Technology Leadership: What's It Worth?

By Paul A. Strassmann

To my misfortune, Xerox had just recorded a steep decline in profit and revenue growth. The increase in my IT budget exceeded the anticipated revenue increases for the coming year. All the Board wished to hear was how the proposed outlays for IT spending contributed to the profitability of Xerox. On the surface this appeared a simple enough request, but after some analysis and reflection it became clear that the request was far from simple.

In 1974 I was responsible for Xerox's global IT spending. There were 86 operating units, each spending a great deal of money on IT-and I couldn't be sure that the IT money was being spent prudently. The stark reality was that there was no way I could perform global cost-benefit analysis to anybody's satisfaction. When I looked at my peers in other companies it became clear that none of them could prove how IT related directly to corporate profits, either.

What was true in 1974 with regard to cost justification of IT still holds true for most corporations. Multidivisional global corporations have serious difficulty even discovering their total level of IT spending. When they then attempt to correlate IT spending with divisional profitability (something I have done quite often) the resulting patterns are random and completely unrelated. In government agencies the problems of evaluating the contributions of IT are much worse: since the value of services cannot be measured there is no way one can evaluate the benefits of overall IT spending with overall IT benefits except by making the preposterous assumption that all work would be performed only using pencils and paper.

In the absence of a rigorous discipline for measuring the effects of IT on results, thousands of corporate and government leaders are suffering from a case of the Emperor's New Clothes: they believe that their investments in IT are sound, reasonable, and productive because everyone else believes that as well. What is lacking, however, are proofs that their assumptions apply in their particular situation. Unfortunately, in the rush to spend money on the latest and best IT the result is that many corporations' IT infrastructures are draining economic value every day. The reason for that is not that the technologies are intrinsically faulty. The economic drain arises from applying IT to solving the wrong problems or in using IT to magnify or accelerate undesirable business practices.

Many corporate leaders are blinkered from this truth by the continual hyping of IT in the media and by market consulting firms who conduct IT leadership polls. These polls are unreliable, in part because of small sample sizes but chiefly because the questions are asked of IT proponents or staff personnel with no way of judging the effectiveness of IT.

Voting on IT leadership by calling IT proponents is intriguing, cheap, and a totally useless way to judge whether leadership is or isn't present in a company. For instance, in September 2000, a well-known U.S. IT magazine ranked 500 companies by their IT leadership achievement. 3Com came out as number one in that ranking. A few months later 3Com was undergoing massive layoffs and its stock price was in free fall. As a rule, failing firms are always more likely to beautify their accomplishments.

Another popular method of identifying technology leadership is to look at IT outlays. In 1964, professor Dick Nolan presented this hypothesis (to be widely known as the "Stages of Growth Hypothesis") in an article in the Harvard Business Review. There he basically said that the company that increases its IT spending faster than others leads the parade in maturity and accomplishment. Today there are a number of consulting firms that produce annual rankings. These are largely based on the assumption that higher levels of spending equal greater sophistication and leadership. I have learned that IT alone cannot save a company's leadership or strategic dilemmas. Believing it will do so can distract leaders and drain precious resources.

What few people take the trouble to do is to correlate spending with actual economic outcomes, such as profits after taxes, or even better, economic value added (EVA). I have done such analyses for 2,865 U. S. industrial corporations. In each case I plotted IT outlays per employee against rates of return on equity (ROE) producing a completely random distribution. Clearly such a scatter plot shows that there is zero correlation between IT spending and economic outcomes. But what else does the data indicate? Does it mean that that the leaders of the companies with negative returns are stupid? And the people in the positive zone are great leaders?

No. The essence of leadership lies in how an individual leader balances and mixes the ingredients of strategic influence to deliver the most effective results. For a quick thumbnail of these factors, I've listed below 12 key determinants of competitive success. The tabulation indicates which conditions are either favorable or unfavorable to profitability. You may observe that prowess in IT is not one of them-IT is a weak and secondary influence that only makes its effects visible through improving (or deteriorating) one of the primary sources of competitive success.

So the disparity between great profits and dismal losses cannot be accounted for by studying IT spending. Why then is it that over 33 percent of U. S. corporations deliver profits that are insufficient to earn the cost of shareholder capital (that is, deliver a positive EVA) when from an IT spending standpoint the losers are not distinctly different from superior performers? Most of the answer to this puzzle can be found in what I believe is the most rigorous effort ever mounted to measure leadership and performance, the PIMS program started in 1965 by General Electric.

In 1974 it became the Cambridge, MA-based Strategic Planning Institute. PIMS answers the question of drivers of profitability as well as anything I have ever observed anywhere else. Incidentally (and in the spirit of full disclosure), I served on its board of directors in the early 1980s.

For over 20 years, PIMS has been gathering information based on reporting of confidential data by more than 3,000 business units belonging to over 300 corporations. I also believe that one of the reasons for GE's consistent ranking as one of the most profitable companies in the world is that the PIMS way of thinking has been embedded in its management and leadership styles. PIMS offers an excellent methodology for diagnosing the impact of different strategies. PIMS obtains its insights by an examination of relevant data from healthy businesses that have consistently shown leadership, profitability, and growth. The measurable traits of the healthy businesses have then been correlated with every other conceivable ingredient of success and used to shed light on the drivers of profit.

This massive body of evidence from PIMS conclusively shows that operating effectiveness- namely how efficient you are, how quickly you get your invoices out, how quickly you get your personal records straightened out, and so forth is important, but less so than proponents of IT tend to advocate. Not more than 15 percent of the factors of profitability can be attributed to operating effectiveness. Clearly a company can be very efficient as it marches rapidly toward oblivion. I've seen it happen.

That does not mean that one should disregard operating effectiveness and forget about invoicing. All this means that what really differentiates corporations is their competitive position, that is, their strategic positioning as well as the strategic moves they make in order to achieve greater advantage against their competitors who are also trying to achieve similar gains. The belief that advantageous strategic positioning is the decisive key to corporate profitability is now supported by compelling evidence.

Go back up to www.strassmann.com