IDC Whitepaper Demonstrating Business Value

7/28/2019 IDC Whitepaper Demonstrating Business Value

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W H I T E P A P E R

D e m o n s t r a t i n g B u s i n e s s V a l u e :S e l l i n g t o Y o u r C - L e v e l E x e c u t i v e s

Sponsored by: Microsoft

Randy Perry Al Gillen

April 2007

I N T R O D U C T I O N

IT professionals today face a number of challenges. As if it were not enough that they

have to stay ahead in one of the world's fastest-changing industries, where new

technologies can emerge and become obsolete in less than a five-year span, they

also must deal with internal business issues, in which top management often views

their area of the business as a cost center rather than as a resource that boosts

employee productivity and improves corporate agility in a globally competitive

environment.

This IDC White Paper is designed to better equip IT professionals to communicate

the business value that IT operations provide to a company's operations by

integrating a focus on the corporate return on investments associated with IT projects.

The goal is to help IT professionals transform how executives in their organizations

value the business drivers enabled by IT projects and, in the process, increase the

ability to justify and fund IT initiatives.

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D E M O N S T R A T I N G B U S I N E S S V A L U E :T H E S E V E N - S T E P P R O C E S S

This paper discusses the seven-step process for understanding, measuring, and

articulating the business value to be delivered by an IT project. The steps are

displayed in Figure 1.

F I G U R E 1

T h e S e v e n - S t e p P r o c e s s f o r D e m o n s t r a t i n g t h e B u s i n e s s V a l u e

o f I T P r o j e c t s

Source: IDC, 2007

S t e p 1 : D e m o n s t r a t e A l i g n m e n t w i t h S e n i o r

E x e c u t i v e s

When attempting to justify a new IT project, IT organizations first must gain alignment

with their parent organization. This alignment must incorporate common corporate

mandates, including managing the growth of costs while improving services or

capabilities. Most important, IT professionals must be able to discuss the project in

terms of not just the underlying technology but also how it will support business

needs, enhance employee productivity, and/or optimize the customer experience.


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2007 IDC #206363 3

At this stage, IT needs to champion a business case to demonstrate how the project

will result in a competitive advantage for corporate objectives. To drive home this

message, IT must make sure that the business case captures and presents business

value metrics such as revenue generation, customer online interactions, customer

growth, and customer retention.

Key actions to take at this stage include:

! Initiate dialog regarding the project with business decision makers and in

particular with the CFO organization.

! Understand the financial decision-making criteria upon which the project will be

evaluated.

! Working with the relevant financial organizations, develop a business case

framework for the IT initiative that meshes with the organization's overall financial

decision metrics.

S t e p 2 : E s t a b l i s h a B a s e l i n e f o r C u r r e n t

P e r f o r m a n c e

Successful organizations establish key performance indicators (KPIs) to identify

potential problems long before they impact the bottom line. KPIs can include internal

metrics such as achieving a particular volume of goods sold or driving toward a

particular mix of premium products. They can also be measured externally, using

factors such as customer satisfaction.

IT departments should establish benchmarks by measuring their current performance

internally with KPIs. These benchmarks should be used as a baseline against which

to compare expected performance improvements to be gained by the new IT

initiative. Benchmarks could incorporate metrics that measure the relationship of IT to

other business units and to the business as a whole, such as average user downtime

hours per year. KPIs could also include upside benefits of IT, such as the volume of

electronic business that its systems and software enable.

The Appendix includes a sample benchmarking guide with several useful categories

that most companies can quantify and track.


! Understand overall corporate performance goals.

! Translate corporate goals into IT performance metrics.

! Establish benchmarks to measure current performance and develop appropriate

KPIs in the areas to be addressed by the initiative.


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S t e p 3 : E s t a b l i s h R e a l i s t i c B u s i n e s s a n d

P e r f o r m a n c e O b j e c t i v e s

Any IT investment should have a measurable impact on a business' overall financial

bottom line, and this step establishes the appropriate financial objectives and analysis

framework based on an organization's overall decision metrics. Organizations measurethe financial impact of investments in a variety of ways, including metrics such as total

cost of ownership (TCO), return on investment (ROI), internal rate of return (IRR), and

payback. The sections that follow look more carefully at some of these metrics.

TCO

TCO is a measurement of the total life-cycle costs of an IT investment, including

acquisition, implementation, management, and retirement. A TCO analysis helps

decision makers determine which solution/product carries the lowest cost through its

entire life cycle.

The challenge is to focus on all costs to the organization not purely IT costs. The

list of cost factors associated with a specific technology, service, or activity is called

the chart of accounts. Traditionally, companies focused on the purchase price of the

technology or the primary capital expense, ignoring the more significant life-cycle

costs to operate, manage, and maintain that technology; operations expense; and the

impact on end-user productivity. More than 4050 distinct factors may need to be

considered when performing a TCO analysis. Table 1 demonstrates how these

factors can be grouped into five major categories.

T A B L E 1

T C O M a j o r C a t e g o r i e s

TCO Groups TCO Methodology

Hardware: Systems, networking, storage, and peripherals

critical to operations.

Initial purchase price amortized over the typical l ife of the

hardware plus annual upgrade and direct maintenance costs,

typically at 1525% of purchase.

Software: Operating system, application, middleware. Initial purchase and annual licensing fees.

IT staff: Full-time equivalents (FTEs) who support the

clients, servers, storage, security, applications, and

users.

Annual loaded salary (salary x load factor to account for

benefits and overhead) of IT staff time associated with

management, maintenance, and training.

Services: Outsourced IT support or technology, which can

include bandwidth and maintenance.

Annual cost of service contracts.

User productivity: As a cost, it is the value of the working

hours users do not have access to the applications

needed to perform their jobs. Network, server, and

application downtime are the primary sources.

Annual loaded salary of user time lost due to application

downtime, discounted by a partial-productivity factor (i.e.,

users can make business calls). As a result, only some portion

of the loaded salary (usually 1050%) is counted as cost.

Source: IDC, 2007


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Through the course of numerous TCO studies, IDC has found that the majority of the

three- or five-year costs comes from two key areas: staffing costs and user downtime.

Figure 2 depicts the typical TCO allocation for a server environment over a three-year

time frame.

F I G U R E 2

T y p i c a l T h r e e - Y e a r S e r v e r T C O

Outsourced costs

(3.0%)Software (7.0%)

Server hardware

(7.0%)

IT staff training

(8.0%)

Downtime user

productivity

(15.0%)

Staffing (60.0%)

Note: The figure is based on over 300 interviews conducted across numerous platforms,

presented in composite form.

Source: IDC, 2007

Because the single largest factor affecting TCO is staffing cost, IT initiatives that can

reduce IT labor costs are likely to find greater acceptance among financial decision

makers, and initiatives that enable IT consolidation or automation can significantly

reduce TCO across the IT infrastructure. Recent IDC research has shown that such

technology initiatives coupled with organizationwide improvements in IT management

processes can reduce IT labor costs by as much as 50%.

Translating Cost to Value with ROI Analysis

In addition to quantifying the costs associated with the chart of accounts, most

organizations also require a metric to estimate the business value to be delivered by

the investment. Perhaps the most widespread metric used in this regard is ROI.

ROI is the financial return expected to be delivered by an investment and may

encompass multiple methodologies for describing the cash flow of the investment. ForIT managers, describing projects in ROI terms yields two benefits:

! The ability to articulate the expected benefits of the IT investment on the

business in financial terms

! The ability to compete for resources on an equal footing with projects from other

business units


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Conducting an ROI analysis is an extension of simple cost-benefit analysis, which

compares a current environment with a projected environment. Benefits are quantified

from the changes in the IT department and related changes in the overall

organization. Quantifiable benefits fall into three groups:

! Cost reduction. This category refers to actual reductions in operational costs,

such as expenditures on personnel, outside services, or capital expenditures for

hardware, software, or space. Cost reduction usually results from more efficient

management of resources, which enables the IT group or supported group to

reduce spending on resources or grow without increasing resources.

! Increased productivity. This category refers to better productivity on the part of

both end users and IT staff. Ideally, increased output will have a fairly direct

financial value such as increased sales, more invoices processed, or reduced

overtime. Such productivity gains are easily quantifiable and easily justified.

When increased productivity gains are realized outside the IT department, a

cooperative effort is required on the part of IT management and operational

department management to quantify the benefits.

IT staff productivity translates to IT staff having more time to perform higher-level

activities to support the business or engage in projects that have been put on

hold for lack of staff resources.

! Increased revenue.A well-managed IT environment can impact revenue in four

ways:

# Speed time to market. By getting products and services to market faster,

an organization may be able to establish market share sooner and grow it

more quickly, increasing overall revenue for the business.

# Improve Web site reliability. For a business that relies on ecommerce, amore reliable Web site results in less potential for lost revenue. In the long

run, customers may migrate from competitors' less reliable sites, thus

increasing market share.

# Improve customer service. A more reliable infrastructure that can help

expeditiously deliver business solutions may lower customer churn and

provide greater opportunity for upselling and cross-selling.

# Provide IT services as a product offering. An efficient IT department that

can develop cutting-edge solutions may be a candidate to offer services to

external customers, turning IT into a direct profit center.

An ROI analysis enables IT professionals to leverage the TCO analysis to create a

business case for a financial decision maker. For example, a TCO analysis is useful

to show that a migration to a next-generation server platform will lower the total costs

related to delivering a specific service over time.


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By comparison, using an ROI analysis, an IT manager can compare the cost savings

identified in the TCO analysis with the costs for the servers and justify the return for

implementing a server consolidation initiative that involves obtaining funding to

purchase those next-generation servers.

The Appendix includes a list of financial terms used in ROI analysis, as well as a

sample ROI analysis, including the multiyear investment profile and cash flow

analysis, for a hypothetical server consolidation investment.

Payback

IT projects tend to have initial up-front investments, with the benefits phasing in and

growing over time due to several factors:

! Deployment time. Deployment time is associated with even simplistic

deployments. Even IT services require some time to transition. Benefits cannot

start until after the deployment period.

!User adoption. After full deployment, there remains a learning curve whereusers are not realizing all the benefits. As IT and users become familiar with the

technology, the impact of the technology's benefits will grow.

! Growth.As the number of users grows so do the benefits, especially when tied

to efficiency and scalability.

At some point, the benefits realized exceed the cumulative investment, and the cash

flow for the project becomes positive. This is the point at which the project pays for

itself, and it is known as the payback period.

Variables Affecting ROI Analysis

A number of variables affect ROI analysis, including:

! Determining the appropriate ROI level. Organizations may ask themselves

"How much ROI is enough?" The answer varies with each organization.

Go/no go hurdles may be set so high that they exclude nearly all IT investments

from the discussion. For example, from late 2002 until only recently, many

companies had set payback periods to as low as three months. This policy was

put in place to discourage IT investment.

! Analysis time horizon. When embarking on an ROI analysis, an organization

must be clear on the time horizon for the analysis. Because investments typically

occur up front with benefits stretched out over time, the longer the time horizon,

the better the expected ROI will typically be. Most organizations require three- to

five-year horizons for ROI analysis.


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! Settle on financial performance metrics to be used to judge the investment: TCO,

ROI, payback, etc.

! Establish specific performance thresholds.

! Apply financial models to demonstrate expected financial benefits to be derived

from the project.

S t e p 4 : I d e n t i f y t h e B a r r i e r s , R i s k s , a n d

S o l u t i o n s

All investments have risks. The successful business case identifies risks and shows

how they can be overcome or mitigated, even in a less-than-optimal deployment

experience. Some risks that typically need to be addressed are as follows:

! User acceptance/adoption. Deployment takes longer than planned, or benefits

are delayed because users are slow to adopt.

! Vendors and service providers. Critical technology providers do not deliver on

time, execute poorly, or go out of business.

! Management commitment and funding. Management changes to project

priorities delay deployment.

! Human resources. Limitations include lack of training or not having the right

people to execute and manage the project.

! Technology. Technology implementation is affected by early obsolescence,

incompatibility, lack of standards, or limited scalability.

! Market. Competitive pressures or customer demand push back the project.

! Legal and governance. Unforeseen or new requirements create additional

costs.

! Organization. Political infighting or parent company relationships limit benefits.

! Dependencies. One project is dependent on the completion of another project,

and the first project is delayed.

! Financial. The organization's financial position changes adversely, affecting the

schedule or canceling a partially completed project.


! Identify barriers and risks associated with the project.

! Develop mitigation strategies for showstopper risks.


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S t e p 5 : D e v e l o p a R o a d M a p

In addition to justifying individual projects, an IT organization must demonstrate the

value to be provided by its overall portfolio of investments and how the investments

work together to support the organization's overall goals. An IT road map shows how

the technology infrastructure will evolve to meet these goals, starting from where it istoday and typically extending out three to five years. The road map includes much

more than technology and should include key dependencies, activities such as

implementation of IT management best practices, and development and training of

both IT staff and end users.

As the road map nears completion, it should be presented to senior management to

gather input and to demonstrate that future personnel and technology initiatives are

part of a structured plan that benefits the organization.


! Create a three- to five-year road map with specific IT goals and objectives.

! Show key technology road map dependencies.

S t e p 6 : S h o w H o w E a c h P r o j e c t F i t s i n t o t h e

R o a d M a p

With a big-picture plan in place, an IT organization should articulate how each project

ties into the overall road map and contributes to long-term and short-term business

goals. At this stage, the business cases developed for each subproject are applicable.

Each project should contribute to the overall plan, and IT projects or investments

should be managed as a portfolio. Larger or more risky projects can be grouped with

projects of more certain returns so that the failure or delay of one project does not

jeopardize the entire plan.


! "Slot" each project into the road map.

! Demonstrate each project's role in the overall plan.

! Articulate the specific value of each project to the organization and of its role in

the overall technology road map.

S t e p 7 : M e a s u r e , A n a l y z e , a n d C o m m u n i c a t e

The final step consists of measuring the business metrics resulting from the IT project

investment; performing necessary analysis to measure the actual financial impact,

measured in TCO, ROI, or other means favored by the organization; and

communicating those results to senior management. This critical, but often

overlooked, step enables the organization to learn from its experience and factor

those learnings into the initial analysis and objective-setting stages for future projects.


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Organizations should periodically benchmark the overall IT environment and monitor

KPIs specific to each project and assess the results to tweak the plan and

demonstrate progress to senior management. Follow-up cost-benefit analysis should

be conducted three to six months after the rollout of each major project to show

success and establish a track record so that the next project will be easier to justify.


! Measure the project's performance against the benchmarks identified in earlier

stages.

! Perform financial analysis using the models and framework adopted by the

organization.

! Communicate performance against the plan back to executive management.

! Be flexible. Corporate goals will change and so must your plan.

C H A L L E N G E S / O P P O R T U N I T I E S

Demonstrating the business value of IT investments presents challenges and

opportunities. Challenges to IT include gaining fluency in the language of financial

analysis and decision making and working with financial and executive audiences to

articulate the business value proposition of IT investments.

The opportunities associated with successfully selling IT projects to C-level

executives are significant and can include savings in IT labor costs, the potential for

improved business agility, and the ability to better serve customer needs. Such

opportunities can help organizations create true differentiation versus competitors.

Some of the specific challenges and opportunities identified in this IDC White Paperinclude:

! Selling the strategic value of IT initiatives. Selling the value of IT projects to

C-level executives requires that they view IT not merely as a cost center but as a

strategic enabler of corporate business strategy.

! Addressing under-resourcing in IT. Over the past five years, many companies

have squeezed their IT budgets by delaying the acquisition of new technologies

and by periodically reducing IT staff. This trend has left many organizations

seriously under-resourced to address new opportunities and poorly equipped to

capitalize on long-term growth opportunities.

! Repositioning IT as a business enabler. IDC believes that CIOs and senior IT

managers should reposition IT operations as a well-managed critical resource to

support business growth rather than treat it as a cost center that needs to be

starved to minimal life-support levels.


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C O N C L U S I O N

IT is one of the world's fastest-changing industries, and process changes at the

business level can force major architectural changes to applications and

infrastructure. At the same time, IT operations are the lifeline for many organizations'

ability to address next-generation customer needs and go-to-market models.

Yet, too often, corporate management perceives IT as a cost center rather than as a

resource that boosts employee productivity and improves corporate agility in a

globally competitive environment.

IT professionals today need to:

! Change corporate culture to organize and manage IT like a business. If IT

management believes that it is running a cost center, then IT will be a cost center.

! Establish the use of business value metrics for IT when dealing with corporate

executives. Remind senior executives that responding to companywide

challenges requires a well-managed IT department.

! Promote the value of IT and speak to other corporate management through the

use of business terminology. Leverage business-oriented benefits of IT

investment as opposed to traditional cost reduction discussions.

! Utilize the seven steps outlined in this paper, tailored to the specific requirements

of each organization.

Companies can realize substantial organizationwide long-term benefits if IT

professionals can build a better dialog and understanding with C-level management.

Improved communication can result in benefits to an IT organization the next time a

major IT project needs to be funded or the next time a corporation needs to reduce

costs while boosting capabilities.


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A P P E N D I X

S a m p l e B e n c h m a r k i n g G u i d e

Table 2 provides a sample benchmarking guide, which is associated with Step 2:

Establish a Baseline for Current Performance.

T A B L E 2

S a m p l e B e n c h m a r k i n g G u i d e

Financial IT Efficiency Service Quality Best Practices

IT budget per user PCs/PC management staff Downtime hours per month Backup and recovery plan for

client systems

IT budget/revenue Servers/server administration Annual hours per user Backup and recovery plan for

server systems

IT operating expenses/

IT capital budget

Network devices/networking

staff

% proactive - total staff

Average number of help desk

calls/week

Annual calls/user

MTTR (hours)

Time to launch new business

application to 95% of users

(months)

Client system management

Server management

Client applications

management

SLAs

Note: For each area under Best Practices, answer a) no strategy/policy, b) have policies but not enforced,

c) policies enforced and some automation, d) fully automated across the enterprise.

Source: IDC, 2007


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R O I A n a l y s i s T e r m s

Table 3 provides a list of financial terms typically used in ROI analysis.

T A B L E 3

F i n a n c i a l T e r m s U s e d i n R O I A n a l y s i s

Term Definition Use

Net present value (NPV) Given an interest rate, NPV equals total

benefit minus total cost, discounted to

reflect value in initial year of investment.

All investments should use NPV.

Discount factor Percentage reduction of the value of

future cash flows accounting for inflation

and risk. Many companies use the rateat which they can borrow (cost of

capital) plus a risk factor.

Usually a companywide standard, but

may vary by type or size of investments.

Return on investment (ROI) NPV/(total investment). Used to rank investments. Must be

positive.

Internal rate of return (IRR) "Hurdle rate." The value another

investment would need to generate in

order to be equivalent to the cash flows

of the investment being considered.

Complex equation.

Usually a companywide standard. Not

useful if the project has a cash flow that

goes positive then negative.

Payback The time it takes for the project to

become cash flow positive.

Usually a companywide standard for

measuring risk. When companies do notwant to spend money, they establish an

unrealistic payback.

Analysis period Time period in years of the analysis. Usually coincides with the operational

life of the technology, but may be a

company standard three or five years.

Source: IDC, 2007

Sample ROI Analysis

To demonstrate an ROI analysis, we consider the hypothetical case of an

organization purchasing two next-generation eight-processor servers (including

hardware and operating system) to replace/consolidate 12 two-processor servers.

Figure 3 provides the annual server investment profile, in which the significant

up-front investment required in hardware, software, and staff is followed by reduced

annual IT staff and maintenance fees in year 1 and beyond.


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F I G U R E 3

S e r v e r I n v e s t m e n t P r o f i l e

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000160,000

180,000

Year 0 Year 1 Year 2 Year 3

($)

IT staff

Training

Maintenance

Install

Software

Hardware

Source: IDC, 2007

This example is fairly typical in that roughly 41% of the total investment in year 0 is

made before any benefits are realized. This heavily front-loaded profile may be

alarming to financial professionals and would require a strong justification on the part

of IT management, for example, by using metrics such as improved business agility

and better employee productivity.

Figure 4 and Table 4 depict the cash flow associated with this example, assuming the

server consolidation deployment requires four months. The investment reflects the

figures depicted in Figure 3, and the benefits are modeled on a 50% reduction in

IT labor and annual maintenance costs. The user environment is growing 20%

annually. In this scenario, the payback period is 15 months and the three-year ROI is

131% (NPV of total benefits/total costs).


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F I G U R E 4

S e r v e r C a s h F l o w

-200,000

-100,000

0

100,000

200,000

300,000

400,000

500,000

600,000

Year 0 Year 1 Year 2 Year 3

($)

Benefits Costs Cash flow

Source: IDC, 2007

T A B L E 4

C a s h F l o w R O I A n a l y s i s ( $ )

Year 0 Year 1 Year 2 Year 3 NPV

Benefits 0 95,793 287,380 517,284 682,820

Costs 155,844 167,869 179,534 191,379 522,241

Cash flow (155,844) (71,896) 107,846 325,905 160,579

Source: IDC, 2007

C o p y r i g h t N o t i c e

External Publication of IDC Information and Data Any IDC information that is to be

used in advertising, press releases, or promotional materials requires prior written

approval from the appropriate IDC Vice President or Country Manager. A draft of the

proposed document should accompany any such request. IDC reserves the right to

deny approval of external usage for any reason.

Copyright 2007 IDC. Reproduction without written permission is completely forbidden.

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IDC Whitepaper Demonstrating Business Value