22 December 2009

The New ERP – Part 29

What makes technologies valuable?

Let us stop for a few moments to think about just what it is that makes new technologies valuable to a business enterprise. If we take this time to think, it should occur to us that there is no inherent value in new technologies. Just like everything else that resides within your enterprise, new technologies only add to Operating Expenses (OE) in and of themselves. It is only in the application of technologies to business processes that value may be found.

Interestingly, the value delivered through the application of technologies to business processes may be broken down into three elementary categories – categories that we have discussed on numerous occasions elsewhere in these posts:

  1. Increasing Throughput (T)
  2. Reducing Inventories or driving down the demand for new Investment (I)
  3. Cutting or holding-the-line on Operating Expenses (OE) while sustaining significant growth
If you and your management team are going to purchase new technologies as part of a process of ongoing improvement (POOGI), you will know – or should recognize – automatically that you will either increase Investment (capitalized purchases) or increase Operating Expenses (in at least one year), or both (since any capitalized purchase will be amortized as an expense over multiple future periods. Therefore, it is also important that your team has compared this proposed improvement project with other improvement options using this simple formula:

ROI = (delta-T – delta-OE) / delta-I
Where ROI = Return on Investment,
T = Throughput (Revenue less Truly Variable Costs only),
OE = Operating Expenses, and
I = Investment.

As you can see from this simple formula, the ROI is maximized by achieving the highest value for delta-T while holding delta-OE and delta-I as low as possible. This leads to a very simple set of priorities:

  1. Projects that increase Throughput are generally a top priority
  2. Projects that reduce Investment (including reductions to inventories – being the most common reduction in Investment) should be considered next
  3. Projects that reduce Operating Expenses are generally reserved for last for consideration

The Technology Value Matrix

If you will review carefully the accompanying figure you will see immediately something about what makes new technologies or, more appropriately, new applications of technologies valuable. In this matrix, the lowest value values are to the lower left - "Commodity Technologies." Commodity technologies are those that are widely available, they tend to have a "standardizing" affect on the enterprise, and they are generally applied in a typical (read: non-innovative) way. Examples of such technologies include desktop computers, graphical user interfaces (GUIs), network servers, relational or other databases, and so forth.

So, what would a "Wasteful Technology" or technology application be?

Consider a small business that has a typical range of departments. They do everything from R&D to shipping and receiving, invoicing, and general ledger accounting. In the shipping department is a bright young lad that never completed college, but he is a hard worker. He is effective, full of good ideas, and does whatever it takes to keep customers happy inasmuch as it lies within his power to do so. The president and founder of this young company still works in the R&D department helping to design the next generation of products. This firm generally introduces four to six new products a year, so the president doesn't even work in R&D on a full-time basis. On the other hand, the young man in shipping is constantly working 50 or 60 hours a week trying to assure that the firm's customers' orders are filled on-time.

While this scenario is not based on any particular client with whom I have worked in the past, the general scene is not all that distant from far too many clients in my experience. All too frequently, if an investment is going to be made in technology, the president and R&D 'guru' is far more likely at having $10,000 thrown toward a high-end CAD workstatation, while the guy working 50 or 60 hours a week in shipping remains stuck doing his work on a six-year-old machine that is long past its prime. Or, worse, the guy in shipping is still filling out paperwork on shipments by hand, and these data are then being keyed by someone else into the firm's accounting software.

Let's compare these two options based on the following (usually true) assumptions:

  • The firm does not expect the technology investment in R&D to accelerate time to market, the frequency by which new products are introduced to the market, or have any other affect leading directly to increased throughput

  • The firm will not include in its calculations any supplementary beneficial effects on Operating Expenses that my accrue through increased accuracy, support for significant growth, or the elimination of potential data redundancies under the old regime

  • Investment (delta-I) will be the same for each option

Improvement Option
Effect on Throughput
Effect on Investment
Effect on Operating Expenses
New CAD workstation for President in R&D
No increase in Throughput
Increase by $X
Increase by $Y
New automation for shipping
Yes, increase Throughput
Increase by $X
Increase by $Y (amortization of investment) LESS
decrease in overtime wage expense

Time and time again I have spoken with companies that make just such foolish expenditures on new applications of technologies. Why would a company make a decision to spend money for what is clearly zero-dollars in net benefit to the organization?

The answer is usually found in one of two areas:

  1. Company politics – the investment goes to the person or department with the greatest "pull" in the organization

  2. The company's management team simply considers all IT expenditures an "expense" and, therefore, never calculates a return-on-investment
Such an approach is folly on multiple counts, but considering that time, energy and money are all limited resources within a firm, it seems blatantly silly to "spend" any of them where there is no return on the "investment."

That, in a nutshell, is a display of "wasteful technology." Since the firm had no deliberate plan to do anything particularly "differentiating" along with the purchase of the new CAD workstation for the president, and since CAD in itself is "standardizing" (not "differentiating"), the high expense for an engineering "workstation" made about as much since as the purchase of a $10,000 Rolodex™ for one of the secretaries.

[To be continued]

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