June 2004      

	WHAT'S NEW! The CIO Conference July 14-16, 2004 Pebble Beach, CA, United States Hosted by SearchCIO To obtain the following new publications from The Alinean Press, Please email: iurrutia@alinean.com - “Using IT Value-Chain Management to Maximize Shareholder Value and Gain Competitive Advantage” by Thomas Pisello and William Johnston - “Return on IT (ROIT™)” Definitions and Glossary
	IN THIS ISSUE: FEATURE STORY: The Importance of Return on IT (ROIT™)» Top 20 Mid-Sized U.S. Businesses Deriving the Greatest Return on IT Investments»
	Quote of the Month "The small and midsize business market will continue to be a major source of opportunity for IT vendors through 2005. SMB IT spending will reach $400 billion worldwide in 2004, and will increase by 7 percent in 2005." – Mika Yamamoto Krammer, research VP, Gartner Research – May 11, 2004
	SEND TO A FRIEND Email this Newsletter to:   ^ Email Address   About Alinean Today’s rapidly changing economic climate supports the renewed need for information technology cost-justification. Alinean aligns IT spending and business performance through research methodologies and customized software tools, which measure and quantify the value of technology investments. For more information on Alinean and its tools for vendors, consultants and IT/Finance professionals call 407.382.0005 or visit www.alinean.com.

The Importance of Return on IT (ROIT™)

Alinean’s research shows that more than 40 percent of IT projects fail to meet expectations, yielding a significant opportunity to improve IT investment performance without any increase in spending.

By measuring expected returns on proposed IT investments and doing post-deployment value audits, companies can use ROI measurement to improve alignment, optimize investment risk-reward profiles, reduce operating costs and gain competitive advantage from their IT investments.

Alinean’s Return on IT (ROIT™) metric is a single key performance indicator that measures the efficiency and effectiveness of IT spending against overall company performance. The metric is a top down measurement of IT spending productivity, correlating IT spending with financial performance into a concise, comparative metric for current performance assessment and planning.

By identifying overall ROIT performance, companies have a meaningful business planning tool that allows them to determine the appropriate level of both IT expenditure and expected results relative to competitors.
 

How ROIT™ is Determined
To measure the overall ROIT, the traditional ROI formula (ROI = Net Benefits / Costs) is used to compare overall company benefits from IT investments relative to the costs of IT.

Benefits are measured in the ROIT formula using an overall corporate performance metric by which many executives and business units are measured - the Stern Stewart EVA® metric, a measure of a company’s sustainable profitability. Although IT is not wholly responsible for positive and competitive EVA results, it is an important and vital contributor, and EVA is the overall net benefit or result of corporate investments and spending, including IT.

Costs in the ROIT formula can be measured as the total IT spending including formal IT spending (allocated and controlled by the CIO and IT group), business unit IT spending (the IT budget controlled by business units and leaders), and indirect (shadow) IT spending (the hidden expenditures of business units and users) to get a complete picture of the total IT investments.

Total IT spending is estimated based on industry research from Alinean and data collected via IDG and IDC on more than 500 companies worldwide. The survey results of the annual IT budget and total cost of ownership (TCO) studies are statistically extrapolated across Alinean’s database of more than 7,000 companies worldwide.¹

[1] Since IT spending is rarely reported in annual reports or financial filings either direct research and surveys or statistical extrapolation is used to derive IT spending. To populate a significant database beyond a few hundred companies requires statistical modeling and extrapolation as Alinean has performed.

Typical IT spending allocation across formal IT spending, business unit and shadow spending. Recently due to increasing project backlog, shadow spending has increased from less than 10% of total spending, to almost 20% in typical organizations.

The formula for ROIT™ is represented as:

ROIT = EVA / IT Spending

Where:

• EVA = Net Profit – Cost of Capital * Shareholder Equity
• Shareholder Equity = Assets – Liabilities
• Cost of Capital is calculated using the weighted average cost of capital (WACC) formula²
• IT Spending = Formal IT Spending + Business Unit IT Spending + Indirect (Shadow) IT Spending

[2] The Weighted Average Cost of Capital (WACC) = ((Equity / (Debt + Equity)) * Cost of Equity) + ((Debt /( Debt + Equity)) * Cost of Debt) where the Cost of Equity = Risk free rate + (Stock’s Beta x Market Risk Premium). The risk free rate is based on the 10-year treasury yield index provided by Reuters (WCB:TNX quote data). The company Beta is provided by Reuters and represents the week-to-week percent price change to the relevant index's week-to-week percent price change for a given period. The Market Risk Premium represents the reward for investors for taking the risk of putting their money in stocks generally. Market risk premium is determined for the economy as a whole, and for the US economy is around 7%. This represents the margin by which the market as a whole has surpassed the performance of risk-free securities over a long period of time. This does not take into account the short term peaks and troughs of the markets, but considers a more secular trend spanning many decades. The underlying assumption is that (over a long period) investors would have driven the prices of shares up or down so as to equate the yield from shares to be equal to the return below which they would not have invested in the market. Over 1926-1996, the arithmetic average of this value is about 7% in the US market. (This number is updated every year in the handbook ‘Stocks, Bonds, Bills and Inflation’ published by Ibbotson Associates).

ROIT™ Leader Characteristics
Alinean’s ROIT research has found that companies can be grouped into four categories based on their IT spending vs. performance characteristics:

• Frugal Leaders –These companies spend less, on average, than their peers on IT, and derive a higher impact from IT and other business investments. These companies often are not innovative in how they apply IT; rather, they take a wait-and-see approach, investing in new technologies as they become mature. These companies often have higher capabilities and more established processes than their peers.

The biggest danger is if the business model for the sector fundamentally shifts; their ‘behind the curve’ position could cause them to lose significant ground and market share. Unless these companies misstep, their leadership position is normally secure.

• Investing Leaders –These companies are, on average, spending more than their peers on IT, but their IT and other business investments are still paying off. These companies tend to have higher-than-average budgets for innovation, or are investing in specific near-term projects and initiatives to reinvent the business or process change using technology. One downside is that when a market retracts, these companies sometimes are not as adept as their more frugal peers in scaling operations quickly to meet changing market demands. In general, these ‘leaders through investment’ are trying to improve their companies’ competitive positioning with strategic spending.

Over time, these companies should improve their market position, reap the rewards from their investments, and become a ‘Frugal Leader’ for a period of time.

• Investing Followers – On average, these companies are spending more than their peers on IT, and are not positioned as well. It could be that these companies are investing in reinventing their business, improving processes, launching new products or other important short-term investments to reap longer-term rewards. It could also indicate that the company is not investing in the right IT projects for strategic advantage and business operating efficiency improvements, has squandered the value from these investments, or has not implemented best practices to help reduce ongoing TCO.

If the ‘Investing Follower’ does not see a move to ‘Investing Leader’ or ‘Frugal Leader’ over time, change is in order.

• Frugal Followers – These companies are, on average, spending less on IT than their peers, and are also not in an attractive competitive position compared to the leaders. These companies often are technology investment laggards, who have some positive traits with regard to their frugal ways, and implementing best practices to help reduce costs. Whether due to a lack of investing in innovative technology, some inherent product lifecycle challenge, or recognizing some other fundamental business shift in the sector, these companies have fallen behind their peers.

These followers often need to migrate in the near term to an investment phase in order to effect a change in their competitive position.

The Bottom Line
ROIT performance is not driven by how much companies spend, but rather by how they spend and how well the spending is managed.

When the overall ROIT results were examined, there appeared to be few direct correlations between IT spending and success. While there are clearly some leaders who are frugal, a company is just as likely to get poor results by under-spending. Similarly, spending more on IT could result in a competitive edge, but can also just as easily be squandered.

For information on how to benchmark your company to achieve greater ROIT please visit www.alinean.com.

Top 20 Mid-Sized U.S. Businesses Deriving the Greatest Return on IT Investments

For the past two years, companies of all sizes have closely monitored the bottom line, dramatically cutting IT costs and delaying projects to stay afloat in a troubled economy. Even as the market shows early signs of recovery, small and mid-sized companies in particular have a tendency to be extremely cautious when it comes to spending. It’s time to reconsider the ‘frugal’ strategy.

A recent study of mid-market companies by Alinean revealed a new trend emerging in the correlation between IT spending and company performance. When the economy was tanking, the most successful strategy for obtaining and maintaining a high ROIT™ (return on IT) often consisted of spending less than the competition, and taking a wait-and-see approach to investing in new technologies. Now companies need to start investing and innovating again to take the lead.

Mid-Market Leaders
Alinean analyzed the ROIT of more than 5,000 mid-market companies, with between $10M and $1B in revenue, and a minimum of 20 employees. Following are the top 20 U.S. companies Alinean identified as deriving the greatest value from their IT investments.

The growing shift in IT spending best practices, from ‘Frugal Leaders’ to ‘Investing Leaders’ is just beginning to take shape. As the market continues to rebound, companies that spend more than their peers on IT – investing in selected initiatives to reinvent the business or process change using technology, and closely managing these investments – are most likely to advance into leadership positions. Alpine Group and The Finova Group are two examples of companies investing heavily in IT, and seeing a high return.

One caveat true in any market: The amount of money spent on IT is insignificant in regards to ROIT, if companies aren’t investing in the ‘right’ initiatives. And while a correlation between IT spending and performance is now evident in several key industries, performance remains dependent on how well the spending is managed.

ROIT™ Across Industries
Often companies compare their IT spending to overall averages from analyst groups. But IT plays a significantly different role in every sector; some, including financial services and pharmaceuticals, rely heavily on IT to create competitive advantage – while other sectors, like education and mining, typically use IT more tactically. The top 10 sectors currently seeing the greatest return on their IT investments include: