The Value Proposition: IP - a new metric for the Information Age

Despite all the journals, reports and seminars which have been produced on the subject, it remains extremely difficult for companies to justify their sometimes vast IT budgets.

It's not exactly a quantitative science. We have all sat through talks espousing flexible architectures and state-of-the-art development methodologies - but do they make profits?

At last, we believe we can provide an answer, courtesy of Paul Strassman. Strassmann spent over 30 years working as chief information officer for the likes of General Foods, Kraft, Xerox and the US Department of Defence, and has spent the latter part of his career developing an innovative set of economic indicators that reveal how companies spend money on information.

We are convinced that his metrics are the only way to measure and benchmark the information management infrastructure of an enterprise.

Established accounting practice is based on a capital-intensive view of the world. It is designed for lending organisations and investors to manage their risk. It is preoccupied with the capital value of a company - i.e. its value if wound-up. Dead things are valued more highly than people, skills and ideas, and ratios such as ROI, ROA and ROE (Return On Investment, Assets and Equity) quantify the efficiency of a company at creating accounting profits from capital.

But capital intensive companies only represent about a quarter of the UK economy; for the other 75 per cent, the cost of information management has become the biggest input - such things as management, data analysis, research, training, information worker salaries, IT and any other expense that is not accounted for as a product cost.

For an information-intensive company such as a bank, the salary bill is the biggest single expense. Information technology is one of the fastest growing components of the costs of information management and is typically around 10 per cent. Good IT systems improve the productivity of information workers.

The information-based economy needs metrics that measure how good a company is at converting those costs of information management into profit. Strassmann has devised a simple ratio that he calls information productivity (IP). It is simply the ratio of the Economic Value-Added (EVA) to the total cost of information management.

EVA is an established way of expressing the added value the company generates after paying a reasonable rate of interest to its share holders. To express this as an equation:

Information Productivity = Economic Value-Added/Cost of Information Management

EVA is a well-understood and accepted accounting value. In order to make meaningful comparisons between companies it is important to use a value for the costs of information management that is in the public domain and not subject to dispute. Insurance is a highly information-intensive industry. The Butler Group found that using these metrics, Britannic came out with an IP rating of 0.18, and was ranked 36th overall. Legal and General's IP figure was 0.02, and was ranked 674th.

It's clear that IP is a very sensitive indicator. It penalizes companies with high costs and poor returns. Companies which report accounting profits that are less than shareholders could reasonably expect show up as a negative figure.

There could be any number of reasons for a poor IP rating - for example, lack of profit-generating lines of business, excessive management costs or poor IT.

It is easy to jump to erroneous conclusions based on these figures, like the weekly IT papers did late last year when they saw that National Westminster Bank was bottom of its class. They assumed that IT was to blame, but this cannot be justified from the figures.

Butler Group recommends targeting IT budgets at revenue-generating activities rather than simply automating existing business practices. Increasing the numerator in the information productivity equation has got to be a better strategy than shaving a percentage point off your costs; after all, you have had the last decade to install office automation systems.

Lloyds TSB hit the news headlines recently by putting a 'techie' on the board. For a bank with one of the highest IP ratings, it should be in a strong position to forge ahead into e-banking. If it doesn't, First-e will cream off its best customers before it has finished its pilot study! It's a fast-moving area to be in and the CIO appointment reflects the seriousness of the situation. IT is no longer an automation system to be counted as an overhead.

Internet start-ups are all the rage at the moment. They typically raise money quickly, investing in slick software systems to take a slice out of the revenues of established and slower moving plcs. They can afford to take risks because they are so small and have little to lose. Information productivity can't be calculated for them because there are no published profits. Their business models can be copied just as quickly by another start-up or an established plc that can just as easily raise the money and hire expertise. Fortunes for these guys are as volatile as ether, but one day they may appear in one of our IP ranking tables. When they do, their numbers should be outstanding. Information management costs will be shockingly low, ensuring that with modest Economic Value-Added they should shoot to the top of the table.

* If you would like to know more about Butler Group's Strassmann assessment services, please visit the http://www.ButlerGroup.com Web site or e-mail Jonathan.Stephenson@ButlerGroup.com.