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C h a p t e r

2 Developing IT Strategy for Business Value1

1 This chapter is based on the authors’ previously published article, Smith, H. A., J. D. McKeen, and S. Singh. “Developing IT Strategy for Business Value.” Journal of Information Technology Management XVIII, no. 1 (June 2007): 49–58. Reproduced by permission of the Association of Management.

Suddenly, it seems, executives are “getting” the strategic potential of IT. Instead of being relegated to the back rooms of the enterprise, IT is now being invited to the boardrooms and is being expected to play a leading role in delivering top- line value and business transformation (Korsten 2011; Luftman and Zadeh 2011; Peslak 2012). Thus, it can no longer be assumed that business strategy will naturally drive IT strategy, as has traditionally been the case. Instead, different approaches to strategy development are now possible and sometimes desirable. For example, the capabilities of new technologies could shape the strategic direction of a firm (e.g., mobile, social media, big data). IT could enable new competencies that would then make new busi- ness strategies possible (e.g., location-based advertising). New options for governance using IT could also change how a company works with other firms (think Wal-Mart or Netflix). Today new technologies coevolve with new business strategies and new behaviors and structures (see Figure 2.1). However, whichever way it is developed, if IT is to deliver business value, IT strategy must always be closely linked with sound business strategy.

Ideally, therefore, business and IT strategies should complement and support each other relative to the business environment. Strategy development should be a two-way process between the business and IT. Yet unfortunately, poor alignment between them remains a perennial problem (Frohman 1982; Luftman and Zadeh 2011; McKeen and Smith 1996; Rivard et al. 2004). Research has already identified many organizational challenges to effective strategic alignment. For example, if their strategy-development processes are not compatible (e.g., if they take place at different times or involve differ- ent levels of the business), it is unlikely that the business and IT will be working toward the same goals at the same time (Frohman 1982). Aligning with individual business units can lead to initiatives that suboptimize the effectiveness of corporate strategies (McKeen and Smith 1996). Strategy implementation must also be carefully aligned to

16 Section I • Delivering Value with IT

ensure the integration of business and IT efforts (Smith and McKeen 2010). Finally, com- panies often try to address too many priorities, leading to an inadequate focus on key strategic goals (Weiss and Thorogood 2011).

However, strategic alignment is only one problem facing IT managers when they develop IT strategy. With IT becoming so much more central to the development and delivery of business strategy, much more attention is now being paid to strategy devel- opment than in the past. What businesses want to accomplish with their IT and how IT shapes its own delivery strategy are increasingly vital to the success of an enterprise. This chapter explores how organizations are working to improve IT strategy develop- ment and its relationship with business strategy. It looks first at how our understanding of business and IT strategies has changed over time and at the forces that will drive even further changes in the future. Then it discusses some critical success factors for IT strategy development about which there is general consensus. Next it looks at the dif- ferent dimensions of the strategic use of IT that IT management must address. Finally, it examines how some organizations are beginning to evolve a more formal IT strategy- development process and some of the challenges they are facing in doing so.

Business and iT sTraTegies: PasT, PresenT, and FuTure

At the highest level, a strategy is an approach to doing business (Gebauer 1997). Traditionally, a competitive business strategy has involved performing different activi- ties from competitors or performing similar activities in different ways (Porter 1996). Ideally, these activities were difficult or expensive for others to copy and, therefore, resulted in a long-term competitive advantage (Gebauer 1997). They enabled firms to charge a premium for their products and services.

Until recently, the job of an IT function was to understand the business’s strategy and figure out a plan to support it. However, all too often IT’s strategic contribution was inhibited by IT managers’ limited understanding of business strategy and by busi- ness managers’ poor understanding of IT’s potential. Therefore, most formal IT plans were focused on the more tactical and tangible line of business needs or opportunities

New Capabilities

New Behaviors & Structures

N ew

T ec

hn ol

og

y

New Strate gie

s

Figure 2.1 Business and IT Strategies Co-evolve to Create New Capabilities

Chapter 2 • Developing IT Strategy for Business Value 17

for operational integration rather than on supporting enterprise strategy (Burgelman and Doz 2001). And projects were selected largely on their abilities to affect the short- term bottom line rather than on delivering top-line business value. “In the past IT had to be a strategic incubator because businesspeople simply didn’t recognize the potential of technology,” said a member of the focus group.

As a result, instead of looking for ways to be different, in the past much business strategy became a relentless race to compete on efficiencies with IT as the primary means of doing so (Hitt et al. 1998; Porter 1996). In many industries, companies’ improved information-processing capabilities have been used to drive down transaction costs to near zero, threatening traditional value propositions and shaving profit margins. This is leading to considerable disruption as business models (i.e., the way companies add value) are under attack by new, technology-enabled approaches to delivering products and services (e.g., the music industry, bookselling). Therefore:

Strategists [have to] honestly face the many weaknesses inherent in [the] industrial-age ways of doing things. They [must] redesign, build upon and reconfig- ure their components to radically transform the value proposition. (Tapscott 1996)

Such new business strategies are inconceivable without the use of IT. Other factors, also facilitated by IT, are further influencing the relationship between the business and IT strategy. Increasingly, globalization is altering the economic playing field. As countries and companies become more deeply interrelated, instability is amplified. Instead of being generals plotting out a structured campaign, business leaders are now more likely to be participating in guerilla warfare (Eisenhardt 2002; Friedman 2005). Flexibility, speed, and innovation are, therefore, becoming the watchwords of competi- tion and must be incorporated into any business or IT strategy–development process.

These conditions have dramatically elevated the business’s attention to the value of IT strategy (Korsten 2011; Weiss and Thorogood 2011). As a result, business executives recognize that it was a mistake to consider technology projects to be solely the responsibility of IT. There is, thus, a much greater understanding that business executives have to take leadership in making technology investments in ways that will shape and/or complement business strategy. There is also recognition at the top of most organizations that problems with IT strategy implementation are largely the fault of leaders who “failed to realize that adopting … systems posed a business—not just a technological—challenge” and didn’t take responsibility for the organizational and process changes that would deliver business value (Ross and Beath 2002).

Changing value models and the development of integrated, cross-functional systems have elevated the importance of both a corporate strategy and a technology strategy that crosses traditional lines of business. Many participants remarked that their executive teams at last understand the potential of IT to affect the top line. “IT recently added some new distribution channels, and our business has just exploded,” stated one manager. Others are finding that there is a much greater emphasis on IT’s ability to grow revenues, and this is being reflected in how IT budgets are allocated and projects prioritized. “Our executives have finally recognized that business strategy is not only enabled by IT, but that it can provide new business opportunities as well,” said another manager. This is reflected in the changing position of the CIO in many organizations over the past decade. “Today our CIO sits on the executive team and takes part in all

18 Section I • Delivering Value with IT

business strategy discussions because IT has credibility,” said a group member. “Our executives now want to work closely with IT and understand the implications of tech- nology decisions,” said another. “It’s not the same as it was even five years ago.” Now CIOs are valued for their insight into business opportunities, their perspective across the entire organization, and their ability to take the long view (Korsten 2011).

However, this does not mean that organizations have become good at developing strategy or at effectively integrating business and IT strategies. “There are many incon- sistencies and problems with strategy development,” said a participant. Organizations have to develop new strategy-making capabilities to cope in the future competitive environment. This will mean changing their current top–down method of developing and implementing strategy. If there’s one thing leading academics agree on, it’s that future strategy development will have to become a more dynamic and continuous pro- cess (Casadesus and Ricart 2011; Eisenhardt 2002; Kanter 2002; Prahalad and Krishnan 2002; Quinn 2002; Weill et al. 2002). Instead of business strategy being a well-crafted plan of action for the next three to five years, from which IT can devise an appropri- ate and supportive technology strategy, business strategy must become more and more evolutionary and interactive with IT. IT strategy development must, therefore, become more dynamic itself and focused on developing strategic capabilities that will support a variety of changing business objectives. In the future, managers will not align business strategy and IT at particular points in time but will participate in an organic process that will address the need to continually evolve IT and business plans in concert with each other (Casadesus and Ricart 2011).

Four CriTiCal suCCess FaCTors

Each focus group member had a different approach to developing IT strategy, but there was general agreement that four factors had to be in place for strategy development to be effective.

1. Revisit your business model. The worlds of business and IT have traditionally been isolated from each other, leading to misaligned and sometimes conflicting strategies. Although there is now a greater willingness among business manag- ers to understand the implications of technology in their world, it is still IT that must translate their ideas and concepts into business language. “IT must absolutely understand and focus on the business,” said a participant.

Similarly, it is essential that all managers thoroughly understand how their business as a whole works. Although this sounds like a truism, almost any IT man- ager can tell “war stories” of business managers who have very different visions of what they think their enterprise should look like. Business models and strate- gies are often confused with each other (Osterwalder and Pigneur 2010). A business model explains how the different pieces of a business fit together. It ensures that everyone in an organization is focused on the kind of value a company wants to create. Only when the business model is clear can strategies be developed to articu- late how a company will deliver that value in a unique way that others cannot easily duplicate (Osterwalder and Pigneur 2010).

2. Have strategic themes. IT strategy used to be about individual projects. Now it is about carefully crafted programs that focus on developing specific business

Chapter 2 • Developing IT Strategy for Business Value 19

capabilities. Each program consists of many smaller, interrelated business and IT initiatives cutting across several functional areas. These are designed to be adapted, reconfigured, accelerated, or canceled as the strategic program evolves. Themes give both business and IT leaders a broad yet focused topic of interest that chal- lenges them to move beyond current operations (Kanter 2002). For example, one retail company decided it wanted to be “a great place to work.” A bank selected mobile banking as a critical differentiator. Both firms used a theme to engage the imaginations of their employees and mobilize a variety of ideas and actions around a broad strategic direction. By grouping IT and business programs around a few key themes, managers find it easier to track and direct important strategic threads in an organization’s development and to visualize the synergies and interdepen- dencies involved across a variety of projects spread out across the organization and over time.

3. Get the right people involved. One of the most important distinguishing factors between companies that get high business value from their IT investment and those that don’t is that senior managers in high-performing companies take a leadership role in IT decision making. Abdication of this responsibility is a recipe for disas- ter (Ross and Beath 2002). “In the past it was very hard to get the right people involved,” said a focus group member. “Now it’s easier.” Another noted, “You don’t send a minion to an IT strategy meeting anymore; it’s just not done.” In this type of organization, the CIO typically meets regularly with the president and senior busi- ness leaders to discuss both business and IT strategies.

Getting the right people involved also means getting business managers and other key stakeholders involved in strategy as well. To do this, many com- panies have established “relationship manager” positions in IT to work with and learn about the business and bring opportunities for using technology to the table. Research shows that the best strategies often stem from grassroots innovations, and it is, therefore, critical that organizations take steps to ensure that good ideas are nurtured and not filtered out by different layers of management (DeSouza 2011). “We have two levels of strategy development in our organization,” said a focus group participant. “Our relationship managers work with functional managers and our CIO with our business unit presidents on the IT steering committee.” This com- pany also looks for cross-functional synergies and strategic dependencies by hold- ing regular meetings of IT account managers and between account managers and infrastructure managers.

4. Work in partnership with the business. Successful strategy demands a true partnership between IT and the business, not just use of the term. Strategy decisions are best made with input from both business and IT executives (Ross and Beath 2002). The focus group agreed. “Our partnerships are key to our success,” stated a manager. “It’s not the same as it was a few years ago. People now work very closely together.” Partnership is not just a matter of “involving” business lead- ers in IT strategy or vice versa or “aligning” business and IT strategies. Effective strategizing is about continuous and dynamic synchronization of capabilities (Smith and McKeen 2010). “Our IT programs need synchronizing with business strategy—not only at a high level, but right down to the individual projects and the business changes that are necessary to implement them properly,” explained another participant.

20 Section I • Delivering Value with IT

The Many diMensions oF iT sTraTegy

One of the many challenges of developing effective IT strategy is the fact that technology can be used in so many different ways. The opportunities are practically limitless. Unfortunately, the available resources are not. Thus, a key element of IT strategy is determining how best to allocate the IT budget. This issue is complicated by the fact that most businesses today require significant IT services just to operate. Utility and basic support costs eat up between 30 and 70 percent of the focus group members’ budgets. That’s just the cost of “keeping the lights on”—running existing applications, fixing problems, and dealing with mandatory changes (e.g., new legisla- tion). IT strategy, therefore, has two components: how to do more with less (i.e., driving down fixed costs) and how to allocate the remaining budget toward those projects that will support and further the organization’s business strategy.

With occasional exceptions, CIOs and their teams are mostly left alone to deter- mine the most cost-effective way of providing the IT utility. This has led to a variety of IT-led initiatives to save money, including outsourcing, shared services, use of software- as-a-service (SaaS), global sourcing, and partnerships. However, it is the way that IT spends the rest of its budget that has captured the attention of business strategists. “It used to be that every line of business had an IT budget and that we would work with each one to determine the most effective way to spend it,” said a manager. “Now there is much more recognition that the big opportunities are at the enterprise level and cut across lines of business.”

Focus group members explained that implementing a strategic program in IT will usually involve five types of initiatives. Determining what the balance among them will be is a significant component of how IT strategy delivers business value. Too much or too little emphasis on one type of project can mean a failure to derive maximum value from a particular strategic business theme:

1. Business improvement. These projects are probably the easiest to agree on because they stress relatively low-risk investments with a tangible short-to-medium-term payback. These are often reengineering initiatives to help organizations streamline their processes and save substantial amounts of money by eliminating unnecessary or duplicate activities or empowering customers/suppliers to self-manage transac- tions with a company. Easy to justify with a business case, these types of projects have traditionally formed the bulk of IT’s discretionary spending. “Cost-reduction projects have and always will be important to our company,” stated one member. “However, it is important to balance what we do in this area with other types of equally important projects that have often been given short shrift.”

2. Business enabling. These projects extend or transform how a company does business. As a result, they are more focused on the top-line or revenue-growing aspects of an enterprise. For example, a data warehouse could enable different parts of a company to “mine” transaction information to improve customer ser- vice, assist target marketing, better understand buying patterns, or identify new business opportunities. Adding a new mobile channel could make it easier for customers to buy more or attract new customers. A customer information file could make it more enjoyable for a customer to do business with a company (e.g., only one address change) and also facilitate new ways of doing business.

Chapter 2 • Developing IT Strategy for Business Value 21

Often the return on these types of projects is less clear, and as a result it has been harder to get them on the IT priority list. Yet many of these initiatives represent the foundations on which future business strategy will be built. For example, one CIO described the creation of a customer information file as “a key enabler for many different business units. . . . It has helped us build bench strength and move to a new level of service that other companies cannot match” (Smith 2003).

3. Business opportunities. These are small-scale, experimental initiatives designed to test the viability of new concepts or technologies. In the past these types of proj- ects have not received funding by traditional methods because of their high-risk nature. Often it has been left up to the CIO to scrounge money for such “skunk- works.” There is a growing recognition of the potential value of strategic innovation projects in helping companies to learn about and prepare for the future. In some companies the CEO and CFO have freed up seed money to finance a number of these initiatives. However, although there is considerably more acceptance for such projects, there is still significant organizational resistance to financing projects for which the end results are unpredictable (Quinn 2002; Weiss and Thorogood 2011). In fact, it typically requires discipline to support and encourage innovation exper- iments, which, by definition, will have a high number of false starts and wrong moves (DeSouza 2011). The group agreed that the key to benefiting from them is to design them for learning, incorporate feedback from a variety of sources, and make quick corrections of direction.

4. Opportunity leverage. A neglected but important type of IT project is one that oper- ationalizes, scales up, or leverages successful strategic experiments or prototypes. “We are having a great deal of success taking advantage of what we have learned earlier,” said one manager. Coming up with a new strategic or technological idea needs a different set of skills than is required to take full advantage of it in the mar- ketplace (Charitou and Markides 2003; DeSouza 2011). Some companies actually use their ability to leverage others’ ideas to their strategic advantage. “We can’t compete in coming up with new ideas,” said the manager of a medium-sized company, “but we can copy other peoples’ ideas and do them better.”

5. Infrastructure. This final type of IT initiative is one that often falls between the cracks when business and IT strategies are developed. However, it is clear that the hardware, software, middleware, communications, and data available will affect an organization’s capacity to build new capabilities and respond to change. Studies have found that most companies feel their legacy infrastructure can be an impediment to what they want to do (Peslak 2012; Prahalad and Krishnan 2002). Research also shows that leading companies have a framework for making targeted investments in their IT infrastructure that will further their overall strate- gic direction (Weill et al. 2002). Unfortunately, investing in infrastructure is rarely seen as strategic. As a result, many companies struggle with how to justify and appropriately fund it.

Although each type of project delivers a different type of business value, typi- cally IT strategy has stressed only those initiatives with strong business cases. Others are shelved or must struggle for a very small piece of the pie. However, there was a general recognition in the group that this approach to investment leads to an IT strategy

22 Section I • Delivering Value with IT

with a heavy emphasis on the bottom line. As a result, all participating companies were looking at new ways to build a strategy-development process that reflects a more appropriate balance of all dimensions of IT strategy.

Toward an iT sTraTegy-develoPMenT ProCess

Strategy is still very much an art, not a science, explained the focus group. And it is likely to remain so, according to strategy experts. Strategy will never again be a coherent, long-term plan with predictable outcomes—if it ever was. “Leaders can’t predict which combinations [of strategic elements] will succeed [and] they can’t drive their organiza- tions towards predetermined positions” (Quinn 2002). This situation only exacerbates the problem that has long faced IT strategists—that is, it is difficult to build systems, information, and infrastructure when a business’s direction is continually changing. Yet this degree of flexibility is exactly what businesses are demanding (Chakravarty et al. 2013; Luftman and Zadeh 2011; Korsten 2011). Traditional IT planning and budgeting mechanisms done once a year simply don’t work in today’s fast-paced business envi- ronment. “We always seem to lag behind the business, no matter how hard we try,” said a manager.

Clearly, organizations need to be developing strategy differently. How to do this is not always apparent, but several companies are trying ways to more dynamically link IT strategy with that of the business. Although no one company in the focus group claimed to have the answer, they did identify several practices that are moving them closer to this goal:

• “Rolling” planning and budget cycles. All participants agreed that IT plans and budgets need attention more frequently than once a year. One company has cre- ated an eighteen-month rolling plan that is reviewed and updated quarterly with the business to maintain currency.

• An enterprise architecture. This is an integrated blueprint for the development of the enterprise—both the business and IT. “Our enterprise architecture includes business processes, applications, infrastructure, and data,” said a member. “Our EA function has to approve all business and IT projects and is helpful in identify- ing duplicate solutions.” In some companies this architecture is IT initiated and business validated; in others it is a joint initiative. However, participants warned that an architecture has the potential to be a corporate bottleneck if it becomes too bureaucratic.

• Different funding “buckets.” Balancing short-term returns with the company’s longer-term interests is a continual challenge. As noted earlier, all five types of IT projects are necessary for an effective IT strategy (i.e., business improvement, business enabling, business opportunities, opportunity leverage, and infrastruc- ture). In order to ensure that each different type of IT is appropriately funded, many companies are allocating predetermined percentages of their IT budget to different types of projects (Smith and McKeen 2010). This helps keep continual pressure on IT to reduce its “utility costs” to free up more resources for other types of projects. “Since we implemented this method of budgeting, we’ve gone from spending 70 percent of our revenues on mandatory and support projects to spending 70  percent on discretionary and strategic ones,” said a manager. This

Chapter 2 • Developing IT Strategy for Business Value 23

is also an effective way to ensure that IT infrastructure is continually enhanced. Leading companies build their infrastructures not through a few large investments but gradually through incremental, modular investments that build IT capabilities (Weill et al. 2002).

• Relationship managers. There is no substitute for a deep and rich understand- ing of the business. This is why many companies have appointed IT relationship managers to work closely with key lines of business. These managers help business leaders to observe their environments systematically and identify new opportunities for which IT could be effective. Furthermore, together relationship managers can identify synergies and interdependencies among lines of business. One organization holds both intra- and interfunctional strategy sessions on a regular basis with busi- ness managers to understand future needs, develop programs, and design specific roadmaps for reaching business goals. “Our relationship managers have been a sig- nificant factor in synchronizing IT and business strategies,” said its manager.

• A prioritization rubric. “We don’t do prioritization well,” said one participant. IT managers have long complained that it is extremely difficult to justify certain types of initiatives using the traditional business case method of prioritization. This has led to an overrepresentation of business improvement projects in the IT portfolio and has inhibited more strategic investments in general capabilities and business opportunities. This problem is leading some companies to adopt multiple approaches to justifying IT projects (Chakravarty et al. 2013; Ross and Beath 2002). For example, business-enabling projects must be sponsored at a cross-functional level on the basis of the capabilities they will provide the enterprise as a whole. Senior management must then take responsibility to ensure that these capabili- ties are fully leveraged over time. Infrastructure priorities are often left up to IT to determine once a budget is set. One IT department does this by holding strategy sessions with its relationship and utility managers to align infrastructure spending with the organization’s strategic needs. Unfortunately, no one has yet figured out a way to prioritize business opportunity experiments. At present this is typically left to the “enthusiasms and intuitions” of the sponsoring managers, either in IT or in the business (DeSouza 2011). “Overall,” said a manager, “we need to do a better job of thinking through the key performance indicators we’d like to use for each type of project.”

Although it is unlikely that strategy development will ever become a completely formalized process, there is a clear need to add more structure to how it is done. A greater understanding of how strategy is developed will ensure that all stakeholders are involved and a broader range of IT investments are considered. The outcomes of strategy will always be uncertain, but the process of identifying new opportunities and how they should be funded must become more systematic if a business is going to real- ize optimum value from its IT resources.

Challenges For Cios

As often happens in organizations, recognition of a need precedes the ability to put it into place. IT leaders are now making significant strides in articulating IT strategy and linking it more effectively with business strategy. Business leaders are also more open

24 Section I • Delivering Value with IT

to a more integrated process. Nevertheless, some important organizational barriers that inhibit strategy development still remain.

A supportive governance structure is frequently lacking. “Now that so many s trategies are enterprisewide, we need a better way to manage them,” explained one manager. Often there are no formal structures to identify and manage interdepen- dencies between business functions and processes. “It used to be that everything was aligned around organizational boundaries, but strategy is now more complex since we’re working on programs with broader organizational scope,” said another. Similarly, current managerial control systems and incentives are often designed to reward thinking that is aligned to a line of business, not to the greater organiza- tional good. Enterprisewide funding models are also lacking. “Everything we do now requires negotiation for funding between the lines of business who control the resources,” a third stated. Even within IT, the group suggested it is not always clear who in the organization is responsible for taking IT strategies and turning them into detailed IT plans.

Traditional planning and budgetary practices are a further challenge. This is an often-neglected element of IT strategy. “Our business and IT strategies are not always done in parallel or even around the same time,” said a participant. As a result, it is not easy to stay aligned or to integrate the two sets of plans. Another commented, “Our business plans change constantly. It is, therefore, common for IT strategies to grow far- ther and farther apart over time.” Similarly, an annual budgeting process tends to lock an organization into fixed expenditures that may not be practical in a rapidly changing environment. IT organizations, therefore, need both a longer-term view of their resourc- ing practices and the opportunity to make changes to it more frequently. Even though rolling budgets are becoming more acceptable, they are by no means common in either IT or the business world today.

Both business and IT leaders need to develop better skills in strategizing. “We’ve gotten really good at implementing projects,” said an IT manager. “Strategy and inno- vation are our least developed capabilities.” IT is pushing the business toward better articulation of its goals. “Right now, in many areas of our business, strategy is not well thought through,” said another manager. “IT is having to play the devil’s advocate and get them to think beyond generalities such as ‘We are going to grow the business by 20 percent this year.’” With more attention to the process, it is almost certain to get better, but managers’ rudimentary skills in this area limit the quality of strategy development.

Over and over, the group stressed that IT strategy is mainly about getting the balance right between conflicting strategic imperatives. “It’s always a balancing act

Barriers to Effective IT Strategy Development

• Lack of a governance structure for enterprisewide projects • Inadequate enterprisewide funding models • Poorly integrated processes for developing IT and business strategies • Traditional budget cycles • Unbalanced strategic and tactical initiatives • Weak strategizing skills

Chapter 2 • Developing IT Strategy for Business Value 25

Conclusion

Effective strategy development is becoming vital for organizations. As the impact of IT has grown in companies, IT strategy is finally getting the attention it deserves in business. Nevertheless, most organizations are still at the earliest stages of learning how to develop an effective IT strategy and synchronize it with an overall business strategy. Getting the balance right between the many differ- ent ways IT can be used to affect a business is a constant challenge for leaders and one on

which they do not always agree. Although there is, as yet, no well-developed IT strat- egy–development process, there appears to be general agreement on certain critical suc- cess factors and the key elements involved. Over time, these will likely be refined and bet- ter integrated with overall business strategy development. Those who learn to do this well without locking the enterprise into inflexible technical solutions are likely to win big in our rapidly evolving business environment.

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C h a p t e r

3 Linking IT to Business Metrics1

1 This chapter is based on the authors’ previously published article, Smith, H. A., J. D. McKeen, and C. Street. “Linking IT to Business Metrics.” Journal of Information Science and Technology 1, no. 1 (2004): 13–26. Reproduced by permission of the Information Institute.

From the first time IT started making a significant dent in corporate balance sheets, the holy grail of academics, consultants, and business and IT managers has been to show that what a company spends on IT has a direct impact on its performance. Early efforts to do this, such as those trying to link various measures of IT input (e.g., budget dollars, number of PCs, number of projects) with various measures of business performance (e.g., profit, productivity, stock value) all failed to show any relationship at all (Marchand et al. 2000). Since then, everyone has prop- erly concluded that the relationship between what is done in IT and what happens in the business is considerably more complex than these studies first supposed. In fact, many researchers would suggest that the relationship is so filtered through a variety of “conversion effects” (Cronk and Fitzgerald 1999) as to be practically impossible to demonstrate. Most IT managers would agree. They have long argued that technology is not the major stumbling block to achieving business performance; it is the business itself—the processes, the managers, the culture, and the skills—that makes the differ- ence. Therefore, it is simply not realistic to expect to see a clear correlation between IT and business performance at any level. When technology is successful, it is a team effort, and the contributions of the IT and business components of an initiative cannot and should not be separated.

Nevertheless, IT expenditures must be justified. Thus, most companies have concentrated on determining the “business value” that specific IT projects deliver. By focusing on a goal that matters to business (e.g., better information, faster transaction processing, reduced staff), then breaking this goal down into smaller projects that IT can affect directly, they have tried to “peel the onion” and show specifically how IT delivers value in a piecemeal fashion. Thus, a series of surrogate measures are usually used to demonstrate IT’s impact in an organization. (See Chapter 1 for more details.)

More recently, companies are taking another look at business performance met- rics and IT. They believe it is time to “put the onion back together” and focus on what

28 Section I • Delivering Value with IT

really matters to the enterprise. This perspective argues that employees who truly understand what their business is trying to achieve can sense the right ways to per- sonally improve performance that will show up at a business unit and organizational level. “People who understand the business and are informed will be proactive and … have a disposition to create business value every day in many small and not-so-small ways” (Marchand et al. 2000). Although the connection may not be obvious, they say, it is there nevertheless and can be demonstrated in tangible ways. The key to linking what IT does to business performance is, therefore, to create an environment within which everyone thoroughly understands what measures are important to the business and is held accountable for them. This point of view does not suggest that all the work done to date to learn how IT delivers value to an organization (e.g., business cases, productivity measures) has been unnecessary, only that it is incomplete. Without close attention to business metrics in addition, it is easy for IT initiatives and staff to lose their focus and become less effective.

This chapter looks at how these controversial yet compelling ideas are being pursued in organizations to better understand how companies are attempting to link IT work and firm performance through business metrics. The first section describes how business metrics themselves are evolving and looks at how new management philosophies are changing how these measures are communicated and applied. Next it discusses the types of metrics that are important for a well-rounded program of business measurement and how IT can influence them. Then it presents three differ- ent ways companies are specifically linking their IT departments with business met- rics and the benefits and challenges they have experienced in doing this. This section concludes with some general principles for establishing a business measurement pro- gram in IT. Finally, it offers some advice to managers about how to succeed with such a program in IT.

Business MeasureMent: an Overview

Almost everyone agrees that the primary goal of a business is to make money for its shareholders (Goldratt and Cox 1984; Haspeslagh et al. 2001; Kaplan and Norton 1996). Unfortunately, in large businesses this objective frequently gets lost in the midst of people’s day-to-day activities because profit cannot be measured directly at the level at which most employees in a company work (Haspeslagh et al. 2001). This “missing link” between work and business performance leads companies to look for ways to bridge this gap. They believe that if a firm’s strategies for achieving its goal can be tied much more closely to everyday processes and decision making, frontline employees will be better able to create business value. Proponents of this value-based manage- ment (VBM) approach have demonstrated that an explicit, firmwide commitment to shareholder value, clear communication about how value is created or destroyed, and incentive systems that are linked to key business measures will increase the odds of a positive increase in share price (Haspeslagh et al. 2001).

Measurement counts. What a company measures and the way it measures influence both the mindsets of managers and the way people behave. The best measures are tied to business performance and are linked to the strategies and business capabilities of the company. (Marchand et al. 2000)

Chapter 3 • Linking IT to Business Metrics 29

Although companies ascribe to this notion in theory, they do not always act in ways that are consistent with this belief. All too often, therefore, because they lack clarity about the links between business performance and their own work, individuals and even business units have to take leaps of faith in what they do (Marchand et al. 2000).

Nowhere has this been more of a problem than in IT. As has been noted often, IT investments have not always delivered the benefits expected (Bensaou and Earl 1998; Holland and Sharke 2001; Peslak 2012). “Efforts to measure the link between IT investment and business performance from an economics perspective have… failed to establish a consistent causal linkage with sustained business profitability” (Marchand et al. 2000). Value-based management suggests that if IT staff do not understand the business, they cannot sense how and where to change it effectively with technology. Many IT and business managers have implicitly known this for some time. VBM simply gives them a better framework for implementing their beliefs more systematically.

One of the most significant efforts to integrate an organization’s mission and strategy with a measurement system has been Kaplan and Norton’s (1996) balanced scorecard. They explain that competing in the information age is much less about managing physical, tangible assets and much more about the ability of a company to mobilize its intangible assets, such as customer relationships, innovation, employee skills, and information technology. Thus, they suggest that not only should business measures look at how well a company has done in the past (i.e., financial performance), but they also need to look at metrics related to customers, internal business processes, and learning and growth that position the firm to achieve future performance. Although it is difficult putting a reliable monetary value on these items, Kaplan and Norton sug- gest that such nonfinancial measures are critical success factors for superior financial performance in the future. Research shows that this is, in fact, the case. Companies that use a balanced scorecard tend to have a better return on investment (ROI) than those that rely on traditional financial measures alone (Alexander 2000).

Today many companies use some sort of scorecard or “dashboard” to track a vari- ety of different metrics of organizational health. However, IT traditionally has not paid much attention to business results, focusing instead on its own internal measures of performance (e.g., IT operations efficiency, projects delivered on time). This has per- petuated the serious disconnect between the business and IT that often manifests itself in perceptions of poor alignment between the two groups, inadequate payoffs from IT investments, poor relationships, and finger-pointing (Holland and Sharke 2001; Peslak 2012; Potter 2013). All too often IT initiatives are conceived with little reference to major business results, relying instead on lower-level business value surrogates that are not always related to these measures. IT organizations are getting much better at this bot- tom-up approach to IT investment (Smith and McKeen 2010), but undelivered IT value remains a serious concern in many organizations. One survey of CFOs found that only 49 percent felt that their ROI expectations for technology had been met (Holland and Sharke 2001). “Despite considerable effort, no practical model has been developed to measure whether a company’s IT investments will definitely contribute to sustainable competitive advantage” (Marchand et al. 2000). Clearly, in spite of significant efforts over many years, traditional IT measurement programs have been inadequate at

30 Section I • Delivering Value with IT

assessing business value. Many IT organizations believe, therefore, that it is time for a different approach to delivering IT value, one that holds IT accountable to the same measures and goals as the rest of the business.

Key Business Metrics fOr it

No one seriously argues that IT has no impact on an organization’s overall financial performance anymore. There may be disagreement about whether it has a positive or a negative impact, but technology is too pervasive and significant an expense in most firms for it not to have some influence on the corporate bottom line. However, as has been argued earlier, we now recognize that neither technology nor business alone is responsible for IT’s financial impact. It is instead a joint responsibility of IT and the busi- ness. This suggests that they need to be held accountable together for its impact. Some companies have accepted this principle for individual IT projects (i.e., holding business and IT managers jointly responsible for achieving their anticipated benefits), yet few have extended it to an enterprise level. VBM suggests that this lack of attention to enter- prise performance by IT is one reason it has been so hard to fully deliver business value for technology investments. Holding IT accountable for a firm’s performance according to key financial metrics is, therefore, an important step toward improving its contribu- tion to the corporate bottom line.

However, although financial results are clearly an important part of any mea- surement of a business’s success today, they are not enough. Effective business metrics programs should also include nonfinancial measures, such as customer and employee satisfaction. As already noted, because such nonfinancial measures are predictive of future performance, they offer an organization the opportunity to make changes that will ultimately affect their financial success.

Kaplan and Norton (1996) state “the importance of customer satisfaction probably cannot be overemphasized.” Companies that do not understand their customers’ needs will likely lose customers and profitability. Research shows that merely adequate satis- faction is insufficient to lead to customer loyalty and ultimately profit. Only firms where customers are completely or extremely satisfied can achieve this result (Heskett et al. 1994). As a result, many companies now undertake systematic customer satisfaction surveys. However, in IT it is rare to find external customer satisfaction as one of the metrics on which IT is evaluated. While IT’s “customers” are usually considered to be internal, these days technology makes a significant difference in how external custom- ers experience a firm and whether or not they want to do business with it. Systems that are not reliable or available when needed, cannot provide customers with the informa- tion they need, or cannot give customers the flexibility they require are all too common. And with the advent of online business, systems and apps are being designed to inter- face directly with external customers. It is, therefore, appropriate to include external customer satisfaction as a business metric for IT.

Another important nonfinancial business measure is employee satisfaction. This is a “leading indicator” of customer satisfaction. That is, employee satisfaction in one year is strongly linked to customer satisfaction and profitability in the next (Koys 2001). Employees’ positive attitudes toward their company and their jobs lead to posi- tive behaviors toward customers and, therefore, to improved financial performance

Chapter 3 • Linking IT to Business Metrics 31

(Rucci et al. 1998; Ulrich et al. 1991). IT managers have always watched their own employee satisfaction rate intently because of its close links to employee turnover. However, they often miss the link between IT employee satisfaction and customer satisfaction—both internal customer satisfaction, which leads to improved general employee satisfaction, and external customer satisfaction. Thus, only a few companies hold IT managers accountable for general employee satisfaction.

Both customer and employee satisfaction should be part of a business metrics program for IT. With its ever-growing influence in organizations, technology is just as likely to affect external customer and general employee satisfaction as many other areas of a business. This suggests that IT has three different levels of measurement and accountability:

1. Enterprise measures. These tie the work of IT directly to the performance of the organization (e.g., external customer satisfaction, corporate financial performance).

2. Functional measures. These assess the internal work of the IT organization as a whole (e.g., IT employee satisfaction, internal customer satisfaction, operational performance, development productivity).

3. Project measures. These assess the performance of a particular project team in delivering specific value to the organization (e.g., business case benefits, delivery on time).

Functional and project measures are usually well addressed by IT measurement programs today. It is the enterprise level that is usually missing.

Designing Business Metrics fOr it

The firms that hold IT accountable for enterprise business metrics believe this approach fosters a common sense of purpose, enables everyone to make better decisions, and helps IT staff understand the implications of their work for the success of the organi- zation (Haspeslagh et al. 2001; Marchand et al. 2000; Potter 2013; Roberts 2013). The implementation of business metrics programs varies widely among companies, but three approaches taken to linking IT with business metrics are distinguishable.

1. Balanced scorecard. This approach uses a classic balanced scorecard with mea- sures in all four scorecard dimensions (see the “Sample Balanced Scorecard Business Metrics” feature). Each metric is selected to measure progress against the entire enterprise’s business plan. These are then broken down into business unit plans and appropriate submetrics identified. Individual scorecards are then developed with metrics that will link into their business unit scorecards. With this approach, IT is treated as a separate business unit and has its own scorecard linked to the business plan. “Our management finally realized that we need to have everyone thinking in the same way,” explained one manager. “With enterprise systems, we can’t have people working in silos anymore.” The scorecards are very visible in the organization with company and business unit scorecards and those of senior execu- tives posted on the company’s intranet. “People are extremely interested in seeing how we’re doing. Scorecards have provided a common framework for our entire company.” They also provide clarity for employees about their roles in how they affect key business metrics.

32 Section I • Delivering Value with IT

Although scorecards have meant that there is better understanding of the business’s drivers and plans at senior management levels, considerable resistance to them is still found at the lower levels in IT. “While developers see how they can affect our customers, they don’t see how they can affect shareholder value, profit, or revenue, and they don’t want to be held accountable for these things,” stated the same manager. She noted that implementing an effective scorecard program relies on three things: good data to provide better metrics, simplicity of metrics, and enforcement. “Now if someone’s scorecard is not complete, they cannot get a bonus. This is a huge incentive to follow the program.”

2. Modified scorecard. A somewhat different approach to a scorecard is taken by one company in the focus group. This firm has selected five key measures (see the “Modified Scorecard Business Metrics” feature) that are closely linked to the com- pany’s overall vision statement. Results are communicated to all staff on a quarterly basis in a short performance report. This includes a clear explanation of each mea- sure, quarterly progress, a comparison with the previous year’s quarterly results, and a “stretch” goal for the organization to achieve. The benefit of this approach is that it orients all employees in the company to the same mission and values. With everyone using the same metrics, alignment is much clearer all the way through the firm, according to the focus group manager.

In IT these key enterprise metrics are complemented by an additional set of business measures established by the business units. Each line of business identifies one or two key business unit metrics on which they and their IT team

Sample Balanced Scorecard Business Metrics

• Shareholder value (financial) • Expense management (financial) • Customer/client focus (customer) • Loyalty (customer) • Customercentric organization (customer) • Effectiveness and efficiency of business operations (operations) • Risk management (operations) • Contribution to firmwide priorities and business initiatives (growth)

Modified Scorecard Business Metrics

• Customer loyalty index. Percentage of customers who said they were very satisfied with the company and would recommend it to others.

• Associate loyalty index. Employees’ perception of the company as a great place to work. • Revenue growth. This year’s total revenues as a percentage of last year’s total revenues. • Operating margin. Operating income earned before interest and taxes for every dollar of

revenue. • Return on capital employed. Earnings before interest and tax divided by the capital used

to generate the earnings.

Chapter 3 • Linking IT to Business Metrics 33

will be measured. Functional groups within IT are evaluated according to the same metrics as their business partners as well as on company and internal IT team performance. For example, the credit group in IT might be evaluated on the number of new credit accounts the company acquires. Shared IT services (e.g., infrastructure) are evaluated according to an average of all of the IT func- tional groups’ metrics.

The importance the company places on these metrics is reflected in the firm’s generous bonus program (i.e., bonuses can reach up to 230 percent of an individual’s salary) in which all IT staff participate. Bonuses are separate from an individual’s salary, which is linked to personal performance. The percentage influence of each set of business measures (i.e., enterprise, business unit, and individual/team) varies according to the level of the individual in the firm. However, all staff have at least 25 percent of their bonus linked to enterprise performance metrics. No bonuses are paid to anyone if the firm does not reach its earnings-per-share target (which is driven by the five enterprise measures out- lined in the “Modified Scorecard Business Metrics” feature). This incentive sys- tem makes it clear that everyone’s job is connected to business results and helps ensure that attention is focused on the things that are important to the company. As a result, interest is much stronger among IT staff about how the business is doing. “Everyone now speaks the same language,” said the manager. “Project alignment is much easier.”

3. Strategic imperatives. A somewhat different approach is taken by a third focus group company. Here the executive team annually evaluates the key environmen- tal factors affecting the company, then identifies a number of strategic imperatives for the firm (e.g., achieve industry-leading e-business capability, achieve 10–15 percent growth in earnings per share). These can vary according to the needs of the firm in any particular year. Each area of the business is then asked to identify initiatives that will affect these imperatives and to determine how they will be measured (e.g., retaining customers of a recent acquisition, increased net sales, a new product). In the same way, IT is asked to identify the key projects and mea- sures that will help the business to achieve these imperatives. Each part of the company, including IT, then integrates these measures into its variable pay pro- gram (VPP).

The company’s VPP links a percentage of an individual’s pay to business results and overall business unit performance. This percentage could vary from a small portion of one’s salary for a new employee to a considerable proportion for senior management. Within IT, the weight that different measures are accorded in the VPP portion of their pay is determined by a measurement team and approved by the CIO and the president. Figure 3.1 illustrates the different percentages allo- cated to IT’s variable pay component for a typical year. Metrics can change from year to year depending on where management wants to focus everyone’s attention. “Performance tends to improve if you measure it,” explained the manager. “Over the years, we have ratcheted up our targets in different areas. Once a certain level of performance is achieved, we may change the measure or change the emphasis on this measure.”

34 Section I • Delivering Value with IT

An important difference from the scorecard approach is the identification of key IT projects. “These are not all IT projects, but a small number that are closely aligned with the strategic business imperatives,” stated the manager. “Having the success of these projects associated with their variable pay drives everyone’s behavior. People tend to jump in and help if there’s a problem with one of them.” The goal in this process is for everyone to understand the VPP measures and to make them visible within IT. Targets and results are posted quarterly, and small groups of employees meet to discuss ideas about how they can influence business and IT goals. “Some amazing ideas have come out of these meetings,” said the manager. “Everyone knows what’s important, and these measures get attention. People use these metrics to make choices all the time in their work.”

Each of these business measurement programs has been implemented somewhat differently, but they all share several key features that could be considered principles of a good business metrics program for IT:

1. Focus on overall business performance. These programs all focus employees on both financial and nonfinancial enterprise performance and have an explicit expecta- tion that everyone in the organization can influence these results in some way.

2. Understanding is a critical success factor. If people are going to be held accountable for certain business results, it is important that they understand them. Similarly, if the organization is worried about certain results, this must be communicated as well. Holding regular staff meetings where people can ask ques- tions and discuss results is effective, as is providing results on a quarterly basis. Understanding is  the goal. “If you can ask … a person programming code and they can tell you three to four of their objectives and how those tie into the compa- ny’s performance and what the measures of achieving those objectives are, you’ve got it” (Alexander 2000).

3. Simplicity. Successful companies tend to keep their measures very simple and easy to use (Haspeslagh et al. 2001). In each approach already outlined, a limited number of measures are used. This makes it very easy for employees to calculate

Business Results 40%

Report Card Goals 30%

Partner Satisfaction

10%

Application Delivery Effectiveness

5%

Production Availability

5%

Member Retention

5%

Product Recovery

5%

Key Projects 30%

IT Performance 60%

IT Variable Pay 100%

figure 3.1 Percentage Weightings Assigned to IT Variable Pay Components for a Particular Year

Chapter 3 • Linking IT to Business Metrics 35

their bonuses (or variable pay) based on the metrics provided, which further strengthens the linkage between company performance and individual effort.

4. Visibility. In each of the programs already discussed, metrics were made widely available to all staff on a quarterly basis. In one case they are posted on the com- pany’s intranet; in another they are distributed in a printed report; in a third they are posted in public areas of the office. Visibility encourages employee buy-in and accountability and stimulates discussion about how to do better or what is working well.

5. Links to incentive systems. Successful companies tend to include a much larger number of employees in bonus programs than unsuccessful ones (Haspeslagh et al. 2001). Extending incentive schemes to all IT staff, not just management, is important to a measurement program’s effectiveness. The most effective programs appear to distinguish between fair compensation for individual work and competencies and a reward for successfully achieving corporate objectives.

aDvice tO Managers

The focus group had some final advice for other IT managers who are thinking of implementing a business metrics program:

• Results will take time. It takes time to change attitudes and behavior in IT, but it is worth making the effort. Positive results may take from six months to a year to appear. “We had some initial pushback from our staff at the beginning,” said one manager, “but now the metrics program has become ingrained in our attitudes and behaviors.” Another manager noted, “We had a few bumps during our first year, but everyone, especially our executives, is getting better at the program now [that] we’re in our third year. It really gets our staff engaged with the business.” If there has been no dramatic difference within three years, management should recognize that it is either using the wrong measures or hasn’t got employee buy-in to the pro- gram (Alexander 2000).

• Have common goals. Having everyone measured on the same business goals helps build a strong team at all levels in the organization. It makes it easier to set priorities as a group and collaborate and share resources, as needed.

• Follow up on problem areas. Companies must be prepared to take action about poor results and involve staff in their plans. In particular, if companies are going to ask customers and employees what they think, they must be prepared to act on the results. All metrics must be taken seriously and acted on if they are to be used to drive behavior and lead to continuous improvement.

• Be careful what you measure. Measuring something makes people pay attention to it, particularly if it is linked to compensation. Metrics must, therefore, be selected with care because they will be a major driver of behavior. For example, if incen- tives are solely based on financial results, it is probable that some people may be so driven that they will trample on the needs and interests of others. Similarly, if only costs are measured, the needs of customers could be ignored. Conversely, if a metric indicates a problem area, organizations can expect to see a lot of ingenuity and sup- port devoted to addressing it.

36 Section I • Delivering Value with IT

• Don’t use measurement as a method of control. A business metrics program should be designed to foster an environment in which people look beyond their own jobs and become proactive about the needs of the organization (Marchand et al. 2000). It should aim to communicate strategy and help align individual and organizational initiatives (Kaplan and Norton 1996). All managers should clearly understand that a program of this type should not be used for controlling behavior, but rather as a motivational tool.

Conclusion

Getting the most value out of IT has been a serious concern of business for many years. In spite of considerable effort, measurement initiatives in IT that use surrogates of busi- ness value or focus on improving internal IT behavior have not been fully successful in delivering results. Expecting IT to participate in achieving specific enterprise objectives— the same goals as the rest of the organiza- tion—has been shown to deliver significant benefits. Not only are there demonstrable financial returns, but there is also consider- able long-term value in aligning everyone’s behavior with the same goals; people become more supportive of each other and more

sensitive to the greater corporate good, and decisions are easier to make. A good business metrics program, therefore, appears to be a powerful component of effective measure- ment in IT. IT employees may initially resist accountability for business results, but the experiences of the focus group demonstrate that their objections are usually short lived. If a business measurement program is carefully designed, properly linked to an incentive pro- gram, widely implemented, and effectively monitored by management, it is highly likely that business performance will become an integral part of the mind-set of all IT staff and ultimately pay off in a wide variety of ways.

References

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Chapter 3 • Linking IT to Business Metrics 37

and the Bottom Line.” Sloan Management Review (Summer 2000): 69–89.

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  • Section I: Delivering Value with IT
    • Chapter 2 DEVELOPING IT STRATEGY FOR BUSINESS VALUE
      • Business and IT Strategies: Past, Present, and Future
      • Four Critical Success Factors
      • The Many Dimensions of IT Strategy
      • Toward an IT Strategy-Development Process
      • Challenges for CIOs
      • Conclusion
      • References
    • Chapter 3 LINKING IT TO BUSINESS METRICS
      • Business Measurement: An Overview
      • Key Business Metrics for IT
      • Designing Business Metrics for IT
      • Advice to Managers
      • Conclusion
      • References

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