Tags

, , , , , , , , , ,

IT organizations with focus on cost reduction are generally less cost efficient than those focusing on business value creation

 A year ago, an IT organization was forced to reduce cost levels and become more cost efficient.  Expensive consultants were called in to identify cost reduction opportunities. Vendor contracts were to be re-negotiated, further outsourcing to India was discussed with more expensive consultants, lean programs were started, staff count was reviewed and even cheaper stationary and employee office tools were considered. Projects were postponed and recruitments cancelled. The key question was – what was essentially needed to meet the SLAs of their critical systems. Senior managers had to commit to the cost savings in their budgets with great frustration.

The scenario is quite common for many IT organizations. Today many IT organizations are pressured by CFO/CEO to cut cost and at the same time deliver higher value to the enterprise (more for less) – which can be seen as an impossible task. Are the expectations too high and unreasonable? Let us examine the case if the demand is reasonable, and how to react to that demand in a successful way.

Let us start from the beginning. An organization can deliver value with one of three distinct strategies.

  • Operational Excellence: system and process driven strategy (production strategy) with an aim of producing low cost products and services at reasonable quality.
  • Customer Intimacy: knowledge driven strategy (marketing strategy) with an aim to optimize business value and loyalty by understanding and adjusting to customer needs.
  • Product Leadership: innovation driven strategy  (innovation strategy) with an aim to develop new products and services that customer will need in the future.

IT has traditionally adopted an Operational Excellence strategy. Meaning that IT services are developed with focus on low cost and risk (with decent quality – meeting agreed SLAs) through outsourcing, leanification, standardization and implementing best practice frameworks. The governance structure is based on planning and controlling to ensure high cost control. Managers are rewarded to keeping cost limits and delivering on time.

When IT organizations with an Operational Excellence culture face cost reduction demand, they generally intensify their Operational Excellence approach. More outsourcing, more lean units, and more plans and controls. Internal efficiency and cost levels are the key performance metrics in an “inside out” approach. This is quite natural. But many activities to reduce cost are very costly, take long time and targets are seldom achieved. The probability of actually achieving the cost reduction is not very high. A more sever problem is that business value is reduced with every initiative to reduce cost.

An increased pressure from digitalization and unpredictability in the business environment have forced IT organizations to adapt a Customer Intimacy strategy. IT governance, based on Agile IT Performance Management, need to constantly be updated and adjusted based on business requirements using agile methods to supply the right services at the right time. Knowledge and understanding of business, performance management and change capacity are the key assets in this approach. Performance metrics are measuring business impact of IT behavior in this “outside in” approach.

The Customer Intimacy IT organization has a different approach to cost reduction than Operational Excellence IT organizations. Cost reduction is not a surprise to the organization because the demand has been foreseen and just another trend to deal through prioritization. The whole IT organization is quickly aligned to the new objective. It is not a big deal.

The highly regarded research company Gartner comes to surprising conclusions when reviewing the performance of the two IT strategies (Operational Excellence and Customer Intimacy). In fact, enterprises with an IT organizations focusing on Customer Intimacy (performers) have higher performance than enterprises with IT organizations focusing on Operational Excellence (followers).

  • Higher profit growth
  • Higher Return on Equity (RoE)
  • Higher business value and customer satisfaction
  • Higher cost efficiency

The last statement is surprising as one would assume that IT organizations focusing on Operational Excellence is more cost efficient than others. It is in the nature of that strategy. How can that be?

My point of view is that the main pre-requisite for Operational Excellence to work is high investments to achieve cost efficiency over long and stable time. When Volvo produce cars, then they invest heavily in infrastructure, machinery, processes, and competence in a production chain that will produce standardized cars (low variation) over long time. Any change is costly. Economics of scale is key. Lean philosophy (Toyota way) is used to reduce cost even further by eliminating unnecessary activities and cost – to keep it simple.

The problem is that IT is working in an unpredictable environment and is constantly affected by new business requirements, technology trends and change. This is far from the ideal situation for an Operational Excellence strategy. There is not enough time and stability to turn high investments into productivity gains and cost efficiency. IT organizations are stuck with the perception that Operational Excellence will reduce cost for IT but the reality is different. The result is often low cost efficiency – and limited business value.

IT organizations with focus on cost reduction are generally less cost efficient than those focusing on business value creation

 My view is not that Operational Excellence should be ignored, but rather that it is necessary to understand the problems with such strategy in today’s IT environment. The primary focus should be Customer Intimacy to drive revenue growth and customer value, and a secondary focus on Operational Excellence to ensure stability, and efficiency processes and infrastructure.

Recommendation:

  • Next time the CEO/CFO issues an IT cost reduction program, focus on creating a Customer Intimacy strategy driven by an agile performance management structure. It is more likely that you will achieve cost efficiency with this approach than re-negotiating vendor contract.

The key question was whether it was possible to achieve both cost efficiency and increased business value. Yes, it is possible – but not through Operational Excellence. Outsourcing, review of vendor contracts, and leanification/standardization will not solve the problem – even though it has been the approach of many IT organizations. Approximately 50% of CIOs use this approach with limited success and frustration of CEO/CFO. Soon they will be replaced by a new CIO how understand how Customer Intimacy and Agile IT Performance Management works. Using IT in a smarter way. Then the CFO/CEO will be happy with IT’s performance (cost efficiency, revenue growth and business/customer value).

Hans Legend 1