and distinctions between competitors.

Rubin’s own analysis of IT spending compared to a company’s financial performance made him question the traditional measure of IT ROI, typically arrived at by dividing the IT spend into net revenue. The assumption behind that measurement was that net revenue should rise proportionally to the IT spend. Consequently, if revenue did not rise with a higher spend, the investment should be adjusted accordingly. Or more simply, the IT spend should be limited to a set percentage of net revenue. But such a calculation, in Rubin’s view, ignores periods of investment and market change, which is why he suspects it hasn’t correlated well with business results.

Rubin therefore began experimenting with other calculations and found that IT spending as a measure of business success correlated much better to another factor: operating expenses. He believes that comparing the IT spend to operating expenses better accounts for shifts in corporate realities: entering new markets, making previously deferred upgrades to the IT infrastructure and other capital improvements to competitiveness and efficiency, not to mention reacting to market shifts. While Rubin can’t prove that this is the reason for the better correlation to business results that he derived from comparing IT spending to operating expenses rather than net revenue, the prima facie evidence comes from calculations across hundreds of companies in more than a dozen industries. So for companies looking for a yardstick to measure normalized IT spending trends over time, Rubin says his metric does a better job, especially because it employs two factors a business can control: operating expenses and IT spending. But enterprises still need to track the IT spend against net revenue, Rubin notes, even though revenue is, ultimately, not something anyone can control. “You don’t want to spend money you don’t have, so you have to be aware of that figure,” he says.

IT Intensity: How to Find the Sweet Spot

Further research showed Rubin that comparing IT spending to operating expense in order to measure IT’s impact on business performance was not the answer to determining whether the right amount of money was being invested in technology. It turns out that calculating the relationship between the IT spend as a percentage of operating expenses and the spend as a percentage of net revenue is what a CIO needs to do to arrive at an optimal IT investment for his business. Rubin believes this is true because the triangulation that occurs when these two calculations are used can better account for the interplay between IT investment (operational expenses) and fiscal reality (net revenue) and thereby provides a dynamic measurement for an intrinsically dynamic environment. This helps the CIO make sufficient investments when the revenue is there but throttle back when it isn’t—while alerting management to the fact that the situation is, indeed, dynamic. The downshifting on investment can then be understood as temporary so as not to threaten future profits.

That triangulation led to Rubin’s IT intensity concept, which is that there is a sweet spot for technology spending. For most enterprises, that means spending more as both a percentage of operating expenses and of net revenue than they are now doing. “The objective analysis shows that spending wisely and applying IT intensity analysis can get you more return,” says Gartner’s Howe.

But the research does not mean the sky’s the limit. Rubin’s calculations show that technology investments hit a saturation point after which no further business value is obtained. For example, he found no examples of any type of financial institution outperforming its peers by spending more than 14.1 percent of operating expenses on technology—essentially demonstrating that for banks there’s a ceiling for IT investments. For the subcategory of investment banks, that ceiling was 13.1 percent. For spending as a percentage of net revenue, the figures were 9.1 and 8.2 percent.

Rubin has created IT intensity charts for more than a dozen industries based on historical IT spending and their financial results. All show the same basic IT intensity curve and the sweet spot at its apex, although the curve itself differs from industry to industry. That makes sense, says Gartner’s Howe, because business models and degree of dependence on IT to deliver business functions vary across industries.

There are also variances within industries. This means that you can’t just pick the IT intensity curve for your industry and automatically align your spending to it, Howe says. “People don’t spend their dollars equally wisely,” he explains.

But the pattern holds despite these variances because the variables to factor in—labor rates, multiplicity of platforms, geographic dispersion and market volatility, for example—are still finite.

1 2 3 4 5 Page 4
Page 4 of 5
Discover what your peers are reading. Sign up for our FREE email newsletters today!