Defining an IT Strategic Roadmap Brief # 2: A Shareholders Return Approach to IT Value Creation
As discussed in the previous article in this Brief Series, the new Digital Age has considerably changed the role of IT in enterprises— IT is no longer in a supporting role to the business areas; IT is now at the center of every business strategy, and must be considered instrumental for the success of every business process in all enterprises. All business processes must be transformed using a “digital strategy” as its core.
Many articles exist on the digital strategy subject; therefore, rather than elaborating on how and why IT is, or must be, at the core of every business initiative, let’s discuss where IT executives should start when determining their IT Strategic Road Map.
Bottom-Up vs. Top-Down Assessment
In the last decades many CIOs and IT Executives have focused on bottom-up approaches for determining their IT strategic goals. They start by assessing the effectiveness, quality, and maturity of their IT services and processes using frameworks (such as ITIL); and then develop an “IT strategy and Operational Road Map” to improve the maturity of their IT services and processes. In other words, many IT leaders tend to do a bottom-up operational assessment to understand what needs to be changed and improved in the IT areas to meet customer needs.
This bottom-up approach is, and will indeed continue to be, necessary because IT processes and IT services need to have high quality, structure, and effectiveness; however, this approach does not necessarily guarantees that customer needs (internal and external) are effectively met. Even if the IT operational improvements are defined based on customer surveys, the surveys are operational and tactical (i.e., incident response time, problem escalation effectiveness, etc.).
IT leaders need to learn how IT impacts Shareholders’ Return!
Since IT has become a strategic and core component to every business area, IT leaders need to learn how to assess how IT initiatives and IT Services impact the bottom line and support the business growth—in other words, they also need to know how to do a “top-down” assessment before defining or updating their strategic plan and road map.
A Fundamental Change is required in IT Strategic Planning
IT leaders and IT managers need to start strategically planning the way CEOs and the heads of business areas do: IT leaders need to expand their focus and determine how IT impacts Shareholders! — And that is not just for their existing IT services, but also for every new initiative.
An important question would therefore be: When CEOs and the head of business areas start the preparation of their Strategic Plan, where do they start? Sure, they define or update the vision, strategic goals, organization and customers’ needs, etc.; but where do they start?
The topic of metrics for assessing the effectiveness of strategic planning is one that keeps surfacing. C-level executives use various strategic metrics that go all the way from pure impact on the P&L, to more comprehensive metrics, such as ROA (Return on Assets), ROE (Return on Equity), and EVA (Economic Value Added). They all have pros and cons and truthfully all are useful for various purposes.
These and other financial methods can help in understanding how IT initiatives, services, and assets create strategic value; but CEOs in for-profit enterprises place a major attention on how strategic initiatives and strategic plans impact shareholders’ value— and probably the most important metric for this purpose is TSR, or Total Shareholder Return. There is a lot of free information online on what TSR is, and how it is calculated; but there is not enough information on how to specifically link TSR to IT; therefore, let’s briefly discuss it.
The Value of an IT Strategy in Total Shareholder Return (TSR)
Simply, TSR is the sum of ‘change in the company’s share price’ plus the ‘cash flow yield’ generated by the utilization of capital. Ok, this is financial stuff, but how can IT impact TSR? By understanding how IT impacts the TSR drivers, including:
Change in Share Price: The change in price of a company share comes from two components the Profit Growth and the Investor Expectations.
Therefore, to determine and estimate how an IT strategy or initiative impacts TSR, we need to determine how IT can impact:
- Profit growth, as a result of new initiates that create revenue growth, or net profit growth
- Investor expectations, as a result:
- An improvement in the enterprise Gross Margin (high Gross Margins indicate high profitability and strength in share pricing power).
- OpEx % of Revenue (Low % of operational expenses, or OpEx, represents higher operational efficiencies).
- Inventory Turnover (Very important to low-margin enterprises).
Cash Flow Yield: This is based on Capital Utilization. Therefore, if the strategic initiative with IT optimizes the use of capital, improving cash flow, then IT can create a positive change in TSR.
Final Note: This article provides a high-level overview on the use of TSR for IT Strategic Planning. The EVC (Enterprise Value Creation) Architect Training and Certification program from Glomark-Governan, and delivered by Global Lynx trainers and consultants, teaches how to use the TSR model in IT Strategic Initiatives, and as an objective model for scenario analyses and strategic IT portfolio choices. Stay tuned for more IT Strategic Road Map articles in this Blog Series!
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