Managing Technological Change (Part 2 of 2)
- Technology as a Profit Center
- Summary
- Harris Kern's Enterprise Computing Institute
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Part 1 of this series looked at technological change in the American workplace—in particular, senior management’s view of these changes, and how their viewpoint affects how IT staff do their jobs. Case studies showed the IT department as an accounting "cost center." This article explores how to view the IT department as a "profit center."
Technology as a Profit Center
Let’s look at an example where the technology itself is the breadwinner. A midwestern farming equipment business relies on salespeople to find prospects, make sales, and return orders to corporate headquarters. Traditionally, the salespeople write up purchase orders and phone in the orders by a particular time of day to ensure that the delivery information is processed by the next day. The purchase orders themselves are mailed or taken directly to the central office for reference and record keeping. The clerical staff at the home office are then responsible for fulfilling the order by finding the stock in the warehouse, boxing and shipping it, and making sure that the product arrives at the designated location on time and in one piece. The entire process generally takes three days to a week. Since the company is in a strong business cycle for the farming sector, business is relatively brisk, with about 20 orders per day coming in from the sales force. At an average cost of $50 per item and five-day work weeks, the company averages about $5,000 a week in sales, or a modest $250,000 in sales per year (subtracting two weeks for holiday closings).
But the director of sales has heard of a new technology that would allow salespeople to use laptop computers to deliver purchase orders electronically, directly to a centralized database stored at the warehouse. If an order is received before 3:00 p.m., the order could actually be shipped overnight and delivered the next day. The director goes for the idea, spending $2,000 dollars per laptop for his 20 best salespeople ($40,000) and another $10,000 for the fulfillment system, software, and peripherals.
With the promise of overnight delivery, orders zoom up to 50 a day. Everything else being equal, with a $50,000 investment, sales revenue for one year has gone from $250,000 to $650,000—an 800% return on investment (ROI). In other words, new technology is directly responsible for adding nearly half a million dollars to the bottom line!
Of course, the previous scenario is an oversimplification. there are many more variables and costs that enter the day-to-day operation of any business.
The farm equipment example still falls under the same general accounting rules as the railroad example discussed in my previous article. The new product delivery system can easily be classified as "office equipment," devalued as cost, and treated as such. The big difference in perception is that the electronic farm-product delivery system can be directly credited with increased cash flow that not only pays for the initial expense but also adds considerably to net profit.
But how much does technology investment really add when the "intangibles" are thrown in? In this case, introducing, maintaining, and integrating the new order system incurs cost of integration. Like productivity, this concept has little meaning in terms of standard accounting practices, but a very real meaning in terms of economic value, both real and potential.
In terms of new technology, there is a direct inverse relationship between the productivity gains and the cost of integration of any new technology: ROI equals productivity minus cost of integration. The mathematical formula is simple. Defining productivity and the cost of integration in "real terms" is not so simple. But it’s the technical manager’s job as well as the business manager’s job to be able to understand, describe, and utilize these concepts.
Now, let’s return to the pragmatic from the theoretical. How do we test our theories in the real world to make the best management and technology decisions?
The technology managers in all these case studies are essentially dealing with the same situation. New technology is being introduced, and each needs to know how much it’s going to cost. The difference between the scenarios in Part 1 and the farm equipment example is simply a matter of perspective. Is technology an asset or a liability? Older corporations are naturally inclined to assume that any investment in software is an expense. It’s hoped that the investment will eventually provide returns in terms of either increased strategic advantage or decreased productivity costs. But measuring either is elusive. For years, corporations have poured millions or even billions of dollars into state-of-the-art IT systems in order to stay competitive. But very rarely, unless the corporation is itself a technology company, have they seen a clear cut and immediate advantage in terms of market position, sales, or net profit.
Because of this lack of obvious ROI, most business cases for technology investment involve primarily internal resources that can be clearly understood and controlled. A million-dollar inventory management system is not going to increase sales. In fact, its very existence depends on goods that have not been sold. So how does one justify paying a million dollars unless a million dollars can be made or saved? Since it’s unlikely that the company will be able to sell, lease, or rent the use of the inventory to either internal or external users, chances are that the only cost benefit will be seen as savings. This has been both the bane and the boon of the typical IT manager since SABRE was first introduced in the 1950s. SABRE alone didn’t necessarily allow American Airlines to increase sales, but it did allow the airline to manage sales more efficiently. By putting an end to overbooking and poor flight scheduling, and decreasing the number of irate passengers, American could focus on filling up planes and could fulfill schedules more simply and easily with a real-time information system. But how are these business advantages recorded in the accountants’ books?