THE ECONOMICS AND POLITICS OF
INFORMATION MANAGEMENT

An account of an executive seminar

by Paul Strassmann
London, 27 June 1996
Reproduced with permission from the KPMG IMPACT Program

Executive Summary
Information productivity: how do you measure it?
Are you spending the correct amount on IT?
Information and Knowledge Capital, winners and losers, and why?
Information governance: how to enhance performance?


    Executive summary

    Productivity is the key to management effectiveness: "Without productivity objectives a business does not have direction; without productivity measurements it does not have control." This is Paul Strassmann's starting point in developing a number of challenging measures of the value and productivity of information within an organisation, based on his analysis of the corporate financial data of thousands of organisations world-wide. His views on information illuminate much of the work on `Information as an asset' that the KPMG IMPACT Programme is currently undertaking through the Hawley committee.

    Paul Strassmann's presentation at the IMPACT Distinguished Seminar held on 27 June 1996 was based on three fundamental beliefs. First, that knowledge and information are replacing capital as the primary sources of wealth creation, so that the successful organisation in the 21st century will be one which cultivates and makes the most of its knowledge and information assets. Second, that what you measure not only defines what you can manage but also dictates your management style; third, that information - who owns it or has access to it - is highly political, and must be managed accordingly.

    He argues that in order to achieve information superiority an organisation must first understand its assets: the value of its information; how well that information is being applied; the true cost of its IT. To this end he has defined measures of information productivity and knowledge capital that can be used to look at the relative performance of organisations and of divisions within an organisation. Once an organisation understands the value of its information assets Strassmann recommends that it establishes a proper strategic framework for the governance of those assets. He described his model governance constitution and discussed how proper governance can enhance the performance of the organisation. Any organisation that attempts to improve its performance by optimising its processes and its use of resources without a governance framework risks wasting effort to achieve volatile or ill-conceived goals, and of failing to understand the true costs or benefits of new systems developments.

    Strassmann advocates that the role of Chief Information Officer (CIO) for information management should be as wide-ranging as that of the Chief Finance Officer (CFO) for the financial management of the organisation. His definition of information management, which includes all information processes, not just those which involve IT, is one not currently shared by many Chief Executives, who more commonly limit the CIO's portfolio to IT processes. Strassmann regards this short-sightedness as the primary reason why computers so often fail to deliver the expected results.

    Paul Strassmann's early career with Xerox included periods as chief information systems executive and vice-president of strategic planning for office automation. He was Director of Defense Information in the Department of Defense, where he was responsible for organising and managing corporate information management for the whole of the Pentagon. He is now an independent consultant and Distinguished Visiting Professor at the National Defense University in Washington and at the US Military Academy at West Point.

Information productivity: how do you measure it?

In an age where information is the key to economic success, information productivity is vitally important. Yet very little work has been done to measure it.

Most CIOs and Boards equate information with information technology. Their efforts to increase information profitability therefore focus on cutting the costs of IT, the current emphasis being on outsourcing computer operations and other non-core activities. Yet Strassmann's analysis of corporate financial data shows that IT costs the average US industrial company only about 2.5% of revenue.

A much more profitable area to address in order to increase productivity is information management. Strassmann defines information management very broadly, to cover all activities that allocate, simplify or reduce the costs of information processes or that increase their effectiveness and quality, whether or not those processes involve information technology. This involves coordinating suppliers, employees and customers in tasks that include managing, training, counselling, coordinating, recording and reporting - all activities, in fact, that are not directly involved in the production or delivery of products and services to the customer. (It is for this reason that the cost of information management is often regarded as `overhead'.)

He approximates the cost of information management from company financial statements as:

    Cost of information management
    = Cost of Sales, General&Administrative + Cost of Research&Development

His figures show that the average cost of information management is about 25% of revenue, and growing. He compares this with the cost of capital, which he defines as:

    Cost of capital
    = (Shareholder equity + Capital surplus) x Interest rate for equity capital

He finds that over 80% of US organisations invest more on information than on capital. This suggests to him that the conventional definition of productivity as return on capital investment (ie net profit / capital) is inadequate, and that information is replacing capital as the primary source of wealth creation.

Strassmann defines information productivity as the return on information management costs:

    Information productivity
    = Value added by information /Cost of information management

where

    Value added by information
    = Net profit - (Financial capital assets x Interest rate for borrowing)

This calculation recognises that capital is a commodity, and deducts the cost of `paying rent' on it. In almost half of the US firms that Strassmann has studied, `value added by information' is negative. A firm may be paying its managers substantial bonuses based on net profit while failing to exploit its information.

In the public sector, which doesn't take account of revenue and capital in the same way, Strassmann's productivity definition is still valid, but regresses to:

    Information productivity
    = Cost of operations / Cost of information management

Strassmann argues that information is fundamentally different from capital in that the more you use it the cheaper and more profitable it becomes. For example, the more Microsoft exploit their customer information to sell new products, the lower their costs become and the more profit they make.

He advocates taking regular measurement of information productivity in order to evaluate trends, to identify the principal causes of misalignment between information spending and productivity results, and to identify danger areas where the organisation is doing worse than its competitors.

Are you spending the correct amount on IT?

IT's share of total capital expenditure has increased steadily since the 1970s to the extent that in a significant number of organisations IT spending now exceeds the value added to the organisation by information. Nevertheless, Strassmann's measurements show that there is no direct link between IT spending and return on equity. Neither does he find evidence of the predicted savings in manpower costs from using IT to flatten organisational hierarchies.

His measurements do confirm that the number of information workers in an organisation is directly related to spending on information management (measured in terms of Sales General & Administrative + R&D), as it is to IT spending. This is unsurprising, since each information worker increases the management overhead and adds to the demand for computer equipment, infrastructure and IT support.

His general equation for IT spending is:

    IT spending
    = a + b*(Cost of Sales General&Administrative) + c*Profits + d*Desktops + e*Professionals - f*Executives

where a,b,c,d,e and f are constants that vary for different industry sectors. (Strassmann suggests that spending decreases for each executive because it is already paid for since the executives' high costs are already included in the Sales, General & Administrative expense line item.)

His findings suggest that outsourcing (other than in a carefully chosen piecemeal fashion) tends to increase IT spending and to decrease information productivity in the medium term, because it involves `giving away' information that may be expensive to re-acquire. His findings also confirm the fact (widely suspected among IT Directors) that an increasing proportion of IT spending is not covered by the IT budget, but is subsumed into administrative costs. (Strassmann now routinely adds 22% to the published IT budget to allow for this.)

A CIO needs to be able to compare IT expenditure with that of competitors, both in absolute terms and in terms of cost per information worker, in order to assess his/her organisation's effectiveness. It is also useful to compare divisions within an organisation.

Information and Knowledge Capital, winners and losers, and why?

The wealth of an organisation is based on its accumulation of useful knowledge - its knowledge capital. The value added to an organisation by information, discussed above under `information productivity' can be regarded as an annual return on its accumulated knowledge capital. Mirroring the calculation of financial capital as annual return / interest rate, Strassmann defines and calculates an organisation's knowledge capital as:

    Knowledge capital
    = value added by information / interest rate for equity capital

As we have already seen, information assets often exceed capital assets. Arguably, therefore, organisations should take the same due care of information assets as custom, policy and government regulations requires them to take with capital assets. This is particularly important because knowledge is easy to steal - both legally by, for example, `poaching' key employees and illegally by `cyber crime'.

Knowledge capital clearly resides in the heads of employees, not just in terms of the skills they possess but also in the relationships they have developed and in their shared culture and history. Thus a low staff turnover is likely to have a double benefit, leading both to a high knowledge capital (provided that the staff are delivering value from the information they possess) and to reduced management costs, especially for recruitment and training.

Knowledge capital also resides in the minds of suppliers, distributors and customers, for example in the following:

  • brand-name recognition and trust;

  • reduced customer costs for using a firm's products and services;

  • reduced supplier costs by developing a `special' relationship with a firm;

  • features included in products and services to simplify purchasing decisions.

    Strassmann believes businesses will be competing in in this area in the future, as technology allows products and services to be tailored to individual customers' requirements and preferences and opens up new ways of doing business. Important examples include the use of the Internet to purchase items anywhere in the world without currency problems or intermediaries, and Microsoft's ability to exploit the knowledge capital of its customers (in locking them into its products as well as in passing onto them much of the cost for testing new software), which is an important reason for current success.

    Organisations should therefore plan and budget for the accumulation of knowledge capital to improve their competitive advantage. Conversely, organisations which diversify into new business areas without quickly acquiring a knowledge base in these new areas dilute their knowledge capital and suffer competitively as a consequence. For example, the performance of Federal Express, whose reputation as a packaging company was one of information excellence, suffered dramatically after it diversified into air-freight.

    Strassmann described the use of BizcaseTM, a proprietary software tool that takes a business proposal through strategic planning, project costing, benefit analysis, risk assessment, comparison with alternative solutions and business modelling.

    The use of such a standard process for all business proposals can substantially enhance knowledge capital in a number of ways:

  • familiarity of presentation style enhances the reader's understanding;

  • standardisation helps to ensure that nothing is overlooked;

  • consistency of presentation allows costs and benefits of competing projects to be compared;

  • familiarity with the process leads to reduced costs for presenting new proposals.

  • Information governance: how to enhance performance?

    The success of an organisation increasingly depends on the speed and skill with which useful knowledge is acquired, shared and applied. This demands that managers perform a balancing act between setting policies to ensure that corporate information can be used effectively and allowing individuals the flexibility to innovate. Few organisations set information policy explicitly, though it is implicit in every casual purchase of a PC and in the development of every non-standard computer system. As the pervasiveness of information increases, the possibilities for conflict grow (and so does the size of the information management budget) and the need to set policy explicitly becomes stronger. As information replaces capital as the real source of power, the politics of who owns or has access to information becomes more strident. Strassmann defines information governance as the creation of structures that will exercise the required authority over corporate information while reducing conflict and achieving consensus over its use.

    Within any organisation, the scope of information varies from personal or local through application or process up to enterprise-wide and beyond, where the enterprise interfaces with its customers and suppliers. You need variety and flexibility locally, in order to foster innovation and personal empowerment, but at higher levels within the organisation information must be subject to standards that ensure that it is secure and that it can be shared economically across information systems. The basis for information governance is a constitutional process that defines suitable constraints for each level in the organisation. Organisations differ, but in Strassmann's view none requires more than seven levels of information.

    Strassmann has designed a model governance constitution that can be adapted and refined (and in many cases simplified) to suit individual needs. What is important is that the issues it covers are addressed, that responsibilities are assigned and that the constitution is enforceable. The constitution should ideally endure over many changes of management, to provide continuity for the organisation's knowledge assets.

    The constitution includes:

  • Goals statements that define the concepts of operation of the business and its supporting information systems in years that are beyond the current budget planning horizon. Goals are hardly ever attained completely, but provide a strong framework for the long-term direction of the organisation's information management.

    eg: Voice, data, video and image information systems shall be inter-operable so that any authorised employee will be able to retrieve on a single display information from any source or location.

  • Specific objectives towards achieving the stated goals.

    eg. By 199x all applications shall run beneath a standard corporate graphic interface in which every employee has received basic training.

  • Management policies that define and allocate responsibilities for information management. These should include some `parliamentary process' to allow staff involvement in policy setting. (All policies should be phrased so that compliance can be tested.)

    eg A senior executive, reporting to ......, shall be the chief information officer of the enterprise, with responsibility for the alignment of information management plans and resources with the approved goals, principles, policies and objectives.

  • Policies for the design, implementation, staffing and financial control of information systems.

    eg Information systems shall be developed and enhanced according to an enterprise-wide methodology.

    All corporate data shall be entered into the Information System only once, at the point of initial origin; all subsequent uses of such data shall rely on copies of the original entry.

  • Planning and finance policies for information.

    eg Business plans must show how information systems contribute to achieving committed operating results.

  • Strassmann stresses the parallel between the scope of responsibility of the CIO and CFO. Just as the CFO is accountable for the management, custody, preservation, integrity, security and assurance of all capital assets, the CIO should be similarly accountable for all the organisation's information assets. He believes that it is only a matter of time until the CIO's responsibilities, like those of the CFO, are enforced by policy or regulation.


    The above summary was prepared by Anne Rogers, anne@hollylaw.demon.co.uk

    (c) Copyright 1996, Strassmann, Inc.
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