W H I T E P AP 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 AT 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 en - 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.

©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.

Key actions to take at this stage include:

! 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 measure the 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 40�50 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 go r i e s

TCO Groups TCO Methodology

Hardware: Systems, networking, storage, and peripherals critical to operations.

Initial purchase price amortized over the typical life of the hardware plus annual upgrade and direct maintenance costs, typically at 15�25% 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 10�50%) 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. For IT 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, a more 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.

©2007 IDC #206363 7

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 where users 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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Key actions to take at this stage include:

! 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.

Key actions to take at this stage include:

! Identify barriers and risks associated with the project.

! Develop mitigation strategies for showstopper risks.

©2007 IDC #206363 9

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 is today 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.

Key actions to take at this stage include:

! 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.

Key actions to take at this stage include:

! "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.

Key actions to take at this stage include:

! 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 AL 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 Paper include:

! 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.

©2007 IDC #206363 11

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 en 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

©2007 IDC #206363 13

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 rate at 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 not want 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 en t P r o f i l e

020,00040,00060,00080,000

100,000120,000140,000160,000180,000

Year 0 Year 1 Year 2 Year 3

($)

IT staffTrainingMaintenanceInstallSoftwareHardware

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).

©2007 IDC #206363 15

F I G U R E 4

S e r v e r C a sh 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.