By Paul Daugherty
Nov.19, 2003 — In today’s volatile utility environment, it’s not the technology you have, it’s the decisions you make that spell victory or defeat. The most effective competitors are not those with the most detailed advance plan, but those who adapt flexibly to rapidly changing circumstances.
The work of economist Paul Romer and others has made it clear that the critical components of competition and growth are intangible assets – know-how, recipes, tacit knowledge. Hard, balance sheet assets no longer matter quite as much as they used to. Difficult-to-value intangibles seem to matter more than ever.
For high-performance utility-related businesses, it’s not enough to have hardware – there’s a surplus of that. It’s not enough to have software — software is becoming more standardized, more like a commodity. What matters is the ability to make the small adjustments and marginal innovations that make all of the difference between winning and losing.
Commodity IT and Marginal Innovation
The proposition that Information Technology has become a commodity is no longer shocking, in fact, it’s rapidly becoming conventional wisdom. Like most conventional wisdom, it is half-true.
There are good reasons why IT should be a commodity. The innovation cycle in any industry typically lasts about 30 years. The Application Software business is about 40 years old. Most of the original players are gone. So, IT resembles the automobile, energy and other basic industries in which a crowd of startups gave way to a few industry leaders. As in the old, basic industries, the focus of IT vendors has moved from innovation to replacement and product extensions.
Every technology, including most recently Enterprise Resources Planning, has moved through a cycle of innovation and standardization. Instead of innovating, ERP vendors now devise strategies to cope with “commoditization” by relying on account control and hoping to grow through services.
So IT is a commodity – but in much the same way that fighter aircraft were a commodity during the Korean War era. The U.S. F-86 Sabre and the Soviet-built MiG-15 looked very much alike. They solved many of the same problems of aviation in much the same way – wings, ailerons, jets, etc.
Innovation at the margin
But the Sabre’s full-power hydraulic flight controls gave it a decisive advantage: the ability to shift more rapidly from one maneuver to another during aerial dog-fights, with frictionless precision. Just when the MiG pilot began reacting to the initial Sabre movement, a rapid change in direction would render the enemy response inappropriate to the new tactical situation. This agility contributed to the Sabre pilots’ impressive 10 to 1 kill ratio against the formidable MiG-15. [From John Boyd and John Warden: Air Power’s Quest for Strategic Paralysis, by David S. Fadok, School of Advanced Airpower Studies, Air University]
Innovation at the margin – the ability to maneuver with frictionless precision – can also create major new capabilities in IT. Consider one example of what could be. The Global Positioning System is now accurate to within five yards, cell phones now have cameras, and “Dial 911” emergency reporting is now available throughout the United States.
Suppose these three technologies were to be integrated. Someone threatened by an attacker or trying to help an accident victim could take a picture with the cell phone and dial 911, immediately and automatically providing authorities with visual information and exact GPS coordinates. Without any fundamental technological advance, this marginal innovation could greatly amplify the power of the emergency response system.
It’s not all that far-fetched. We have sensors that protect workers in the mining and utility industries. The miners trapped underground in Pennsylvania last year may have been rescued sooner had they been wearing sensors that may have pinpointed their location immediately.
Similar marginal innovations using sensors, transponders and wireless communication have helped chemical companies improve their working capital management. In the past, when chemical suppliers sent rail cars of material, it might take the customer a month to use all of the material, a month to process the invoice, and a month to receive payment. The supplier was financing the customer’s inventory for ninety days.
But now, the railcars go out equipped with transponders that measure material usage in real time. The supplier sends invoices weekly, improving cash flow and reducing working capital costs. The system also benefits the customer, since the sensors and transponders also monitor temperatures and provide early warning of safety hazards.
Some transponders, reduced to the size of dust particles, now allow companies to monitor pipelines for breaks, flow conditions, oxygen content, even corrosion. They allow managers to schedule preventative maintenance before pipes break.
A marginal innovation in the utilities industry, automated meter reading (AMR), allows utilities to see customer usage patterns in new ways and develop new products and services, far beyond calculating bills. Suppose the utility sees that, for one month of every year, a customer’s usage falls sharply. This insight might help the utility to package and sell ancillary services to the customer: home security systems; dog-sitting; lawn maintenance; mail and message forwarding.
Such technology can open new competitive possibilities to utility-related businesses struggling to differentiate in the wake of deregulation. It can also create new models for inter-industry collaboration, such as sharing the cost of AMR technology among electric, water and gas utilities.
Doing More With Less
High performance can be the payoff for companies that teach the old IT dog new tricks. But much IT investment is wasted. A survey by Mainstay Partners found that only 28% of companies tie IT investments to their business strategy and goals and only 12% accurately measure their business impact.
Although the absolute level of IT investment has no correlation to financial performance, the composition of investments does. Lagging companies, those with low growth in profit margin, spend 70% of their IT budgets to operate existing IT, and only 30% for innovation. By contrast, leading companies, those with high growth in profit margin, spend only 60% of their budgets to operate existing IT, and dedicate 40% to innovation.
“The differentiator has never been the amount of money you pour into technology,” says Richard Ross, CIO at Amerada Hess. “Measures of return on IT dollars spent, as a percent of corporate revenue, etc., were shown to be meaningless long ago. The difference lies in the decisions you make, i.e. how you manage the dollars spent. As part of this, it is vitally important to understand what is ‘fashion’ and what is ‘classic’ in your delivery.”
In the shoe industry, Ross says, classic shoes like wingtips are predictable. You can be certain how many you will need each year, and contract for the necessary resources at the lowest costs due to the long planning horizon. But spike heels are fashion. To compete, you need to assemble a crack team of merchandisers and manufacturers that can respond immediately to changes in the whim of the market.
“If you don’t segregate your delivery of IT services, you dilute your capability to respond by maintaining fast reaction resources for classic needs such as back office transaction processing, help desk support and ERP systems maintenance,” Ross says. “If you have the guts and the will to commit to long-term planning, you should probably partner for economies of scale and focus your energies on things that will make a difference to the business.”
The CIO of a financial services company recently made a $300 million business opportunity possible with a technically undemanding, flexible, cost-effective innovation that took only 12 weeks to implement. Line managers at the company saw a chance to co-operate with small, Mom & Pop equipment retailers by offering lease financing to their customers. This would help the retailers build sales volume, and the finance company could reach a lucrative new market through the retailers.
The only constraint was that hiring enough sales people to service the small retailers would be prohibitively expensive. The CIO proposed wrapping the essential applications components in XML, so each of the 10,000 retailers in the target market could access the lease applications online, and customize them.
Implications for Technology Investment
Good stewards of capital don’t invest in projects or activities unless they promise to return at least the cost of capital. Investing in commodity technology probably won’t.
TCP/IP became the communication standard in the mid-1970’s, which led to the Internet and eventually to the World Wide Web. It’s no longer necessary for firms to invest in developing communication protocols; they need only to understand what opportunities these standards have created, and how to exploit them.
ERP is following the same path, and will produce similar results. Standardization is inevitable. ERP is fast becoming a commodity, and investing in it will not offer a return above the cost of capital. There is no longer a competitive advantage to having a fully integrated ERP solution. Moreover, the business processes defined and captured by ERP have also become commodities.
Under the circumstances, it is better to share economies of scale and minimize capital commitments by outsourcing both ERP and associated processes. In fact, the market has recognized this; outsourcing is now commonplace. It began with outsourcing of IT, and has evolved into BPO – business process outsourcing.
For example, in 1991, BP opted to outsource the finance and accounting functions for its North Sea operations – both IT and business processes. Eventually four competitors outsourced to the same center, co-operating to share costs and economies of scale. Cost savings exceeded 40% in some cases, and bureaucracy and complications were reduced.
Implications for Technology Organization
The technology environment has changed. Commoditization, standardization, and outsourcing all demand an organizational response. The technology organization must become the hub of a network that includes internal systems, outsourced processes and inter-connections with external parties. Internal systems, because of standardization and “commoditization,” will take up much less of the organization’s time. However, the technology organization will have operational responsibility for HR, customer service and accounting processes – most of which will have been outsourced to specialist providers. Scalable networks that link to other firms or industry consortia will also be part of the technology organization’s bailiwick.
What does this mean to technology leadership? Essentially, CIO will not mean “Chief Information Officer” but rather “Chief Interrelationship Officer.” Internally, the main challenge will be to drive down non-discretionary spending on commodity IT and processes – perhaps by changing vendors, or building best-of-breed application suites with offerings from different vendors. The CIO needs to squeeze the lemon, extracting as much value as possible for as little money as necessary.
“Companies need to look at innovation as a continuous process. They should align changes in strategic direction with the right values, people, resources and partners. What’s more, this approach will only be successful if it is aimed at achieving transformational change that adds significant value to the organization,” observes Tom Halbouty, CIO, Pioneer Natural Resources.
The CIO must also work to make IT drive business value. The performance metrics that used to define IT success – typically 24/7, 99.999% — are introspective and do not address IT’s contribution to business value. No wonder some suggest that IT doesn’t matter. In fact, IT investments that don’t drive value are wasted. The investment focus should be on innovation at the margin that can drive enormous value.
Finally, the CIO will have to sort through and screen out the strategically important from the merely fashionable. From time to time, an idea seizes the popular imagination and makes its way to the boardroom. Y2K, e-Commerce, offshore and other similar initiatives sometimes generate a “bandwagon effect,” and there can be great pressure to climb aboard without thinking. Part of the CIO’s job will be to determine whether such initiatives can drive value, and make a decision on their proper role in the “Interrelationship” grid. Every action must be focused. Unfocused actions are symptoms of panic, not signs of strategy. Part of the CIO’s job is to sharpen the focus.
Frictionless, precise, connected – those are the indispensable attributes of high performance business. Standardization reduces friction. Innovation at the margin means precision. Scalability makes connectedness the only economically rational course. It is easy to mistake the trend toward commoditization of IT as a sign that there is no competitive advantage in IT. Nothing could be further from the truth. Observe the new environment. Orient yourself within it. Decide how to take advantage of opportunities for marginal innovation. Then act!
About the Author: Paul Daugherty is a Partner – Utilities for the Resources Operating Group of Accenture. Daugherty has worked with energy and utility companies in the United States, Europe, Asia, and South America, often focusing on innovative technology approaches to drive business value. He is also the managing partner for Technology and Outsourcing in Accenture’s Resources operating group. Mr. Daugherty is a frequent speaker on industry and technology issues, and has published articles in a variety of publications.
About Accenture: Accenture is a global management consulting, technology services and outsourcing company, committed to delivering innovation. With deep industry and business process expertise, broad global resources and a proven track record, Accenture has more than 80,000 people in 47 countries. Accenture generated net revenues of US $11.6 billion for the fiscal year ended August 31, 2002. Its home page is www.accenture.com.