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Information technology - should you curtail your investment?

Information technology--should you curtail your investment?

How much will your ability to compete improve if you continue to throw money at your information system? A researcher sets up a few scenarios--so you can be the judge. Is management's fascination with the promise of information technology (IT) over? Recent studies show dwindling or, in some cases, negative returns on IT investments made in the late 1970s and early 1980s. A recent working paper from MIT's Management in the 1990s Program reports that corporations would have earned a better return by investing the same money in non-IT capital such as production equipment. A Morgan Stanley economist claims that in the service industry many large investments in IT have resulted in decreased productivity.

Many senior executives feel let down by their IT organizations. And well they should. They were often led to believe that throwing technology at problems would guarantee results. It hasn't.

Nevertheless, while some companies disparage their investments in information technology, others foresee that information technology still has enormous potential for financial return. Some corporations are realizing significant performance gains by adroitly balancing the mix of strategy, management skill, and information technology.

During the next decade, business corporations will be the crucible of change in industrialized countries. Global competition requires corporations to replace obsolete, top-heavy management structures with lean, energetic, and flexible organizations, and IT will play a major role in that change. To achieve this, forward-thinking corporations are simplifying their capital structures and decentralizing decision-making. Information technology makes new forms of capital and organizational management possible.

The entrepreneurial organization

During the industrial revolution, centralization and specialization produced economies of scale. Hundreds, and sometimes thousands, of people were gathered into assembly-line or specialized functions. The corporation added layers upon layers of management to oversee mountains of detail.

In the information age, computers are making middle managers obsolete. Look at such megacorporations as AT&T, where during the industrial age middle management served the role of interpreting strategy, building plans of action, and communicating tasks downward in the organization. This required many layers of management. The low productivity of this extensively hierarchical organization became apparent at AT&T after it was ordered to divest itself of its regional operating companies. Some 100,000 AT&T employees--one-third of its workforce--were fired. Most of these people were administrators or middle managers.

Information technology enables executive management to communicate down into the organization, eliminating some of the need for extensive interpretation of policies. IT also enables employees at the bottom of the organization to assume more responsibility. Business analysts refer to this phenomenon as the flattening of the organization.

The industrial age required large numbers of middle managers to interpret and relay information. Today, they are being squeezed out of the organization. Senior management is pushing accountability and authority down the organizational ladder. The result is smaller, highly responsive, and flexible entrepreneurial units.

The corporation that uses information technology to leverage the efforts of these small entrepreneurial units will position itself to survive in today's global economy. Corporations that don't take advantage of this leverage will die.

Ironically, new management models reflect a very old form of organization: that of the hunter-gatherer tribe. The optimal number of members in a hunter-gatherer tribe was about 30 people. More people caused the tribe to split. A tribe was a highly communications-efficient, highly mobile group. More than 30 people produced a serious breakdown in that efficiency and mobility.

The same principle applies to today's organizations. Corporations that have structured themselves along the lines of small, tribe-like entrepreneurial units have found new efficiencies and mobility. At the same time, large corporations cannot operate simply as a collection of independent tribes. The tribal-sized groups require a corporate infrastructure to integrate and align team efforts with the overall direction of the corporation. Information technology makes this integration possible.

These tribal-sized groups represent the front line of today's streamlined business organization. For example, Jan Carlzon, president of Scandinavian Airlines, refers to pilots, flight and ground crews, baggage handlers, ticketing agents, and other publicly visible employees as making up the front line of his company. These people work as teams (or tribes, if you will) at each airport. The front line has the opportunity to excel every day in the eyes of the customer.

In airline companies, the front line can't operate effectively without an extensive information technology investment. Carlzon feels strongly that top and middle management must support the front line by enabling it to make decisions at the lowest level. At Scandinavian Airlines, this means giving the front line the necessary information and discretion to take whatever action a particular situation requires.

General Bill Creech has achieved worldwide recognition for his radical ideas on decentralized management. In 1978, General Creech took over command of the Tactical Air Command (TAC) of the U.S. Air Force. At that time, TAC was a huge bureaucracy of 115,000 people. The performance was marginal. Fifty percent of the aircraft couldn't fly. There was one death per 1,300 flying hours. The number of sorties had been declining at a 7.8 percent compounded annual rate for the past 10 years. And, beyond that, it took an average of four hours to get a part to an inoperable aircraft.

In 1984, when General Creech left TAC, 80 percent of the aircraft could fly. The rate of deaths had declined to one per 6,000 hours of flying. The number of sorties between 1978 and 1983 rose at an 11.2 percent compounded annual rate. It took an average of only eight minutes to get a part to an inoperable aircraft.

The key to Creech's success at TAC was the creation of tribal-sized work units. When he arrived, there were three huge pools of workers: mechanics, pilots, and ground support personnel. TAC assigned crews from these pools; crew members returned to the pools after they completed their assignments. There were no permanent teams.

Creech broke up the pools. He assigned workers to teams dedicated to a specific aircraft. Each aircraft represented a small business, or tribe, with its own pilots, maintenance crew, and ground-support personnel. Each team was identified with its aircraft. Under Creech's system, TAC rewarded each team based on its performance. With each team focused on its own business unit, the overall performance of TAC changed dramatically.

New financial models, with added value

American corporations are having tremendous difficulty flattening and thinning out their organizations to prepare for global competition. They usually do so only when threatened by a takeover or after a leveraged buyout.

One reason for this is that in the case of a takeover or buyout, stock prices and interest payments determine the amounts that the corporation can spend on overhead. Without the occasion of a takeover or leveraged buyout, these same corporations are unable to place a value on intangible assets, including information, and overhead, including information work.

In their recent book, Relevance Lost, H. Thomas Johnson and Robert S. Kaplan deplored the fixation of corporate executives on short-term performance of their companies. They felt that the short-term view prevented management from understanding the long-term benefits of intangibles. The authors attributed this attitude to the inappropriate use of information technology in corporations--that is, using IT solely for production tasks and not using it to measure the value and contribution of intangibles and information work.

Computers offer substantial possibilities for assisting management in analyzing the largest element of cost--overhead. Typically, corporate accounting practices lump overhead elements such as management and administration into a huge overhead bucket for reporting in financial statements. A good example is the automobile business. Direct labor now represents less than 20 percent of the cost of an automobile. Another 30 percent is raw materials and components. The remaining 50 percent is considered overhead. Today, new computer-based costing systems can identify total product cost, including intangibles and corporate overhead. With current information technology, detailed accounting for corporate and divisional overheads, earlier considered economically impractical, is now entirely possible.

Understanding overhead, or information work, requires a step-by-step approach. The first step is to study information work. The second step is to set goals for improvement. The third step is to measure actual performance against goals. The final step is to reward performance that results in achieving goals and penalize performance that results in falling short.

A new, long-range approach to determining corporate performance is needed. Assessing the economic value added by a company provides an appealing alternative. Value-added measures assess the company's ability to meet stakeholder expectations.

Two companies face off

Let's take, for example, the actual results of two companies. (The names are changed here.) Both companies make extensive use of information technology for supporting basic operations, for providing information to use in decision-making, and for minimizing the number of middle managers required to run the business.

ABC Computer's 1987 sales were about $2.7 billion. The company accomplished this with 7,228 employees for a whopping $368,161 sales per employee. In the same year, Smith's Pharmaceutical Company sold about $597 million with 2,500 employees for $238,968 per employee. The sales-per-employee method to assess corporate performance shows that ABC employees outperformed Smith's by 154 percent.

Why is there a difference in sales per employee?

At first glance, the difference in sales per employee may be attributed to the companies being very different. ABC produces and markets computers; Smith's produces and markets pharmaceuticals.

Upon closer analysis, however, these companies appear more alike than dissimilar. Both deal in high-technology products that are very dependent on R&D investment. Both sales and marketing organizations rely heavily on wholesalers, distributors, and retailers. Both are highly information driven.

Further analysis reveals that sales per employee is not the same measure as economic value added per employee. Look at the figure below for a calculation of the estimated value added per employee for ABC and Smith's.

At ABC, the sales-per-employee figure includes materials and parts contracted out to other manufacturers. The subcontracted material and parts become part of a value-added chain. The company then incorporates them in higher-level assemblies.

To calculate the value added per ABC employee, subtract such passthrough purchases from sales. In 1987, ABC had a cost of sales of $1.3 billion. ABC is a highly leveraged manufacturing company. Since it subcontracts most of its manufacturing, we can estimate passthrough purchases of components and subassemblies as high as 90 percent of its cost of sales.

Likewise, in 1987, Smith's had a cost of sales of $140 million. Smith's is less leveraged than ABC. The company purchases raw materials and formulations and then passes them on as ingredients in their ethical drugs. An estimate of Smith's passthrough purchases is around 60 percent of the cost of sales.

On a value-added basis, the results are almost equal. Why is this?

One possibility is the similar corporate cultures and market-driven infrastructures of the two companies. Both organizations place a high value on people, invest heavily in training and professional development, invest heavily in personal information technology, and reward team and individual performance. Both have very human-oriented policies and beliefs. Both have very successful profit-based reward systems. As a result, both companies have a reputation for highly cooperative corporate environments. The aggressive use of information technology enhances the achievement of a high value-added-per-employee figure in both of these environments.

Economic value added provides a new perspective on corporate performance. Value-added analysis is crucial to assessing and improving corporate productivity. It clarifies an important issue.

The key to improving productivity is understanding when to make and when to buy. Could ABC improve its value added per employee by bringing subcontracted work in-house? What would the impact be on the value-added-per-employee figure?

If the subcontracted work has less value added per employee than the overall corporate rate has, bringing subcontracted work in-house will reduce the overall value added per employee. In particular, it will dilute the value added by management. To maintain a high value-added-per-employee figure, ABC should continue giving the work to a subcontractor who specializes in lower value-added work.

Value-added analysis is causing automobile manufacturers to rethink vertical integration. General Motors once drew strength from a high degree of vertical integration. Now, vertical integration is diluting GM's management talent, talent that is needed to refocus on the market and the timeliness of new products.

Shortening the business cycle

The Ford Motor Company reported record earnings for 1987, exceeding previous performance for Ford as well as for any other automobile manufacturer. Much of Ford's success can be attributed to its being the first American company to bring out the design of the '90s, with advanced IT and an entirely new aerodynamic body. The Taurus and Sable models are each a smashing success.

General Motors, Ford's major U.S. competitor, actually had similarly designed models on the drawing boards before Ford. The major difference in performance between the two auto manufacturers is the length of the business cycle for each.

Ford management aggressively tackled the issue of management overhead in the late 1970s and early 1980s. In addition to reducing the overall number of middle managers, Ford also invested in improving quality and automating manual design and engineering functions. Management carried out its quality programs at all levels of the organization using computer-integrated manufacturing (CIM) as the foundation. The result was:

* Lower overhead costs. * A more capable direct work force. * Lower direct costs per auto. * Reduced lead times for implementing changes. The last result, reducing lead times, turned out to be the key to beating GM to the market. While GM's business cycle from initial design to deliverable product is four to five years, Ford's is three to four years.

When you are last with new models in the market by a year, you will lose more than a year's revenue. The latecomer must win back the loyalty of lost customers, a process that can take several years.

Japanese automobile manufacturers already had business cycles that equaled Ford's 1987 turnaround. As a result, Ford didn't take market share from the Japanese. Rather, it gained its increased market share from General Motors.

Information technology played a key role in reducing the business cycle of the Ford Motor Company. Ford made IT investments that satisfied customer needs by daring to break with its conservative tradition. Because Ford automated the design-to-manufacture process, management accepted larger design risks. Computer-aided designs (CAD) were transferable to computer-aided manufacturing (CAM) machines. The computer-aided operations resulted in improved overall lead time, quality, consistency, and cost. The result was record profits.

General Motors likewise made a significant investment in the CAD/CAM technology. Nevertheless, the focus was on producing lower-cost automobiles rather than on satisfying customer needs for distinctive models. The various GM divisions used a standard body type for their Chevrolet, Pontiac, Oldsmobile, Buick, and Cadillac models. The luxury models suffered the most because there was very little design difference between an expensive Cadillac and a much cheaper Chevrolet. So most of the 10-percent market-share loss over the past two years came from the more profitable luxury line. The results were sagging profits.

Truly the information age

American businesses are trying to create win-win solutions through innovative applications of information technology. Higher quality and reliability mean more value delivered. More value delivered and lower costs result in increased shareholder wealth. In a service-conscious economy, the corporation, its customers, its shareholders, and all other parties with a stake in the enterprise can realize benefits. These parties with a vested interest in the success of the company, the company's stakeholders, are a key ingredient in creating value-added service and long-term corporate financial success.

In 1985, information work represented about 55 percent of the workforce. All industry segments have information jobs. That information work is replacing direct population work is key to the new business era. By 1995, information work will represent 67 percent of the workforce. The key to managing information work is understanding its relationship to creating value for the company's stakeholders.

During the industrial age, economic studies focused on the use of labor and material in producing goods and service. Charles Babbage and Frederick Taylor pioneered scientific management. Using scientific management, industrial enterprises discovered efficiencies in the use of labor and material.

In the information age, information is the transforming resource, and we need to measure the impact and value of information work as it relates to value. For example, quality provides economic value for the company's customers. Information work that improves quality and the value of the product is valid work. Information work that produces no perceivable value to the company's stakeholders should cease.

Using information technology to create and measure the value that is added per employee, team, department, and division will lead to realizing the company's economic potential.

Mr. Vincent is an adviser to FEI's Committee on Information Management.
COPYRIGHT 1990 Financial Executives International
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Copyright 1990, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Vincent, David R.
Publication:Financial Executive
Date:May 1, 1990
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