Measuring the Productivity Impact of IT Investments: Changing the Way Companies Quantify Gains
Prepared for Microsoft by Knowledge@Wharton
Companies buy computers and invest in information technology because they believe those investments will improve their productivity. Clearly, in the manufacturing sector, a new computing technology might increase the number of bicycles or widgets produced in an hour. In other areas of the economy, however, the impact of IT expenditures on a company's productivity is far less clear — and harder to quantify.
That's changing. Firms have been able to measure IT expenses — from acquisitions to the maintenance of computer networks, security, and so on — without much ado. But they are now also finding ways to measure the value of IT expenditures through productivity metrics, among other measures. Not surprisingly, this involves a change in how companies think about their IT investments and the impact these investments have on their bottom line.
Two changes have been crucial. One is that decisions about IT expenditures are no longer being made in a vacuum, says Shafeen Charania, director of the business value division at Microsoft, which helps customers quantify the value to their enterprises of various technology solutions. Instead, IT investments are increasingly linked to a company's business goals. "To look at productivity effectively involves understanding a company's business goals and what makes the company in question successful," he says. The next step: solutions are mapped to support business objectives. The costs and benefits of the investment must then be quantified, along with the risk of implementation — the risk, in other words, that inadequate training, turf battles or other factors could compromise the productivity benefit. The result is a value analysis that describes in risk-adjusted cash-flow terms the business impact that can be achieved by implementing the solution.
Chip Hunter, a management professor at Wharton, agrees that a shift is evident in how IT investments are made. He notes that vendors are moving toward selling and delivering solutions that look at a company as an enterprise rather than focusing on departments as independent silos. They are also working with customers to converge on the right IT solutions. "Vendors used to sell you a box and maybe some training in how to use it," he says. "Now the trend is toward a more holistic consideration of how the technology is going to affect the organization and deliver on the firm's strategy."
A second critical change involves the definition of productivity. Technology used to improve productivity by making it possible to produce goods faster, better or cheaper. "In days past," says Charania, "productivity was a time-and-motion study: How many keystrokes did it take to do this or that?" The focus was on individual productivity. Now, says Donald Koscheka, a principal consultant at Microsoft, the emphasis is on organizational productivity. "If someone has a tool like a spreadsheet or a word processing program, what can I do to make that person an order of magnitude more productive when he is already typing as fast as he can?" he asks. "Only incremental productivity gains can be realized at that level." He maintains that real productivity gains, on the other hand, are generally the result of organizational improvements — "the things that happen between people" — and those typically haven't been measured.
But they can be. For example, Koscheka points out that the claims processing department of an insurance company can improve productivity by getting claims agents to increase the number of claims they process every day. But, he says, the real costs in processing claims lie in the reviews, approvals and transmission of information between insurance companies and law firms. Therefore an IT system that allows the frontline person to make decisions on behalf of the organization, and to resolve claims as quickly as possible, is better in the long run. Here's how it would work: an IT solution could create a window on a computer screen that indicates that any claim below, say, $2,000, and that doesn't involve bodily injury, can simply be paid. That's an organizational benefit, he notes, since in the past it took more than one person to make that decision. With such a system in place, the firm isn't just improving the productivity of one person but of the whole organization. Another benefit is that this type of system reduces litigation by paying claimants earlier and making them more satisfied with the process. The opportunity here is to utilize technology to affect organizational and business-process change.
Who Decides?
As companies think more seriously about the productivity gains that result from IT purchases, one issue that has been pushed front and center in this conversation is accountability. Making sure that IT investments pay off is increasingly seen as critical to the success of those investments.
Traditionally, the chief information officer (CIO) and the IT department have been responsible for making IT purchases. The reason was simple: they were the ones who knew the most about computers and computing technology. But merely acquiring (or building) the right technology is no longer sufficient. Companies must continue to examine each technology solution throughout its investment life cycle, thereby ensuring its proper implementation, its productive use, and its measurable results.
One change is that companies are subjecting the business cases for IT expenditures to the same criteria they apply to other capital expenditures. "The CIO now needs to justify that each investment has the same potential return as, say, building a new factory in Mexico City," Koscheka points out. In recent years, he adds, "the IT industry has been under pressure to keep up with the newest technologies, answering to many departments often without clear goals." The result: Technologies that didn't make smart business sense were sometimes implemented at significant costs. The more rigorous, business-case approach, however, helps CIOs and executives align their IT purchases with business goals to ensure a productive result.
For this kind of economic justification, many customers of information technology have been relying on vendors as well as third-party analysts and consultants. Forward-thinking vendors, seeing the real need for companies to assess the potential value of investments, have been addressing the task head-on by discussing the return on investment for new versions of software applications as well as larger IT purchases. "It isn't enough for me as a vendor to tell a customer that it should roll out an application or operating system with 10 new features," says Koscheka. "The customer should be asking, 'What's the return on investment for those features?'"
Expanded View
Not surprisingly, given the increasing impact of IT investments on a firm's ability to meet its business objectives, the job of the CIO has changed. CIOs no longer have a narrow, IT-centric mandate. While most used to have a purely technical background, those equipped with a broader range of expertise are now at a premium. Moreover, because technology can't simply be overlaid on old business processes, and because of the need for line managers to become more involved in decision-making, CIOs play a larger and more strategic role within firms. "Those with expertise in technology and in business units, who understand the business processes that may need to change, are in demand — but they are rare individuals," says Erik Brynjolfsson, a management professor at MIT who has focused on the impact of IT investments on firm-wide productivity.
Underlying this expanded role for the CIO is a broader shift in how IT decisions are made. CIOs are now frequently called upon to work directly with the CFO and CEO and to effectively present the business-case issues that executives are used to seeing. Decisions about computing technology can also no longer be made in isolation from the business units that will use the technology. "The CIO and the IT organization must work more closely with business people to understand the impact of technology," says Koscheka.
This sounds eminently practical — and easy. But the reality is often different. Koscheka recalls an afternoon a few months ago when he asked the 40 IT people at one company, gathered in a room, a simple question: How do you affect the productivity of the business people in your firm? The response, he recalls, was a sea of blank stares. "They viewed themselves as the people who kept the pipes running, and never correlated the fact that they had this network in the company to the fact that people might actually get business value from it," he says. "In too many companies, there's no connection between IT planning and business-value delivery. That's a gap that needs to be closed."
Another change is required as well. At the same time that IT departments must help those on the business desks meet their business objectives more effectively, the latter group must take responsibility for the IT tools they use.
Charania puts it another way: "Accountability for IT investments must be held on both sides of the house. Clearly the CIO and his organization are responsible for delivering a specific capability at a given service level--branch banking software, for instance, should meet the business functional specifications and run when retail bankers need it. By the same token, the retail bankers must be held accountable for increased revenue, or whatever metric is appropriate, because they have this new capability. If that is not in their objectives, then what chance does the IT investment have to succeed?" In essence, he says, companies should train their corporate eye on the business objectives they are trying to meet — and make sure the users know that they are just as accountable as the IT organization in meeting those objectives, and that each has a role to play in achieving success.
The Impulse to Quantify
In examining the shift in how firms view IT investments, it is worth looking back to consider the reasons behind the recent push to quantify productivity gains. What exactly prompted companies and vendors to focus on the benefits of technology and to try to quantify productivity gains?
There are a few different — but related — explanations. There has been a lot of pressure on companies to make IT investments for 15 years now, but the focus on productivity gains has been recent, notes Hunter, the Wharton professor. He offers a pair of explanations. First, he says, almost all firms have been burned at one time or another by unsatisfactory IT solutions. They were sold a system or implemented a system that didn't deliver the goods, or the system worked as it was designed to work and the company saw the savings, but it cost them in other ways that hadn't been anticipated. "A bank, for example, may have put in a whizzy new call center with cool software, migrated customers over and saved a lot of money — and then lost all its customers because the customers didn't like the interface," he says.
Second, he adds, people know that systems are never as cheap as they first appear. Technology investments may look good, but they must be maintained, and that's often costlier than expected. Both of these factors prompted companies to examine more diligently the potential costs of IT expenditures — and, ultimately, to begin calculating the potential benefits and overall value of those expenditures. The idea behind this was logical: If the costs couldn't be easily gauged, it stood to reason that the benefits would also be difficult to pin down — but it would be very much worth the effort to identify and measure them. In addition, once the potential benefits were parsed and better understood, it would be easier to align them with a company's business objectives.
Adding another explanation, Microsoft's Koscheka notes that 1996 was the year companies sat up and began to measure productivity resulting from IT investments. Until that year, he says, they saw information technology more as simply valuable in itself rather than as a means to add value by improving productivity. People knew computers had an impact on a company, but they could not quantify it — and they did not need to. But in early 1996, the analyst firm Gartner Group (now Gartner, Inc.) issued a paper called "Total Cost of Ownership," which demonstrated that a firm's cost of owning a networked PC was close to $12,000 per user per year. All of a sudden, says Koscheka, customers wanted to know what they were getting for their money.
Organizational Benefits
Whatever prompted this desire to quantify IT investments, the biggest challenge for technology vendors was to revisit old ideas about productivity and come up with new ways of measuring the advantages of IT purchases. A critical realization, Koscheka says, was the recognition that emphasis on individual productivity had to give way to organizational productivity, which in turn needed to concentrate on the higher-level value a company might realize, including the "soft" or intangible benefits of technology. Giving salespeople in a company a laptop that reduces their workload by 10 hours per week, for instance, might enable the company to shrink its turnover rate and improve the morale of its employees. And that can be quantified — the cost of hiring someone to replace an employee, the cost of training, and the loss to sales productivity while the new person is in training. As long as firms could identify a metric to assess the result of a technological solution, technology could be confidently rolled out to tackle an inefficiency or a thorny problem.
This wider view of productivity is becoming more popular — and is supported by new research from academia. A handful of academics conducting studies and research into IT and productivity issues in large American firms have found that the benefits of IT purchases aren't nearly as shallow as Gartner and other studies found. On the contrary, says MIT's Brynjolfsson, computerization and IT purchases have a large and often cumulative effect on overall productivity within companies that extends far beyond simple TCO measures.
Brynjolfsson and Wharton's Lorin M. Hitt, a professor of operations and information management, spent much of the 1990s researching the impact of computerization and IT expenditures on companies' productivity. According to Brynjolfsson, the benefits had typically been rendered invisible for a number of reasons. For many years, particularly in the 1970s and 1980s, firms took a long time to figure out how to set up their organizations to benefit from new technologies. In addition, the productivity gains of computerization were routinely underestimated because macroeconomic measurements were not up to the task of identifying and quantifying them. And finally, many of the benefits were intangible and therefore inherently difficult to measure.
In one paper, "Computing Productivity: Firm-Level Evidence" (October 2001), for example, Brynjolfsson and Hitt analyzed the relationship between the growth of computer spending and the growth of output at the firm level in more than 500 large U.S. firms from 1987-1994. They found that while computerization improves productivity in companies in the short term, the "productivity and output contributions associated with computerization are up to five times greater over long periods" such as five to seven years. Their research also found that the benefits of IT investments are "amplified by relatively large and time-consuming investments in complementary inputs," which include software development, training and organizational changes. In effect, the more money firms spend on making structural changes within a company to take advantage of new technologies and new ways of conducting business — and to better equip employees to use the technologies more effectively — the greater the long-term rewards. These benefits, assert the two professors, have tended to be buried or left unexplored in many other studies.
Looking forward, it is clear that IT expenditures will increasingly come under the microscope in corporate boardrooms and in management meetings — as they should. At the same time, more and more companies should be able to give IT investments a fair reckoning, since new models are providing the ability to identify and enumerate more of the complex benefits of these investments, in addition to the costs.
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