Why is being a CIO such a tough job? Understanding ROI

In a previous blog on this general topic, I mentioned the importance for the CIO to understand Return on Investment (ROI) and its purpose in the area of financial management. Historically the concept of ROI and its various measures including payback period, internal rate of return (IRR) and net present value (NPV) were designed to allow an organization to rank alternative capital investment opportunities with different cash flows as part of their capital budgeting process. Those with the greatest ROI relative to risk were selected and funded.

As I learned in graduate school, one of the most common mistakes people make in applying ROI methodologies is to focus on the measurements themselves and not the underlying assumptions surrounding the cash flow forecasts that produce the ROI. Here is an example from my own experience.

When I was the CIO for the Department of Human Services (DHS) in Oregon, we initiated a state wide data center consolidation project. Seventeen agencies participated and DHS was the largest. The capital investment was estimated to be approximately $24.0 million to build a new state of the art data center. In order to justify the investment the Department of Administrative Services (DAS) was required to show a two year payback in cost savings, based solely on projected personnel savings (i.e., you don’t need 17 data center managers in a consolidated facility). A two year payback is roughly a 50% IRR.

When the project was completed, DAS and the state legislature considered it a failure because the estimated personnel savings were not achieved. To fill the hole, the state agencies who participated were required to cut their budgets by the amount of the shortfall, which displeased the agency heads and agency leadership in general. It was seen as another IT fiasco. What went wrong?

First and foremost, setting an ROI goal for this project at a two year payback or 50% IRR created the wrong incentive for management. In order to achieve this goal, DAS artificially reduced the number of staff required in the new consolidated data center and accelerated the staff reductions to increase the projected savings and achieve a two year payback. This was a mistake and lead to the perception of a failed project, reinforcing my earlier point that the validity of the cash flow projections is paramount. So where did Oregon go wrong?

Essentially, the cash flow projections didn’t reflect reality and were backed into in order to achieve an arbitrary ROI goal. Here are some examples of items that were overlooked:

1. In the out years, the new consolidated data center had the capacity to provide computing services to all state agencies. This benefit was not estimated or included in the cash flow projections.
2. The project consolidated 17 separate agency data networks generating significant savings not included in the cash flow forecasts.
3. The consolidation of the data centers freed up valuable real estate in agency headquarters that was not valued or included in the cash flow forecast.
4. The construction of the data center was completed on schedule and at a cost $2.0 million below the budgeted $24.0 million.
5. Positions were eliminated (approximately 30+ at DHS) and the people who were in these position were able to fill other jobs that were vacant, leave state government for the private sector or retire.
6. The need to invest in 17 separate facilities going forward was avoided but again this benefit was not estimated or included in the cash flows. The State wouldn’t accept cost avoidance as a benefit but maybe this has changed after Katrina and the Gulf of Mexico oil well blowout.

Bottom line, an IT project that produced substantial benefits to the State over the long run was deemed a failure due to highly suspect ROI analysis and guess who took the heat, the CIO’s. In reality and taking into consideration all the benefits produced, if this project achieved a 4 year payback and only a 25% IRR, that’s a lot better than I’m doing in the market.

Why is being a CIO such a tough job? Meeting the tactical and strategic elements of your role

In my last blog on this topic, I raised the following question. What other executive position provides services to every other aspect of the business and what are the implications of this unique role? Generally speaking from my experience the only other functions whose primary role is to service other areas of the business are the “staff” functions. These include human resources, public relations, and to some degree, finance. The “line” functions including marketing, sales and operations are customers of these staff services and rarely if ever have an internal services role. They are totally focused on servicing the firms’ customers and creating and delivering high value products and services.

What makes IT unique is the intensity of the services it provides to the organization. Some examples;

• Are the organizations desktop, laptop and more recently mobile devices working properly and being properly maintained? Are the users properly trained? Are these devices secured?
• Is the firms networks, both voice and data, meeting the organizations requirements and properly secured?
• Are the organizations primary applications working properly and being adequately maintained? Are these applications technologically obsolete and need to be upgraded or replaced?
• Is the organizations data safe, secure and properly structured to meet the organization’s needs? Is the organization taking maximum advantage of data management and discovery tools?
• Is the organization Internet presence meeting its needs?
• Etc…, etc…, etc… and the list goes on.

The point is, unless these and other basic services provided by IT are “buttoned up”, there is likely to be little chance to become a strategic partner with the line executives. This means that the CIO must first assure that his/her department is delivering its services in a high quality and reliable fashion and seen as meeting or exceeding the expectations of the organization. Depending on the situation you face, this requirement of the CIO can take a significant amount of time.

So what is the solution to this dilemma, the desire to focus on the strategic business needs of the organization and the basic responsibility to assure that all IT services are being effectively and efficiently delivered? I think the starting point is to assure that your direct reports have the requisite skills to provide top quality IT services and to do this is in a way that reflects a high level of customer service. As the CIO, you need to communicate to your C-level peers that you understand these responsibilities of your position and make sure they know who specifically within your organization is responsible and accountable for the provision of these services. You also need to listen to and understand your peers’ views on the quality and level of service that IT is providing.

Having set the proper level of expectations on basic IT services, the CIO needs to sell their C-Level peers on the potential opportunities to apply technology to increase revenues, reduce costs and lower asset investments that collectively increase the profits and returns of the business. There are many ways to accomplish this but one of the best is to demonstrate your understanding of the business and where these opportunities exist.

One approach to getting there is to create a small group of analyst that have strong business and IT backgrounds and imbed them in the line organizations. These analysts should study all of the organization’s processes and identify where IT investments can have a significant impact and build the business cases that justify these investments. They should perform this role on a collaborative basis and in partnership with the line organization.

Dealing with this dilemma in the CIO’s role between tactical requirements and strategic focus is a challenge. It must be addressed head on and in a way that assures that IT has the opportunity and capability to be a strategic partner with C-Level peers.

William A. Crowell
wcrowell@asuret.com
twitter: billcio
LinkedIn: Bill Crowell
My Blog: http://bcrowell.wordpress.com/