Early last summer, well before the financial meltdown in mid-September, CIO Michael Twohig met with the executive leadership at Clean Harbors Environmental Services Inc. in Norwell, Mass., to discuss the company’s 2009 budget.
It was the first of many meetings intended to address what they saw as a troubling economy in the coming year, given conditions in the financial markets and general economic indicators.
“Not that we had a real crystal ball, but we were concerned about the direction the future would be taking,” Twohig says.
Despite that early and clear-eyed start, Twohig says he’s back to reviewing his 2009 plan, thanks to the steady drumbeat of bad economic news that started with September’s calamity on Wall Street. He says he is assessing the immediate actions he would take should the economy go into a total tailspin.
He’s working from two plans, based on worst- and best-case scenarios. That’s a common practice, except that now, “Plan B has been heightened,” he says. If put into action, it would call for a significant cut in capital expenditures, the bulk of which would be aimed at the development side of the house. “We always try to run a tight ship, but I’m looking at which projects we could literally do without,” says Twohig.
Like those caught up in the stock market’s wild ride, many IT leaders — even those who foresaw a tough 2009 — are in a heightened state of uncertainty regarding next year’s spending plans. And like Twohig, many of them are revising their spending plans or at least preparing to be fluid and ready to respond to any number of scenarios.
Shvetank Shah, executive director of the IT practice at The Corporate Executive Board Co., notes that in a survey of 52 IT organizations, 78 per cent of the respondents said that they’re re-evaluating their 2009 budget plans, 67 per cent are putting nonessential projects on hold, and 57 per cent are reducing their use of consultants and contractors.
What stands out, Shah says, is “the speed and extent to which the lights are being switched off.” In mid-August of 2008, CIOs were looking at 2.8 per cent budget increases, according to his firm’s survey, but four weeks later, budgets were frozen or at least under heavy scrutiny.
Analyst firms such as Gartner, IDC and Forrester have also revised their IT spending forecasts, sometimes drastically. The consensus is that global IT spending will likely fall somewhere between flat and 4 per cent growth. “On a daily basis, people don’t have an idea of the full impact of what’s happening,” says Gartner analyst Kurt Potter.
In September, a few weeks before the financial meltdown, IT executives who responded to Computerworld‘s annual Forecast survey were already registering concern: 79 per cent said they were either somewhat or very worried about the economy. And the percentage of respondents who reported that their IT budgets would increase in the next 12 months dropped from 47 per cent in last year’s survey to 28 per cent.
With this unusual lack of visibility into next week’s business conditions, IT’s marching orders are shifting to emphasize flexibility, especially as business priorities and resources change. Here are six new factors to consider as the calendar page has flipped from a very dark end of 2008 to a decidedly murky 2009.
1. Understand the Credit Crunch
Today’s credit crunch directly affects IT because, for many companies, technology is the No. 1 “capex” (capital expenditure) item, Shah says. That means IT leaders need to pay more attention to financial metrics such as the weighted average cost of capital, or WACC. “What’s different about this crisis is it’s a capex crisis,” because it involves expenditures used to acquire or upgrade physical assets, he says.
WACC measures the rate that a company is expected to pay to finance its assets. The higher the WACC, the higher the “hurdle rate” in a return-on-investment calculation, or the minimum rate of ROI that must be met to undertake a project.
So imagine, Shah says, a project that last year would have yielded $120 on an investment of $100. If interest rates are now 6 per cent or 7 per cent versus 3 per cent or 4 per cent last year, the project now has to yield more than $120 to make sense. The only choice is to squeeze out more ROI or decrease the investment.
Today, Shah sees hurdle rates increasing by five to seven percentage points, and he says CIOs should keep that in mind when choosing which projects to pursue, freeze or abandon. This will be a particularly hard exercise for companies that are midway through multiyear endeavors that consist of interconnected parts. “It’s a skill set CIOs are learning — how to build small chunks of projects and still have a functional flow to preserve the structure of the technology architecture without abandoning it,” Shah says.
Sometimes capex issues affect IT indirectly. At CPS Energy, CIO Christopher Barron says his budget will likely decrease by 1.5 per cent this year because of plans to build new nuclear reactors and other construction projects. With the cost of capital rising by 20 per cent or 30 per cent, he says, the rest of the company is supporting these initiatives by holding down operational maintenance costs. “If we don’t want to raise our prices past a certain level, we need to trim expenses internally,” he says. IT is also being asked to delay or defer projects, but Barron believes money will be funneled back to IT this year.
2. Compress Payback Periods
Another metric getting renewed scrutiny is payback period, Shah says. “It’s not just about ROI, but what ROI can I get in Q1?” he says. “It’s not just whether the CRM system can make the sales force better, stronger, faster, but can it do that by the end of June, and will I see it in the Q2 financial results?” This will change not just what gets funded but also how you think about sequencing projects and which components you’re going to launch first, he says.
Chubb Insurance Co. CIO Jim Knight says his company will intensify its focus on a goal it has pursued in the past few months to break up projects into smaller components with deliverables every six months. “With demand always increasing and supply not increasing, we’re focusing on how to become more agile in terms of how we provision what we do,” he says.
At the same time, Knight says he is looking at a budget increase for ’09, which he attributes to prudent spending and the fact that Chubb’s specialty area has been less affected by the downturn.
3. Use Concrete Metrics
According to Twohig, projects that show concrete cost reductions will take precedence over those that provide functional enhancements. “If a project reduces operational head count by 10 people, that’s a pretty clear measurement,” he says. “If I’m just enhancing productivity but am unsure how to measure the return, it’s harder to float that kind of project to the top, even though you know it’s good stuff.”
Forrester Research says managed services are poised to explode during the next 24 to 30 months because of brisk technological change, the high cost of capital, the desire to free IT staffers to focus on strategic work that grows revenue, and the need to maintain service levels even while staffing levels fluctuate.
For Clean Harbors, productivity improvements include enhancing reporting functionality and making changes to the ERP system. Projects more likely to be pursued in 2009 include pushing mobile functionality to the field staff, automating invoicing, creating Web self-service features and any project related to the three top corporate priorities — health, safety and compliance.
4. Prepare for Budget Fluctuations
Deep uncertainty is causing some companies to overreact, Potter says, and decisions made now may be changed later. “There’s simply not enough information on what the future will look like,” he says. IT leaders should seek ways to not just be flexible but to turn on a dime.
For instance, in addition to his best- and worst-case scenario plans, Twohig is also prepared to act quickly in the event of a severe downturn. “I’ve looked individual by individual in terms of what people we’d have to do without, based on project priorities,” he says.
Shah says companies are also ditching the usual full-year budget plans and instead are providing funding in quarterly lumps. “Companies are doing scenario planning, which is not new, but it’s coming back in style,” he says. At the close of last year’s fourth-quarter, for example, some enterprises were reserving the right to make decisions as late as the end of December, says Shah.
Barron is preparing for possible fluctuations by using what he calls a “sliding bar” approach. In other words, projects will maintain their ranking on the priority list, but as funding shifts, the bar will be raised or lowered. “The more funding available, the lower the bar goes across the list,” he says.
5. Learn More About So-Called Silver Bullets
The credit crunch practically guarantees that CIOs will be pressured to consider new computing models that promise lower capital costs, such as cloud computing, which refers to a variety of techniques in which technology capabilities are provided as a service. “I’m sensing that the cloud will become to the ’08-’09 recession what offshoring was to the ’02 recession — a silver bullet trumpeted by pundits and business media,” Shah says.
But he warns IT leaders to thoroughly investigate the economics of the cloud, including migration, transition and security costs, as well as the solvency of the vendors that offer it. “Capex is not just affecting end users but also technology vendors,” he says.
6. Ruthlessly Clear Dead Wood
As companies ask all departments to look for efficiencies, IT won’t be excluded, says Potter. Gartner is advising IT leaders to look for savings on three fronts until they return their focus to growth strategies.
The first is IT procurement. Potter says it might be possible to renegotiate or rebid contracts. And some Gartner clients are delaying big purchases, slowing down projects and even slowing the procurement approval process itself, to ensure that a purchase is the right decision and to obtain better deals.
The second category is cost savings within IT. Potter sees a renewed focus on reducing per-unit costs, such as cost per server, per terabyte of storage, per help desk ticket, per programmer or per line of code.
The third focus area is joint business and IT cost savings. This includes evaluating and possibly reducing the application portfolio by a certain percentage and eliminating redundant functionality.
No matter what happens in 2009, the IT organizations that rise to the top will be those that cut carefully if they need to reduce costs, focusing on the margins, not the core. That’s why this downturn is so much different from the dot-com bust, Potter says. “IT was seen as the problem in ’01-’02,” he says. “But this time, IT will be looked to, to make up for possible reductions in staff and for revenue growth.”