What kind of returns can you expect from your IT investment? A recent report from the Butler Group examines how IT affects the profitability and growth potential of organisations. Here is a management summary of its conclusions
The impact of information technology on the profitability of companies and the potential of companies in creating wealth is often an emotive subject where facts and figures are needed to justify its deployment.
In order to get an objective perspective on these issues, we have conducted the largest investigation so far, analysing a large number of companies in both the US and Europe. The conclusions have wider implications than the pure management of IT and will be of special interest for company executives, financial officers, IT managers, and IT strategists.
TRANSFORMING IT COSTS INTO PROFITS
IT spending and profits are unrelated. This will always remain that way because IT is no more than a neutral tool that can leverage good or bad management in either direction.
From the analysis detailed in our report, we can draw a number of conclusions:
– IT has not emerged as a directly measurable strategic player that can be shown to have a decisive strategic influence on corporate profitability.
– IT spending does not exhibit a comparable level of positive correlation with profits as has been found with other strategic variables such as market share, capital intensity and relative customer quality.
This relegates IT spending to an important but only enabling catalytic role. From the standpoint of corporate strategy, IT can be seen primarily as an attractive means that permits corporate management to re-balance its responses to rapidly changing competitive circumstances. Such a role is more than an enormous challenge for computer executives. IT managers must be involved in board-level decisions in order to link IT, in the least costly manner, to enhance the firm’s strategic advantages!
KNOWLEDGE CAPITAL IN EUROPEAN FIRMS
The natural place to look for a role for IT in improving the wealth of an organisation is in the management of intellectual assets. In the past the management of the such resources was treated as pure overhead, and included such functions as administration, co-ordination, sales, marketing, research and development. In fact, this is where we can find the assets for generating growth and innovation, and hence the future wealth of the organisation. Knowledge Capital is an original financial ratio, developed by the report’s author, Paul Strassmann, that can measure these assets and is defined as Economic Value Added (EVA) divided by the Cost of Capital (the metrics). It is an objective measure of the capacity of a firm, or a country, to generate profits by other means than though utilisation of financial capital. Together with the physical and financial assets of a firm, it gives a complete picture of the worth of an organisation, and, in fact, it is reasonably correlated with the stock market valuation of a firm over the long run.
We have computed the Knowledge Capital accumulated by over 3,500 European firms and we compared the effectiveness of different countries and industries in using this capital. In summary, we found that:
– the average Knowledge Capital in this study of European firms was 542m euros per firm in 1999.
– The corresponding figure for US firms is $880m, from a study of 7,287 US firms in 1999.
– The variation in interest rates across Europe does not account for the very large variance in the Knowledge Capital valuations for individual countries or firms.
– A few firms possess a disproportionate share of Knowledge Capital gains as well as losses.
– There is a high correlation between stock market valuation and Knowledge Capital for medium and large companies.
A comparison of the performance of firms, country by country, reveals new insights and results. For instance, Germany displays the highest Knowledge Capital concentration but there is a remarkably low proportion of net Knowledge Capital in the country, which averages only 92m euros per firm.
This figure compares unfavourably with that of the Netherlands, 2,242m euros, and Belgium at 1,485m euros.
Comparison of the performance of firms, sector by sector, also dispels a number of generally accepted views. The technology sector holds only 3% of the total available Knowledge Capital. The average Knowledge Capital per technology firm is not as significant as in other sectors. From the standpoint of global competitiveness, this should be seen as a serious disadvantage for Europe. Almost a third of the European Knowledge Capital is in the financial sector – demonstrating its pivotal strategic position in the economy. This concentration of economic power confirms the exceptionally favourable position held by financial institutions in steering the further development of the European economy.
The best performing sectors in Knowledge Capital – utilities and communications services – show the lowest levels of concentration of Knowledge Capital, whereas some of the poorest performing sectors – basic materials, technology and health care – show the highest degree of concentration. Such findings confirm the long-held views that concentration in economic power is damaging to a particular sector of the economy.
The report justifies and expands these conclusions and gives the detailed facts and figures for Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden and the UK.
Our research confirms that IT is a neutral tool that can help a well-run company to improve its performance and can be disastrous in the hands of an ineffective management team. The potential for increasing the future wealth of a company is measured objectively by its Knowledge Capital and the long-term impact of IT should be in increasing the accumulation of this asset. Comparison of Knowledge Capital across countries and sectors in Europe gives useful insights into the potential for growth of the best performing companies in these countries or sectors.
The Economics of Information, the relationship between IT spending, profits and Knowledge Capital is a Butler Group report. It was written by Paul Strassmann, edited by Jacques Hale and published in July 2001. Electronic download of the report costs £495 for non subscribers. For more information contact firstname.lastname@example.org, tel 01482 323577.