Six rules for finding IT value
Paul Strassman has a relatively older article that has a rather frank discussion on finding value in IT projects. Given my interest in the enterprise application software, which could be classified as one gigantic IT project which has nothing much to do with IT, this article certainly had my antennae up.
Paul begins:
So far - to my best knowledge - nobody has been able to demonstrate that there is a positive correlation between money spent on IT and sustainable profits.
Alright, that's one swing from the bat but let's see if it is on target...
Sure there are articles about the positive contributions of IT. But the proof could be applied to justify greater IT spending as a sure cure for poor for poor financial numbers is still missing. The quest for demonstrating the directly measurable value of IT can be added to the list of fascinating but hitherto unfulfilled ambitions to attract academic fame or consulting contracts.
And quite importantly...
What is always missing is a repeatable technique for performing the calculations that would satisfy a firm's methods for making investment decisions
Alright, Paul is not denying that IT investments contribute/create value for the firm but that a direct measurement of that value created/contributed is so far lacking and when provided is not repeatable in other contexts. I would hazard a guess that demanding controlled repeatability in the real world is an idealistic requirement which is more to be found in the scientific world than the business world.
He continues:
Nevertheless, there are ways of finding IT value - it's just that they are all indirect.
He has outlined 6 key rules that might direct an investigator as to where to look for IT value:
Rule #1: Follow the money - The decisive contribution to an enterprise's profitability is its capacity to manage purchases. Ergo, that is where the contribution of IT should be maximized as that is where the greatest opportunities are - primarily in improving the management of the firm's purchases and in simplifying transaction costs. The relationship between purchasing, transaction costs and profits has not been adequately exploited.
According to Paul Strassmann, purchases account for 54%, transaction costs account for 23% and COGS (Cost of Goods Sold) account for 17% of corporate costs which together account for 94% of corporate costs.
Rule #2: Do not let accountants measure value - The greatest obstacle to the demonstration of IT value can be found in conventional accounting methods. Accounting practices deal exclusively with tangible assets, which explain only 20% of the shareholder worth of profitable firms.
I would tend to agree that the above is so true because while accounting measures a firm's assets, it should actually be in the practice of measuring value for internal reporting purposes and that is a request to deal with the intangibles of running a firm.The worth of the accumulated knowledge of employees, of software, of databases, of organizational capabilities, and of customer relationships does not show up on the general ledger, even though the worth of IT is best reflected in what it contributes to the capacity of people to deliver greater value to customers. Consequently, much of the potential of IT is lost when projects that would increase knowledge capital are said to contribute only to "intangible benefits."
I came across precisely this conundrum while consulting with a manufacturing firm and bringing in Quick Response Methodology in order to improve their manufacturing processes and specifically the lead times on the. The accounting specialist had the idea that the development of new processes and specifically new improved tooling, jigs and fixtures would mean lower manufacturing costs for the firm. I disagreed by pointing out to him that it would mean increased manufacturing and maintenance costs but would dramatically reduce the lead times that the firm was experiencing. That was a dead-end and we beat around the bush for close to an hour and I couldn't convince him. Of course, the problem was the accounting is about tangible assets - what exactly is the worth of reduced lead times - in some cases, we had projected lead time reductions of 60% or so by putting in QRM cells. On the ledger, reduced lead times equalled precisely zero value and increased maintenance costs accounted for net increase in costs.
Rule #3: Focus on shareholder's value - A shareholder perspective will reflect the reality of all financial decision making: you cannot determine the worth of past decisions without the benefit of perfect (and unbiased) hindsight. It follows then that it is not possible to state what share of profits today are attributable to IT decisions made in the past. Therefore, proving rigorously what is todays value of IT as a percentage of current profits cannot be known.
Paul's stress on shareholder value is rather enligtening and his method of comparison roughly breaks down as a comparison of the two branches of making a decision of a particular IT investment:
1. Calculated the discounted present value of cash (using shareholder's cost of capital) as if the firm was making not making the proposed IT investment
2. Calculate the discounted present value of cash as if the firm was making the proposed IT investment assuming some profit plan going forward
The difference of the two should give the value of deploying that particular IT project.
All you are left to do then, in the quest for valuation of IT, is to evaluate the best decision you can make at the time when you commit to a credible plan. The logic of such reasoning propels you to the most obvious conclusion: making no changes to IT as it is presently can be the only valid basis from which all other options can be assessed. If your budget inquisitors can accept such reasoning, you may be able to claim (and get away with it) that the value of IT can indeed be calculated using conventional methods of financial analysis.
Rule #4 - Commit to value after discounting for risks -
Here Paul suggests coming up with various scenarios that reflect the degree of risk and consequent expected payoffs in order to communicate to the various parties the impact that risks bear on the forecasted profit plan and the expected value derived from the investment under these conditions.
Are they [risks] technological (even though that is nowadays a rare occurrence)? How much of the risk is managerial (recognizing that this is the primary culprit in every failed IT venture)? The implicit purpose of early risk recognition is to initiate early risk-containment countermeasures. One of the principles of generating value is to focus not on winning - a compulsion of all technologists - but on making sure that you do not lose - a characteristic of all prudent investors.
Further more,
The benefit of any risk management approach to making IT investments will be to reduce the discount factor used in the calculation of the present worth from a high-risk to a lower-risk premium. This will allow shareholders to accept even seemingly risky IT proposals.
Rule #5 - Keep away from revenue ratios -
Here, I can only plead fuzziness (or ignorance). I can glean from Paul's illustrations and figures that revenue/employee ratios are a less reliable indicator of the effect that investments in IT have on generating additional revenues. Perhaps, one should take away from this suggestion that making revenue ratio comparisons across firms in similar industries or disparate industries is not such a great idea when it comes to comparing the value added by IT at these companies. However, I think that I will need to do some more research about this in order to be convinced. Or if somebody else were kind enough to guide me along...
Rule #6 - Justify the infrastructure -
Paul offers some helpful advice on how to present a well-reasoned case to justify IT investments and he elaborates on three steps that are necesary to demonstrate the value of investing in such IT infrastructure. They are:
1. Demonstrate ongoing cost reductions - Paul demonstrates this in his article by showing the discounted ROI made for IT projects
2. Demonstrate the effect that IT investments have on
operational effectiveness - Paul demonstrates this by alluding to the greater productivity/efficiencies that are gained by deploying IT in other functional areas such as Logistics, Planning etc
3. Demonstrate strategic gains - Paul demonstrates this by calculating the discounted ROI extracted from all the IT projects under consideration.
In conclusion, perusing this article was quite an eye-opener for me because it was instructive about how to make a reasoned case for justifying IT investments specifically in areas such as SCM. There are other articles by Paul Strassman at this
site and I'm sure that they will be worth your while to sift through.
Tags: IT Investment, Discounted Cash, IT value, IT Risk Management Paul Strassmann
Introduction to Supply Chain Council's SCOR Methodology
Paul Harmon of Business Process Trends has an oldish whitepaper on the Supply Chain Council's SCOR Methodology and how firms can go about systematically designing and implementing supply chain processes according to the SCOR methodology. The whitepaper is quite detailed and goes into every part of the SCOR methodology. What I would like to know is how well this process methodology has worked out in practice because my knowledge of the methodology is of one outside looking in. The most updated version of the SCOR process model can be obtained at the Supply Chain Council's website here.
Paul suggests that implementors think about their first SCOR project in terms of six phases as he outlines in his whitepaper:
0. Review Corporate Strategy. This isn't so much a project phase, as a decision to consider whether an existing supply chain can be improved.
Once this decision is taken, a team is set up, trained in the SCOR methodology if necessary, and set to work.
It is not only a committment by the firm to review its supply chain processes but the necessary definition of where the constraints are, where the emphasis ought to be, what variables are significant levers and what variables are not essential to competitive advantage etc. If one has developed the purpose of using one's supply chain as a competitive tool, the one must at the very outset outline how the firm envisions the structure of that competition. That's why this stage is crucial to the review of the SCOR process. An example would be wherein a firm has decided on a decentralized distribution strategy with DCs as close to the customer location as possible. From the follows directions for transportation management, warehouse management, supply and order management with respect to the manufacturing etc etc.
I. Define the Supply Chain Process. SCOR provides a common vocabulary and notation system for defining the major processes that make up supply chains. The first phase the team undertakes is the actual analysis of the existing process. This effort includes decisions about the number and scope
of the supply chain processes to be examined.
The key idea that any cross industry standards group such as the Supply Chain Council brings in is the establishment of standards. A corollary to this is that standards sacrifice innovation flexibility for conforming understanding across the industries adhering to the standard. In the case of SCM, which often spans several industries like warehousing, transportation, suppliers of numerous items across different industries, manufacturers, importers, exporters etc, such a standard is quite crucial because it brings disparate parties together and forces them to learn some bits and pieces of a new language. However, such a standard is only as good as the breadth of adoption and I don't think it has gone as far as it should so that using such a standard becomes essential.
If you were about to reengineer or design a process, then the logical second step is to ascertain what needs to be done - some might go for the low hanging fruit in order to demonstrate competence, some for the big change (in order to demonstrate bigness?? Or perhaps it might be an issue of survival) and still some others might go for something in the middle but crucial to getting it right.
Paul elucidates on how SCOR types all supply chain processes into the following five general sub-types:
Plan, Source, Make, Deliver, and Return. Complex supply chains are made up of multiple combinations of these basic processes.
The SCOR Process model that is captured in a process diagram gives a good idea of how a firm's entire supply chain can be mapped out in terms of the above general sub-types as well as process types (Level 1, Level 2 and Level 3).
II. Determine the Performance of the Existing Supply Chain. Once one has scoped the existing supply chain process, one can use historic data to
define how the existing supply chain is performing. In addition, one can compare the performance of your supply chain with benchmarks to determine how your process stacks up against similar processes in similar industries.
If you knew what you were doing, the next logical step is to know how well you're doing what it is that you're doing. So after understanding how the existing supply chain is structured, the question then becomes about measuring the performance of the current supply chain against which future changes will be measured i.e. creating a baseline.
SCOR defines five generic performance attributes and three levels of measures that the analysts can use.
The measures are numbered (m0, m1, m2 and m3) where
m0 - measure the performance of the organization as a whole (also designated as Internal Facing Measures)
m1 - measure the performance of the supply chain as a whole (aslo designated as Customer Facing Measures)
m2 - measures that are related to Level 2 processes
m3 - measures that are related to Level 2 sub-processes
This type of current performance data benchmarked against same industry competitors or cross-industry firms gives an idea of what the future state performance targets ought to be before rework of the supply chain processes can be started.
III. Establish Your Supply Chain Strategy, Goals and Priorities. Once one has hard data on the performance of your existing supply chain, and
benchmark data, one is in a position to consider if your supply chain strategy is reasonable, and how it might be improved. One can consider alternative
targets for improvement and determine how they might improve the company's performance. Similarly, once can identify which changes would
yield the highest return and priorities any improvement efforts.
Leading up to this point, each of the previous steps has been a lot of legwork, data gathering and analysis, explanation of standards that a firm might adopt etc. This has a two-fold benefit. The first being that the firm itself has a greater and broader understanding of its own supply chain (you might be surprised at how little understanding some firms have of their own processes) and the other being that a lot of data, diagrams and information about the firm has been generated that provides a fact base upon which further work can be carried out i.e. a rigorous numbers based foundation has been laid that can be investigated at a later date. Developing a SCORcard which ranks performance attributes vs competition in the current state and expected future state into three ranks - Superior, Advantage and Parity. This sort of ranking and analysis should ideally be in harmony with the roadmap that heads in the direction of sustained competitive advantage or that there are few key performance attributes that will be chosen as the attributes of focus which in turn should generate the desired competitive advantage. As Paul reports, there is a round trip to Phase 0 that might be beneficient to the firm that is undertaking a supply chain examination. This time round, the development of corporate strategy is in the light of a preliminary diagnosis and additional lab tests to boot. That makes any highly wishful and fanciful thinking hit the road so to speak and adjustments can be made i.e. closed loop feedback in action. The next step in this process is to determine which of the supply chain processes needs improvement or reengineering.
So far so good.IV. Redesign Your Supply Chain as Needed. SCOR provides a number of tools to help in redesigning a supply chain. It provides tools for identify
problems and gaps and suggests the best practices used by companies with superior supply chains. Tools are available to similar your redesign SCOR design so that you can be sure it will yield the results you have targeted.
Its time to get into the nitty gritty of Supply Chain redesign/improvement according to the SCOR model. From carrying out the previous phases, the areas for improvement should have already been identified. A number of time tested techniques have been provided by SCOR in order to improve the performance of supply chain processes which include lists of opportunities and transactions that often cause difficulty.
The redesign team may change its To-Be Thread diagram several times as it explores possibilities and studies the problem in more depth. The place to start, however, is with a tentative redesign.
For the Level 3 process that is under examination, the normal process is to consult the SCOR manual for a typical SCOR model for that process and compare what the firm does with the industry benchmark. The following is a highlight of what constitutes the generalized suggestions for best practices:
As a strong generalization, best practice suggestions can be subdivided into three general types. They can recommend new management practices. They can recommend new employee practices, or they can recommend the use of software applications or systems to automate an activity or to support the employees who perform the activity.
Paul also advises about the suitability of
simulation in such a context wherein changes made to a supply chain are tested within a simulation in order to check the validity of the redesign/improvement. Why?
In complex supply systems, its sometimes hard for humans to identify bottlenecks that are obvious once you run several large sets of data through a simulated model of the system. Simulation can take time and it requires developers who are familiar with the techniques required by the simulation tools, but if you are seeking to make millions of dollars of changes in a key supply chain system, spending two months and a hundred thousand dollars to be sure that your system will work as designed is well worth it.
V. Enable the Redesign and Implement. Once the design is complete, you must implement the redesign using software and human performance
improvement techniques. Then you must implement the new supply chain and gather data to determine if you are, in fact, meeting your new targets.
This goes to the control phase that is emphasised in Six Sigma methodology for continuous improvement that envisions that improved or new processes will need freezing, implementation and finally measurement to see whether targets are reached.
As can be seen from this extended look into the SCOR model for supply chain, there is a high degree of congruence with the
PDCA (Plan-Do-Check-Act) methodology for continuous improvement as well as the
DMAIC (Define-Measure-Analyze-Improve-Control) methodology of Six Sigma. There should be because they're about process improvement but in the case of Supply Chain, the SCOR model has adapted this general process improvement model into the SCM space as well as provided the best practices benchmark so that firm's following the methodology can be continually informed through a feedback loop. However, the SCOR model because of the focus on industry best practices and deriving improved/new processes from that creative pool of what has worked for others or what has worked well points a firm in a particular direction i.e. the direction that other firms in its competitive landscape are headed towards. Ergo, if there is an underlying philosophy that is driving the best firms in a particular industry (be it efficiency, velocity, flexibility etc) in a particular direction, how do you think copying that industry's best practice affects the firm that is redrawing its own processes - in the same direction? This is a serious problem, in my opinion, because I am interested in flexible supply chains over efficient supply chains. And this preference harkens back to the ways in which a firm may derive
sustained competitive advantage. Ask yourself where the source of true sustained competitive advantage is located? Then, ask how adopting process improvements that rely heavily on industry best practices delivers competitive advantage - are they sustainable or merely short term jumps, rapidly copied and thus lost advantages?
The SCOR model seems to be concerned (and rightly so) with execution of the supply chain through well analyzed and developed processes and stresses the steering of corporate strategy in Phase 0 step itself. I think that you're more likely to end up with a very efficient supply chain simply because at this time, there is a clamor about efficient supply chains but only murmurs (or perhaps, silence) about flexible supply chains. Perhaps, one of the factors that has contributed to this state of affairs is that Source/Make has shifted to more efficient means of production/procurement (read outsourcing) and that effect is rippling through the supply chains of many a firm.
So, what are flexible supply chains?
Coming soon to a blog post near you...Tags: SCOR, Supply Chain Council, Process Model, Supply Chain Management, Competitive Advantage
RFID ROI — Not what it seems
I was having a recent discussion over lunch with an executive from a specialty grocer out west who admittedly didn't know what the big hoopla was about RFID. The mother of all grocers and supermarketers is into it in a big way but he didn't know what the point of it was except maybe for pallet level or truckload level tagging. I suggested - maybe its volume throughout the entire supply chain that one surmises without accurate and up to date information, supply chain managers might feel quite out of the loop and without much control. Dr. Peter Harrop has an article RFID ROI - Not what it seems that makes several points. Here's a sampling:
Ask someone in the street about RFID and they may say it is tagging prisoners. However, those in the industry generally talk about putting labels on pallets and cases necessitated by the commendable commands of leading U.S. retailers, which see sales increase and costs decrease as a result of their suppliers doing such tagging.
However, he says, if you follow the money and not the talk:
However, if we look at the major spend and potential spend on RFID, we get a very different picture. The global spend on RFID labels for pallets and cases alone — mainly for Consumer Packaged Goods (CPG) companies — will be around $0.09 billion this year rising to no more than $1.75 billion in 2017, provided the collapse in prices is halted at five cents and users demand it all over the world.
And more:
Most RFID suppliers to the retail and consumer goods industry are losing money, particularly where pallets and cases are concerned. This often amounts to millions of dollars yearly and sometimes more. By contrast, most suppliers to other sectors are making money, providing a secure, enduring support for their customers. Despite this, retail/CPG will probably dominate the RFID market by sales value in ten years’ time.
A two tiered system seems to be developing - one that is centered around the CPG/Retail space which is where the mega bucks are and the other that is centered around niche areas such as pharmaceuticals and high cost parts etc. The break is typical where one part of the market is high volume which insists on lower costs of tags for greater implementation while the other part of the market is high costs of products involved which might needs tags who are not averse to paying a premium for functionality laden tags.
Another surprising insight comes from considering item level tagging compared to pallet/ case and other applications. ...Looking behind these figures we see that item level tagging hugely benefits consumer goods suppliers whereas pallet/case tagging does not. Savvy retailers such as Best Buy, Marks and Spencer in the UK, Boekhandels Groep in the Netherlands and Maruetsu in Japan have also seen how item level tagging is exceptionally beneficial for them as well, multiple paybacks being the norm. Airbus, Boeing and the pharmaceutical companies see the most to be gained from item level tagging.
And,
Legal push is driving drug and tire tagging, which also helps.
All that means that item level tagging is not only happening alongside or even before pallet/case tagging, it usually commands a higher price and sees most participants making satisfactory, sustainable returns.
So what is one to make of this?
FUZZY!! - Still fuzzy.
Taking a peek at mySAP (Transportation area)
This post is a continued peek into the capabilities of mySAP's solution space. Transportation is one of the specialty areas of the firm that I work for (GENCO) and so I am more than familiar with all aspects of the transportation area and it should be a whole lot of fun exploring the capabilities of mySAP in this area. So let's dive right in. There are three main areas in the Transportation solution space namely:
1. Transportation Planning
2. Transportation Execution
3. Freight Costing
Under Transportation Planning, there are five areas:
1. Collaborative Shipment Forecasting - Allows the firm to exchange/adjust forecast infomration between customers and carriers. Since forecasting really is the forward loop of the system, we should be observe a feedback loop (implicity or explicit) that should give back information to the firm and the other stakeholders about reality.
2. Load Consolidation - Any good TMS should have this feature because it is absolutely essential to realizing cost savings from transportation operations. mySAP comes with two options - one option is to carry out the consolidation yourself and the other is to allow the carriers to carry out the consolidation for which presumably you'd have to part with a portion of the savings so realized.
3. Mode and Route Optimization - Any good TMS should have this feature as well. What I would like to know is the internal workings of the Mode and route optimization algorithms, whether it relies on true optimization or some heuristic to achieve the mode and route optimized results. The other obvious question, given the high fuel prices and lack of carrier capacity, is whether this feature extends to the intermodal space or not.
4. Carrier Selection - Another important aspect of any TMS tool is to be able to assign and (and with the following feature of tendering) tender loads to carriers based on some business rules.
5. Collaborative Shipment Tendering - Most TMS come with this feature built in simply because it makes sense to do it. Either that or you'd have to be on the phone getting spot rates for lanes which is the least efficient way to tender large volumes of loads.
Under Transportation Execution, there are five areas:
1. Shipping - This option seems to be a souped up version of the Load Consolidation feature in order to move it from the Transportation planning to Transportation execution.
2. Collaborative Shipment Tendering - Repeated from Transportation planning area. I'm kinda getting ticked off with the repetition thing (not only because I might repeat myself needlessly but also because it inflates the number of features that a product advertises). Sure, it might not be possible to neatly categorize such a subject but that is a flaw in the presentation of the capabilities in neat little silos when such silo based differentiation is not the solution. C'mon SAP, you can do better...
3. Express Ship Interface - Deals with those orders that needs to be shipped out using the Parcel mode. However, I wonder what's driving the logic of whether to send a particular shipment by parcel or not - whether the different modes of Ground, Next Day, Second day etc can be selected/optimized based on delivery dates or priority etc.
4. Distance Determination Service - There are only two service providers for distances - PC Miler or Rand McNally, that are used in the industry and most firms that I have dealt with use PC Miler of some version or the other.
5. Transportation Visibility - Since visibility is a key desire for many firms especially given outsourcing and longer lead times for the products produced in cheap manufacturing locations, this is a feature provided for tracking the movement of an order either by road or by sea.
Under Freight Costing, there are 4 areas:
1. Freight Cost Calculation - An entire industry of freight pay and audit works around this particular topic and this functionality is going to make inroads into their revenue pie.
2. Freight Conditions - A database of freight rates and accessorials that are applied to orders to evaluate the freight costs
3. Freight Cost Settlement - Classic execution of freight pay conducted from within an ERP system so that there is end to end supply chain management.
4. Freight Costing Extensions - Adjustment of freight paid with customers or carriers based on some outlined business rules.
So is anything amiss? Not really. mySAP's transportation piece seems to have everything that I'd expect from a good TMS solution. The natural extensions that might be thought off from the current state are probably contract management with the transportation providers, integration of 3PLs as 3PLs and not as some virtual carrier to whom the loads are tendered, performance of the carriers as well as 3PLs, BI (Business Intelligence) from carrier performance that enables the identification of routes, modes and networks that could be leveraged for better carrier contracts. There is one component that will be of great value to an ERP provider such as mySAP that can leverage existing users through the internet and that is peer collaboration of transportation networks. And that can be entered into using an interface that mySAP could provide albeit for a small fee.
