Justifying Next Gen IT Investments

The role of the chief information officer (CIO) is becoming increasingly complex with the rapid evolution of technology and disruptive business models. In the current business environment, a CIO has to manage existing IT operations within tight budgets and also deliver impressive return on new IT investments. In addition, a CIO has to formulate strategies for next generation technologies such as Blockchain, Internet of Things, Machine Learning and Cognitive platforms, among others.

As a CIO or for that matter a CDO, CMO, CFO, CTO or any senior executive contemplating the decision to invest in a new technology, the key concerns include:

1. What technologies to invest in?

2. How to assess the business value of a technology?

3. How to convince the CEO, the board and other decision makers to approve the investment in a technology?

It is common to see organizations making erroneous investment decisions and wasting valuable resources. Even more notably, organizations are often unable to take necessary investment decisions and missing opportunities in absence of a business case that can demonstrate value to the top management.

In an era when you can disrupt or be disrupted, it is critical for every business to obtain accelerated returns from early implementation of technology. The cost and consequences of not investing into the right technology at the right time are as important as those of wasting into the wrong technology.

This document recommends a framework to create a compelling business case for investments into a next generation technology. It is based on experience of working closely with CXOs, and senior business and IT executives, and helping them in getting approval for technology investments. It is repeatable and can be used to create a business case within a few weeks in most cases.

The framework takes a multi-dimensional approach to define the business value from the perspective of key executive stakeholders. This approach ensures that the business case is convincing when assessed from multiple dimensions, such as, strategy, finance, risk, business process impact and so on.

For the ease of understanding, we present the framework through examples from actual consulting scenarios.

Key Considerations of the framework

With shorter evolution cycles of technology, investments into the latest technologies have incrementally become difficult for CIOs to justify with business owners and the top leadership teams. On one hand is the urgency to adopt the technology for the benefits expected and the competitive edge it provides and on the other hand is the necessity to make sure that the projected costs are well understated, have a well-defined structure and the benefits are not entirely based on notional figures.

Problems

· Faster decision making is required for Next-Gen technology initiatives as the evolution cycle of technology has rapidly increased over time. There is a constant risk of “missing the bus” and losing the competitive advantage if technology adoption is delayed

· There are multiple initiatives vying for the limited CTB or discretionary budget. In the absence of a sound business case or an inability to demonstrate alignment with budget owner’s aspirations, business finds it difficult to approve even beneficial investments

· To be able to convince top management and board members there needs to be a clear cost and benefits structure with “worst-case scenarios” to mitigate the risk of understated costs or overstated benefits

· Higher the threat of digital disruption for an industry or organization, more acute is the problem, as multiple roles in the organizations have started working on similar digital initiatives. Establishing a compelling reason for such initiatives has become more crucial than before.

· Lack of a holistic view, which aligns strategy with business requirements and digital innovations. So it is required every business case create this kind of linkage

Examples from our experience

Where client failed to make much needed investments into technology:

· The CIO of a leading lender is finding it difficult to sell the concept of modernizing its core lending system despite the fact that the legacy systems are based on obsolete “out of support” technology components. A structured business case that highlights the potential business value, risks and consequences is the need of the hour to save the enterprise.

· Late adoption of online digital channels for a book retailer led to a slowdown and ultimate demise. The idea of investing in online channels was under discussions in the organization but was never backed by a strong business case by any stakeholder.

Where client created compelling case for investments into technology:

· A structured business case created by a set of external consultants and sponsored by the CIO of a leading auto finance and leasing company ensured that investments were made into modernizing the BI and analytics landscape by procuring next gen capabilities such as enterprise wide self-service BI and analytics model management.

· A leading bank invested in establishing an accelerator program for startups to promote the creation of breakthrough solutions to disrupt the banking technology landscape.

· An IT savvy CEO of a bank with a will to pioneer new technologies in the country proudly announced the use of blockchain technology for piloting cross border open account trade finance

Traditional Approaches

Traditionally, organizations were not always early adopters of a technology. Today, the success of a business depends primarily on innovation driven by early adoption of the right technology. Moreover, the choices and options to invest in technologies have increased exponentially. These two factors have created a need for a lot more rigor into the business cases. Moreover, major technology investment decisions go to senior business executives and even the board in many cases. Traditional approaches are falling short because of several reasons:

· Low alignment of business aspirations, strategy and goals

· Rudimentary financial analysis not aligned to the CFO vocabulary and methods

· Understated costs or missing cost elements, such as, hidden costs and opportunity costs

· Incomplete research of possible risks with the technology adoption

· Exaggerated benefits, and not accounting for timescale of likely benefits

· Incorrect assumptions about the initiative

· Underestimating the impact on existing business processes, IT landscape and the cost to manage change

· Absent methods to keep validating the business case along the project lifecycle

Recommended Approach

Every technology decision is different, ranging from those that are highly strategic in nature to those needed to reduce operational or technology risks. It is imperative that the nature of technology decision is considered to approach a business case. Types of technology investment decisions:

Impact of technology investment decisions

· Strategic Technology Investments: These initiatives are usually transformational and have the capability to change the way a business operates and change the enterprise’s basic position in the market.

· Business Game Changer Investments: These investments are triggered by business model changes and may have major impact on both business and technology. The aim is to disrupt traditional ways of conducting business, usually enabled by technology.

· Competitive Advantage Investments: Investments made to clearly gain a competitive advantage by adding a specific differentiation through a product, solution or channel.

· Risk Mitigation Investments: Some initiatives if not taken in time may be detrimental to the health of the enterprise. These could range from reducing regulatory or compliance related risks to protecting the basic business model from failing.

· Transactional Investments: These investments are made with a clear goal to reduce costs of conducting business. These investments are centered on the benefits they get in the immediate to mid-term periods.

· Risk Mitigation Investments: Some initiatives if not taken in time may be detrimental to the health of the enterprise. These could range from reducing regulatory or compliance related risks to protecting the basic business model from failing.

· Hygiene Investments: When seemingly frivolous investments made by competitors yield positive results from the market and eventually get dubbed as the norm for the industry, the enterprise is forced to adopt the technologies in a “me too” mode.

Generally, four business case dimensions or their variants are needed. These are:

1) Strategic Alignment: Alignment with stakeholders’ vision, strategy and goals

2) Business Benefits: Benefits for the business through improvements in business processes and impact on business KPIs

3) Financial Viability: Financial case (profitability and viability) for making the investment and the impact on P&L

4) Risks: Consequences of not making the investment

The focus and effort to be put on these dimensions depends on the type of investment.

Mapping of Investment Type and business case dimensions

Strategic Alignment

A business case needs to align with the vision, strategy and goals of the business stakeholder. These will be different for a board member, a CEO, a Head of Business or any other stakeholder. Moreover, every stakeholder would have different motivations and values and would view the investment decision from that perspective. Understanding the persona of the stakeholders and what they value substantially increases the odds of getting the desired decision.

CEO / Stakeholder Persona and what they value most

The Chief Analytics Officer at a Consumer Lending company engaged us to create a business case for investments in analytics which needed to be presented to the new CEO who was seen as a disruptor and would fall under ‘corporate entrepreneur’ persona. We demonstrated how their organization had an opportunity to become an analytical competitor, a position which no one in their industry could claim. We demonstrated their current position and the target that aligned with CEO’s vision.

Business Benefits

Business benefits range from those that are directly quantifiable to those that are nearly impossible to quantify. It is important to establish this concept with transparency before spelling out the business benefits to the stakeholders so that they can appreciate which benefits have been quantified, what assumptions were taken, and which benefits are not quantifiable.

Typically, benefits related to technology costs are easiest to quantify and benefits related to brand are most difficult to quantify. With enough assumptions, anything can be quantified but it may be a futile exercise if it becomes difficult to convince the stakeholders about such numbers.

Business benefits and potential to quantify

· Competitor benchmarking or examples to show correlation between similar technology investments and observed benefits

· Potential business use cases across the value chain

· Improvement in maturity level of an established business objective or capability

Financial Viability

The financial viability can be demonstrated through five financial numbers:

· Net Present Value (NPV)

· Internal Rate of Return (IRR)

· Payback Period

· Return on Investment (ROI)

· Impact on Cash Flows

The financial analysis to calculate these numbers is based on:

· Costs (Capital and Operational)

· Directly and indirectly quantifiable benefits for foreseeable period

· Discounting rate

· Capitalization guidelines as per country’s accounting standards and client’s corporate policy

· Foreign currency exchange rate

· Optimism Levels (% of Estimate) of Indirect benefits

Guidelines for financial analysis:

Using Payback Period — It is the duration of time required to recover the cost of an investment.

• While using the Payback period may help in making decisions on investments, it is convoluted towards a cost being recovered in a short time rather than looking at larger benefits that may be realized in the longer term.
• Using the payback period for investments is useful when liquidity is limited and investments are to be made on a sequential basis.
• This method may be used either with or without discounted cash flows.

Using Net Present Value — It is the difference between the present value of cash inflows and the present value of outflows.

• NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account.
• NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield and is used in capital budgeting to assess the profitability of an investment or project.

Using Internal rate of return (IRR) — It is the discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero.

• Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project.
• As such, IRR can be used to rank several prospective projects a firm is considering.
• Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.

Using Return on Investments — ROI measures the amount of return on an investment relative to the investment’s cost.

• To calculate ROI, the return (or profitability) of an investment is divided by the cost of the investment, and the result is expressed as a percentage or a ratio.
• A key limitation of ROI is that it does not take into account the time value of money. ROI should ideally be used when time horizon of benefits is not too long.
• The returns can be discounted to account for time value of benefits, however, in such a case it is better to use IRR.
• When comparing two investments, ROI must be annualized.

Selecting the Discounting Rate — When analyzing initiatives for financial profitability, the benefits and costs need to be discounted to reflect the present value of a future benefit or cost.

• The discount rate must be equal to what the capital for technology investment costs a company.
• WACC (Weighted average cost of capital) is the weighted average of various sources of capital and considers both cost of debts and cost of equity.
• Since the cost of equity comes from the CAPM (Capital Asset Pricing Model), it also considers various risks that a business faces.
• For strategic projects, it is recommended to use the WACC because there are uncertainties related to future market conditions.
• For projects with a short term benefit horizon, only the cost of debt is used by some organizations, making the projects more viable, since the cost of debt is generally lower than cost of equity and WACC.

Applying Capitalization — Capitalization means recognizing an internally developed software as a fixed asset.

• It helps the CFO to reduce the impact on P&L (Profit and Loss) statement by capitalizing certain costs and reducing the costs shown as expense.
• While the accounting standards specify which costs can be capitalized, there are company specific rules as well, and both need to be complied to
• Generally, if the software is developed for internal use and not for sale, then:
• preliminary costs are expensed
• application development may be capitalized (non-development costs such as, data migration, training and administration, must be expensed)
• post development costs are expensed

It is a good practice to divide the costs under such groupings so that the CFO organization can provide clarity on costs that can be capitalized

Applying a foreign exchange factor — In cases where the license or service for technology needs to be paid in a foreign currency, the impact should be considered.

Using Optimism Levels (% of Estimate) of Indirect benefit — This is a useful method to demonstrate various scenarios of potential benefit realization, giving different values of the financial ratios. Stakeholders can choose the scenario that reflects their optimism of benefit realization from the technology investment.

Sample illustrations demonstrate a way of building the financial analysis.

.Defining direct and indirect benefits with optimism levels

Calculating the financial ratios

Demonstrating scenarios for benefit realizations

Demonstrating net cash flows and breakeven point

Risks (of not doing it)

Risks or consequences of not undertaking a technology initiative can include an impact on one or more of the business risks that most large organization monitor:

· Strategic risk

· Compliance risk

· Operational risk

· Financial risk

· Reputational risk

The risks must be demonstrated with two attributes: ‘Severity of risk’ and ‘Likelihood of risk’.

Severity and likelihood of risk can be qualitative or quantitative depending on the type of risks. Strategic and reputational risks are generally not quantifiable, financial and compliance risks are usually quantifiable, and operational risks are partly quantifiable.

For a financial services company, the business case for investments into an analytical modelling platform, was based on the risks related to IFRS9 and BCBS239 compliance. The risks were divided further into data integrity risks, model management risks and reporting risks. For each risk, the potential level of non-compliance and possible financial impact was demonstrated.

Relevance of Organizational Change Management

Many organizations underestimate the impact of a technological change on employee and organizational culture.

The adoption of change management principles is imperative to a successful transformation, and must be highlighted as a critical success factor in the business case.

All stakeholders whose functions, roles or teams are likely to be impacted through the initiative, must be taken on board at the time of business case approval, otherwise the business case will face a stumbling block even after initial approvals.

For example, an enterprise mobility solution may create opportunities for improving employee productivity and satisfaction by providing anytime, anywhere access. However, such opportunities may not yield benefits unless your organization supports an anytime, anywhere work culture by adapting its leave and tracking hours policies. Such policies have an enterprise-wide impact and affect many stakeholders who must be taken on board to support the business case.

Conclusion

In the words of Bruce Greenwald, ‘In the long run, everything is a toaster’. Rapid technology evolution means that technologies are quickly ready for adoption and for adding business value, and delay in adoption is likely to reduce the associated benefits because the technology would have become a commodity and a hygiene factor. In a highly competitive business environment, the importance of moving early with a technology adoption cannot be overstated. The ability to create a compelling business case for technologies can be a critical difference between success and failure of businesses.