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IT spend as a percent of revenue – a dubious metric at best

Mark McDonald
Ask about IT metrics and you get a range of answers from “all of them are wrong” to “some more wrong than others” and “they are about all we have.” I want to single out one metric in particular – IT spend as a percent of revenue aka sales.

I have no issue with the metric itself. Its clear, easy to calculate and it has an intuitive simplicity that says that there should have some meaning to it. Unfortunately, being easy to calculate does not mean that the metric has any value in making management decisions.

IT spend to revenue is of less use (useless) to management because its one sided – on the downside. Here is what I mean.

CIOs with an IT spend to revenue ratio about the industry average quickly find themselves forces to cut/restructure the IT budget to bring it into line with the industry average. IT is a luxury in this case and IT budgets are fat because the IT budget is above the industry average. We can debate the merits of such a management shortcut in another post.

CIOs with an IT spend to revenue ration below the industry average however, do not find themselves getting greater budget increases to bring them into line with the industry. No these CIOs are rewarded by keeping the undersized budgets while executives see firms more invested in IT as being the ones at a disadvantage or uninformed.
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See the one sided nature of the metric.

A good metric provides information that informs a decision that could go either way. In this case, it is all one way – in favor of being at or below the industry average.

This metric is pernicious for another reason, namely that when sales go up, the IT budget is not allowed to expand at the same rate as sales. Here the CFO states that IT is a source of leverage and it should not rise as fast as sales. If there is not upside to the metric then the downside bias shows itself again.

Finally metric is increasingly irrelevant in terms of managing IT or managing sales for several reasons.

• First, IT transaction volumes have largely divorced themselves from revenue levels since the widespread use of customer and supplier Internet portals in 2003. I talked about this in an early post about a capacity gap. But the point is clear, there is little to say that IT resource demand increases at the same or greater rates because of sales growth.

• Second, sales revenues do not drive IT spend. IT spend is more driven by your choices about product, process, organization, and customer views as well as service levels, structural costs, and contracting terms which all have little to do with sales.

• Finally, there is little causality at best, between sales levels and IT. Sure when IT systems fail it’s tough to book revenue, but there is no general relationship between changes in IT spend and changes in sales levels. IT spend is not like marketing or sales spend in this regard.

So what are we to do?

We need to recognize that the metric has no meaning because the numerator does not influence the denominator. You might as well measure the weight of the Board of Directors and compare it to changes in sales – they have the same ‘connective’ logic between them.

Replace IT budget / revenue with a metric that has meaning – like IT headcount to Free Cash Flow. That is a metric one CIO is using and it makes more sense because it can be managed.

Measure IT headcount because more than 70% of most IT budgets are already contractually committed – effectively removing them for short-term management changes. IT headcount is the result of factors the CIO can control, like the level of automation, the skill of their people, the structure of their operations and the nature of their IT investment budget.

Free cash flow is a better numerator, as it is more indicative of a company’s health. Management can influence free cash flow and manage it to some extent in either a strong or weak economies. Case in point; look at organizations building cash in the recession. Free cash flow is also something that IT can influence as IT systems integrate process and information flows which improves end-to-end process and cash performance.

I know it is harder to measure, free cash flow and IT headcount, but it should produce a clearer signal and inform better management decisions and actions.

One final note, remember that the value of IT exists through time, so any measure of IT should be shown across time – usually via a control chart to separate the true performance signal from day to day operational noise.

First kill all the metrics, starting with IT budget as a percent of revenue or sales.

Recent columns by Mark McDonald

Mark McDonald, group vice president and head of research for Gartner Executive Programs, writes a blog on the Gartner Blog Network.

The opinions expressed herein or statements made in the above column are solely those of the author, and do not necessarily reflect the views of Wisconsin Technology Network, LLC. WTN accepts no legal liability or responsibility for any claims made or opinions expressed herein.

Comments

Robert Merrill responded 4 years ago: #1

To arrive at good metrics, I believe it's also essential to divide "IT" into its component parts. See http://wistechnology.com/articles/5105/ for one way to do this.

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