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NYU Stern Spring 2013

Digital Analytics & Strategy

Digital Analytics & StrategyDigital Analytics & StrategySession Session 1: IT Analytics1: IT Analytics

Measuring IT Productivity and Business ValueMeasuring IT Productivity and Business Value

Prof. Sinan AralProf. Sinan Aral

Digital Analytics & Strategy: Session 1

LearningLearning Objectives Objectives –– IT AnalyticsIT Analytics

1. Understand how IT investments create business value for firms.

2. Understand the IT-Productivity Framework and how

economists measure the productivity effects of IT

capital.

3. Understand the Intangible Investments and

Organizational Practices that Complement IT

Investments.

4. Understand the IT Portfolio Framework for assessing IT Investment Allocations and the respective

contributions of different allocations to business value.

5. Examine Portfolio Allocations and IT Savvy in the

context of a case study of 7-11 Japan.

6. Discuss the importance of Selection and Complements

in achieving Business Value from IT at Zara.

Nominal Share of IT Investment in GDP

1965-2006

0

1

2

3

4

5

6

1965-I 1970-I 1975-I 1980-I 1985-I 1990-I 1995-I 2000-I 2005-I

IT Investment Has Grown Dramatically

IT Investment Has Grown Dramatically The ‘IT Productivity Paradox’

Nobel Prize Winning Economist Robert Solow (1989):

“We see computers everywhere except in the productivity statistics”

Were managers simply irrational?

Why all the investment in IT if it doesn’t contribute to productivity?



IT is associated with greater productivity...

IT Stock (relative to industry average)

Productivity(relative to

industry average)

The ‘IT-Productivity’ Framework

� A “Production Function” describes Output (Q) as a function of Capital (K) and Labor (L):

� The “IT Production Function” includes a measure of ‘IT Capital’:

� Taking logs, we can estimate how IT contributes to Output:

321 βββitititit

LKCQ =

ititititititLKCQ εβββα ++++= loglogloglog 321

21 ββititit

LKQ = “Cobb Douglas” Production Function

The ‘IT-Productivity’ Framework

� An “IT Production Function” describes Output (Q) as a function of Capital (K), Labor (L) and IT Capital (C):

� The “Output Elasticity of IT Capital”� βc=> “The percent increase/decrease in Output (Q) associated with a 1

percent increase in IT Capital (C).” (true when equation in logs)

� The “Marginal Product of IT Capital”� “The amount of output that can be produced for a given unit of IT Capital.”

� When adjusted for inflation: “The increase in dollar Output (Q) per dollar of IT Capital Stock (C).”

� Calculated as Output Elasticity times the ratio of Output to IT input:

ititititititLKCQ εβββα ++++= loglogloglog 321

∂

∂=

Q

C

C

QE

C

C

QE

C

Q

Q

C

C

Q

C

QMP

CC=

∂

∂=

∂

∂=

IT is associated with greater productivity...

IT Stock (relative to industry average)

Productivity(relative to

industry average)

...But what explains the substantial variation across firms?

βC:

Describes the

average

relationship

between the

productivity

of firms and

their IT

Capital Stock

“The Dynamo & The Computer”

Paul David, AER (1990)

• Steam Engine, Electric Dynamo and Computers all experienced productivity slowdown first.

• Inserting Electric Dynamo into old plant design created little productivity boost.

• Redesigning factory floors into distributed modules with a focus on workflow dramatically improved productivity.

• Same is true of computers!

What’s the history lesson?

• New technology inserted into old organizational procedures produces little payoff. Its how new tech enables new work that matters.

Computer Capital

Modern Data Demonstrate this for IT

High IT andDigital Org.



Source: Gormely et al. (1998)

Cost Breakdown for a Typical ERP Installation$millions

HardwareApplication, Web, and database servers $0.8including storage

SoftwareERP application Suite License $3.2(HR, Financials, Distribution)1,000 regular trained users, 2,000 casual users

Implementation9 months to complete pilot site including $9.3process engineering, apps configuration, and testing

30 external consultants as $1,200 a day30 internal staffers at an average salary of $100,000

Deployment3 external consultants at 9 sites for 3 months $7.59 internal staffers at each site for 6 month5 days of user training at an average burdened user salary of $50,000

3 full-time training staff at an average burdenedsalary of $100,000

Start-up Costs Total $20.5

4/5th of IT Investments are “Organizational”

= 1/5th

= 4/5th

“The Iceberg”: Computerization > Computers

Image by Ralph Clevenger

Information Technology Capital (10%)

Technological Complements (15%)

Organizational Assets (75%)Including Human Capital,Business Processes, Culture,

Organizational Capital & Intangible Investments

“Organizational Capital” & “Intangible Investments”:the investments in human capital, business process engineering, skill

development, training and organizational design that complement IT

investments and help firms derive greater business value per IT dollar.

Two Frameworks for Organizational Capital & Intangible Investments

“7 Pillars of Productivity” “IT Savvy”

Digitization

Open Digital Communication

Human CapitalDevelopment

Employee Empowerment

Investments inCorporate Culture

Merit BasedIncentives

OpenInternet Based

Architectures

Managerial IT Competence and

CommitmentRecruiting

7 Pillars of Productivity

Merit Based Incentives

Merit based incentives motivate employees to use information and

decision making power they are given.

ProcessDigitization

Moving from analog to digital processes allows real time tracking of

key performance indicators, data mining and optimization.

Open Communications / Information Access

Encouraging widespread and open communication of information

enables better managerial decisions, more effective collaboration and discovery of new ideas.

Investing inCorporate Culture

High level norms and goals provide culture cohesion and strategic

focus to direct employees toward common goals.

Recruiting the Right People

Analytical skills, computer skills and education complement IT and

enable employees to use IT effectively.

Employee Empowerment

Decentralization of decision rights supports IT business value. Access

to information is wasted if employees are not empowered to make decisions.

Human CapitalTraining helps employees operate digital processes, find information,

make decisions, cope with exceptions, meet strategic goals etc.

Firm-wide IT Savvy

Digital TransactionsPercent digitization of transactions executed with both suppliers

and customers.

IT for Internal Communication

Intensity of electronic communication media such as email,

intranets and wireless devices for internal communications and work practices.

IT for External Communications

Intensity of electronic communication media such as email,

intranets and wireless devices for supplier/customer communications and work practices.

Human CapitalTechnical and business skills of IT people, IT skills of business

people and ability to hire skilled IT people.

Management IT Competence

The degree of senior management commitment to IT projects

and the degree of business unit involvement in IT decisions.

Internet Use

Internet based architectures (i.e., open) for key functions like

sales force management, employee performance measurement, training and post-sales customer support.

*Derived from statistical factor analysis of effective practices in 147 firms from 1999 to 2002.

P r a

c t i c

e s

Co

mp

ete

nc

ies

The IT Portfolio Framework

■ Four Management Objectives for investing in IT

■ Creates an IT portfolio with four asset classes

■ Each asset class has different risk return profiles

■ The role of senior management is to align the IT portfolio to strategy and balance for risk and return

■ Top performing enterprises can get up to 40% more value, i.e., IT Savvy*

*IT Savvy = enterprise’s ability to gain above industry average returns from IT by better management.

-40% Biz Value +40% Biz Value

# offirms

Industry

Average



What’s in the IT Portfolio

IT Portfolio Total IT spend including all technology, digitized data, services, outsourcing, depreciation and people dedicated to IT —broken into asset classes. Can view as flow (i.e., annual spend) or stock (i.e., accumulated spend).

IT Programs Groupings of projects linked to business goals.

IT Projects Sets of activities creating outcomes to a budget and timetable.

IT Activities Core IT capabilities (e.g., specify, code, acquire, test, manage, design, integrate, negotiate, etc.)

Firms Have an IT Portfolio with Four Asset Classes

Source: “Managing the IT Portfolio (Update Circa 2003),” P. Weill & S. Aral, MIT Sloan CISR Research Briefing, Vol. III, No. 1C, March 2003, drawing on Weill & Broadbent 1998.

Informational

Strategic

Transactional

Infrastructure

ManagementObjective

IT AssetClass

Description

Reduce Costs

Provide BetterInformation

EnableInnovation

Provide aShared Basis

Of IT Capability

Transactional

Infrastructure

Strategic

Informational

Provides information for managing, accounting, reporting and communicating internally and with customers, suppliers and regulators, e.g., decision support, planning, control, sales analysis, customer relationship and Sarbanes-Oxley reporting systems

Automates processes, cuts costs or increases the volume of business a firm can conduct per unit cost, e.g., order processing, bank cash withdrawal, billing, and other repetitive transaction processing function.

Provides the foundation of shared IT services (both technical and human) used by multiple applications, e.g., servers, networks, laptops, shared customer databases, help desk, application development.

Supports entry into a new market, development of new products or capabilities, and innovative implementations of IT. Example: ATMs

Data: Percentages are of 2005 total $IT spending (new + sustaining) from 649 enterprises, from MIT CISR Survey.Framework Source: Weill & Broadbent, Leveraging the New Infrastructure: How market leaders capitalize on IT, Harvard Business School Press, 1998.

Rethinking IT as an Investment Portfolio— Four different asset classes

INFORMATIONAL STRATEGICINFORMATIONAL STRATEGICINFORMATIONAL STRATEGICINFORMATIONAL STRATEGIC

TRANSACTIONALTRANSACTIONALTRANSACTIONALTRANSACTIONAL

INFRASTRUCTUREINFRASTRUCTUREINFRASTRUCTUREINFRASTRUCTURE

Increased salesCompetitive advantageCompetitive necessityMarket positioning

Business integrationBusiness flexibilityReduced marginalcost of BU’s ITReduced IT costsby standardization

Increased controlBetter informationBetter integrationImproved qualityFaster cycle time

Cut costsIncrease throughput

17%17%11%11%

46%46%

26%26%

Source: P. Weill, M. Subramani & M. Broadbent, “Building IT Infrastructure for Strategic Agility,” MIT Sloan Management Review, Vol. 44, No.1, Fall 2002.

IT Infrastructure Has Multiple Layers

Where to locate infrastructure & systems capabilities?

Publicly Available Infrastructure (e.g., Internet, Telcos, Industry Nets)

Publicly Available Infrastructure (e.g., Internet, Telcos, Industry Nets)

• Vendors• Telecommunications service providers• Industry services

• Vendors• Telecommunications service providers• Industry services

Shared / CentrallyCoordinated

BusinessUnit 1 Business

Unit 2

• Order processing• Customer portals• Product configuration• Knowledge management

• Order processing• Customer portals• Product configuration• Knowledge management

• Shared & standard applications

• Customer self serve• PC/LAN service

• Shared & standard applications

• Customer self serve• PC/LAN service

• Electronic mail • Large scale processing• Shared customer

database

• Electronic mail • Large scale processing• Shared customer

database

Firm-Wide Information Technology Infrastructure

Firm-Wide Information Technology Infrastructure

Risk-Return Profiles in the IT Portfolio

Source: P. Weill & M. Broadbent Leverage the New Infrastructure: How market leaders capitalize on IT, Harvard Business School Press, June 1998.

*IT Savvy = enterprise’s ability to gain above industry average returns from IT by better management.

Type of ITType of ITType of ITType of IT

StrategicStrategicStrategicStrategic

InfrastructureInfrastructureInfrastructureInfrastructure

InformationalInformationalInformationalInformational

TransactionalTransactionalTransactionalTransactional

Ability to reduce risk & Ability to reduce risk & increase return through better increase return through better

IT Savvy*IT Savvy*

Ability to reduce risk & Ability to reduce risk & increase return through better increase return through better

IT Savvy*IT Savvy*

Strong IT Savvy significantly reduces risk

of failure

Strong IT Savvy significantly reduces risk

of failure

Strong IT Savvy increases infrastructure capability and flexibility for a given

cost

Strong IT Savvy increases infrastructure capability and flexibility for a given

cost

Strong IT Savvy provides management process to

capitalize on the information

Strong IT Savvy provides management process to

capitalize on the information

Strong IT Savvy marginally

reduces risk

Strong IT Savvy marginally

reduces risk

Risk Return CharacteristicsRisk Return CharacteristicsRisk Return CharacteristicsRisk Return Characteristics

High risk, huge potential upside and 50% failure

rate

High risk, huge potential upside and 50% failure

rate

Moderate risk due to long life and business and technical uncertainty

Moderate risk due to long life and business and technical uncertainty

Moderate risk due to difficulty of acting on information to create

business value

Moderate risk due to difficulty of acting on information to create

business value

Lowest risk with solidreturn of 25-40%

Lowest risk with solidreturn of 25-40%

Analogy to Analogy to personal personal

investment investment portfolioportfolio

Analogy to Analogy to personal personal

investment investment portfolioportfolio

Emerging markets

Emerging markets

Options&

Property

Options&

Property

S & P 500 Index fundS & P 500 Index fund

Bonds Bonds

Incr

easi

ng

Ris

kIn

crea

sin

g R

isk

Source: P. Weill & M. Broadbent, Leveraging the New Infrastructure: How market leaders capitalize

on IT, Harvard Business School Press, June 1998.

Tracking the Impact of Information Technology Investments

� Revenue growth

� Return on assets

� Revenue per employee

� Time to bring new product to mkt.

� Sales from new products

� Product or service quality

� Infrastructure availability

� Cost per transaction

� Cost per workstation

� Time to implement a new application

� Cost to implement a new application Information

Technology $

BUSINESS UNIT FINANCIAL PERFORMANCE

BUSINESS UNITOPERATIONAL PERFORMANCE

IT APPLICATIONSBUSINESS VALUE

IT INFRASTRUCTUREBUSINESS VALUE

BusinessBusinessManagementManagement

ITITManagementManagement

Sample Value MeasuresImpact Sought Responsibilities

Dilutionof Impact

Dilutionof Impact

Dilutionof Impact

InformationTechnology $

A

BV BV = BUSINESS VALUE

Time

Dilu

tio

n o

f IT

Im

pacts

B

C



IT Savvy Impacts Firm Performance

1 Next year’s Net Margin 2 Next year’s sales from New and Modified Products/Total Sales.3 Market to Book value in same year as investment. 4 Ave. = Average return for all firms, High (Low) Savvy= additional positive (negative) return for firms in the top

(bottom) 5% of IT Savvy. 5 +(-) = "High Impact" 50% or less of the highest positive (negative) incremental impact for that variable. ++(--) = "Very High Impact" Greater than 50% of the highest positive (negative) incremental impact for that variable. All impacts are statistically significant controlling for firm and industry effects from 147 firms. Source: “Generating Premium Returns on Your IT Investments,”

P. Weill & S. Aral, MIT Sloan Management Review, Vol. 47 No. 2, Winter 2006

Lower Cost of Goods Sold

Profit1 Agility/Innovation2 Market Value3

IT Investment Firms4Ave.

High Savvy

Low

Savvy Ave.

High

Savvy

Low

Savvy Ave.

High

Savvy

Low

Savvy Ave.

High

Savvy

Low

Savvy

IT Infrastructure IT Infrastructure ++5 ---- -- ++

---- -- ++ -- ++ ++

----

Transactional ITTransactional IT +++ + ++

----

+ + ++

-- + + ++

----

Informational ITInformational IT +++ + ++

--

Strategic ITStrategic IT+ + ++

---- ++ ++

----

+ + ++

----

Non-IT Investment

FirmFirm--wide R&Dwide R&D ++FirmFirm--wide Advertisingwide Advertising -- ++

Informational

Strategic

Transactional

Infrastructure

NSF Grant Number IIS-0085725

Low IT Savvy Firm

IT Infrastructure in Focus

Pe

rfo

rma

nc

e:

Pro

fit,

In

no

va

tio

n

Year 1 Year 2 Year 3

50% Greater Positive Impact Compared to Average Firm

50% Negative Impact Compared to Average Firm (Innovation)

>50% Negative Impact Compared to Average Firm (Profit)

Average Firm

High IT Savvy Firm

7-Eleven Japan – an IT Savvy Next Gen Retailer

� Highly evolved IT enabled business model—most profitable Japanese retailer

� 8th largest retailer in the world by market cap—11,000 stores

� 70% of all products sold are new each year in each store

� Each store makes local decisions based on centrally designed systems and processes

� “Total Information System” of 70,000 nodes linking stores, head office, supplier, distribution centers

� Digitized processes allow stores to order and receive fresh foods three times a day

� Emphasis on training and mentoring all employees—hypothesize then test new product selections. Counselors visit each store twice weekly

� Gross margins per store have increased from 5% to over 30% from 1977 to 2005 and stock turnover has decreased from 25.5 to 9 days

� “Its not enough to exchange information. The information has no value unless its properly integrated by the franchisees and makes them work better.” —Toshifumi Suzuki, CEO

Source: Nagayama & Weill, “7-ELEVEN Japan Co., Ltd.: Reinventing the Retail Business Model,” working paper 338, MIT Sloan Center for Information Systems Research, Cambridge, January, 2004 and Aral & Weill (2007) “IT Assets, Organizational Capabilities and Firm Performance: How Resource Allocations and Organizational Differences Explain Performance Variation.” forthcoming in Organization Science

50% of Sales are Original 7-Eleven Branded Products

Source: Seven Eleven Japan, “SEVEN-ELEVEN” 2002.

7-Eleven Japan’s “Total Information System”

Source: Seven-Eleven Japan, “Corporate Outline 2005.”

IT Savvy at 7-Eleven Japan

Human Capital

� Immersive training of 200,000 employees in Point of Sale data analysis, including weather demographic and customer purchasing pattern analysis to improve sales customer satisfaction and ordering.

� Twice weekly visits by company “counselors” to stores reinforce practices and support development of skills.

Management ITCompetence

� Strong commitment of senior management to IT projects comes directly from the CEO, who has been committed to data based decision making and IT based communication since joining 7-Eleven Japan in 1974.

� Business processes are tightly integrated with and enabled by IT decisions.

IT for Open Internal & External

Communication

� Total Information System connects 70,000 computers in stores, at headquarters and at supplier sites to facilitate internal and external communication and coordination.

� Quote – Salesperson of 7-Eleven supplier: “[Their] information system is so good that we can instantly find out which goods of ours are selling [in their stores] to what types of customers and how much.”

� Quote – 7-Eleven executive: “Even if the POS data is used, it cannot be utilized for the next order unless the hypothesis of potential demand is shared among all store clerks as well as the store owner. Therefore we need to establish a system that enables store owners and the ordering clerks to create their hypotheses and share them among part time workers at the store [even if they cannot communicate face to face].”



IT Savvy at 7-Eleven Japan

Digital Transactions

� Digital transactions enable order processing three times per day. Time to delivery is reduced, orders are organized for use (e.g. by temperature –frozen, refrigerated, ambient), and costs of order processing are reduced.

� Digital transactions enable tracking and analysis of Point of Sales (POS) data to inform daily ordering decisions. Each day’s data is analyzed for use the next morning.

� Customer satisfaction goal drives IT enabled business transactions like “Item Control” and “Product Supply Management” designed to directly address customer needs and increase customer convenience.

Internet Use

� The Internet shopping site (www.7dream.com, a strategic IT asset) is integrated with physical stores to offer payment acceptance, pick-up and/or delivery services for products purchased online.

� Use of multipurpose, Internet-enabled store copy machines to provide new services including pre-ordering, printing and purchasing or airline tickets.

Tokyo, Japan, January 18, 2006

Source: Seven Eleven Japan, “Corporate Outline 2004.”

Continuous Improvement & Technology AdoptionZara: IT for Fast Fashion

Zara: IT for Fast Fashion Zara: IT for Fast Fashion – Case Discussion



Zara: IT for Fast Fashion – Case Discussion Zara: IT for Fast Fashion – Case Discussion

Zara: IT for Fast Fashion – Case Discussion Zara: IT for Fast Fashion – Case Discussion

IT Investments

(relative to industry average)

Pro

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vit

y

(re

lati

ve

to

in

du

str

y a

ve

rag

e)

ZARA

7-11 JAPAN

IT Supports Different Strategies LearningLearning Objectives Objectives –– IT AnalyticsIT Analytics

1. Understand how IT investments create business value for firms.

2. Understand the IT-Productivity Framework and how

economists measure the productivity effects of IT

capital.

3. Understand the Intangible Investments and

Organizational Practices that Complement IT

Investments.

4. Understand the IT Portfolio Framework for assessing IT Investment Allocations and the respective

contributions of different allocations to business value.

5. Examine Portfolio Allocations and IT Savvy in the

context of a case study of 7-11 Japan.

6. Discuss the importance of Selection and Complements

in achieving Business Value from IT at Zara.

nyu stern spring 2013 - mitweb.mit.edu › sinana › www › digital analytics & strategy 2013...

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