META Report: Portfolio Management Helps Manage Through Uncertainty: Part 2

By CIO Update Staff

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By Meta Group Staff

Situation Analysis: The complexities of the current economic climate demand sophisticated, flexible management of information technology (IT) investments. The key is to treat IT investments as part of a portfolio and adopt the methodologies of financial portfolio management.


One main benefit of this approach is that it can be applied at varying levels from very basic to extremely sophisticated. Individual organizations can apply portfolio management at the level of sophistication appropriate to their situations. Small organizations, or those in relatively stable situations, can remain at a fairly basic level, while Fortune 50 companies often become very detailed, leveraging complex financial models and management techniques.

In many cases, organizations vary the level of portfolio management sophistication depending on the type of investments under consideration. For example, the "core" investments in a portfolio may not be analyzed in the same depth as "venture" investments.

A second key benefit of IT portfolio management is its introduction of the concept of a management life cycle - with a beginning, a middle, and an end - for each portfolio investment. Great financial managers often know what will drive them to exit an investment even before they buy into it. In contrast, all too often, IT managers do not recognize that software and processes have a life cycle. The result is that, although hardware is refreshed and replaced on a regular schedule in many organizations, software and processes often long outlive their usefulness.

A third important benefit is that portfolio management encourages a regular review of investments. Currently, many IT organizations (ITOs) conduct a single annual review of their investments as part of the annual budget process. The sudden market decline that marked the US economy's entry into the new millennium forced many CIOs to revise their budgets midyear.

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We believe this experience will become the norm in the future. Economic conditions will change too quickly to allow CIOs the luxury of a single annual review of their IT investments. Although events of the magnitude of the 4Q00 capital market slowdown are not likely to happen often, other smaller but still significant events happen almost constantly in markets - and reacting adequately to them requires a much more flexible approach than traditional management and budgeting enables. Companies that wait for the next fiscal year to plan and budget a new IT project to take advantage of a sudden market opening - or to cancel a project when a market suddenly closes - are likely to miss important opportunities and be outmaneuvered by more agile competitors that seize the competitive advantage.

However, shifting investments without planning - by simply reacting to every market blip - is equally wasteful. What the ITO needs is a more flexible method of planning and management that continues throughout the year, rather than being concentrated on a month or two at the end of the summer.

The CIO needs to review various IT investments based on the appropriate cycles per investment class, keeping in mind external drivers, such as changing economic and technical conditions. For projects, portfolio reviews should be tied to project milestones and reasonable points in time to balance across projects and programs. For various IT assets, portfolio rebalancing should be dictated by a combination of asset life cycles, technology evolution, changes in the business, and normal audit/budgeting cycles. However, portfolio review must be balanced with other important business activities - CIOs cannot spend all their time reviewing investments and budgets.

Triggers can help maintain this balance. In the stock market, an investor may set a high and low trigger on a stock - when it drops below the low trigger, the investor may consider buying, and when it reaches the high trigger, the investor will sell. Similarly, the ITO can use both financial and technology triggers to alert the CIO of changing conditions that have a direct impact on IT assets and planned projects.

For instance, many organizations have been slow to move to Windows 2000, in part because of slowing economies balanced against the significant cost of the desktop hardware upgrades they need to make. The CIO and senior business management can set a trigger in the form of a benchmark price for a PC class. When that PC market price falls below that benchmark, it is a sign that the CIO may want to revisit the issue of the Win2000 upgrade and possibly start a full-scale rollout. This, of course, is oversimplified - a decision on accelerating the Win2000 rollout would actually be based on numerous triggering events. Part of the value of using triggers is that once senior IT and business management defines them for each IT asset, a lower-level person can be assigned to constantly monitor them, reporting to the CIO when triggers are reached. When enough of the Win2000 triggers are reached, the CIO knows it is time to revisit the issue.

Portfolio management also requires effective and frequent tracking of ongoing expenses and schedules - both for build-out and operations. Unlike a stock purchase, an IT project's expenses are almost never known accurately at the start. Many organizations fail at predicting, measuring, and tracking changes in the costs of their ongoing projects. Projects are inherently uncertain endeavors. Gaining a better understanding of the actual costs (direct and opportunity) and future return on investment (ROI) are key features of portfolio management. Without this capability, the CIO cannot understand the true cost/benefit proposition for any one of the portfolio entries. Portfolio management's frequent sampling also helps CIOs manage risk and complexity.

Timing is also often vital to realizing the business value of a new IT project. Therefore, project management must also include better tracking of the progress of project build-outs and an ongoing comparison of progress to changes in the pace of market development. For instance, the pace of development of many technology-driven markets has slowed dramatically since 4Q00, making expensive projects designed to grasp new opportunities in those markets much less urgent. The opposite is also true, of course - if the IT project falls behind the market, then it may be better to stop the project than to produce an Edsel.

Tracking ongoing project costs and scheduling is the job of project managers. Many ITOs lack competent, experienced project managers, and without them, effective portfolio management of projects is impossible.

Portfolio management creates alignment between the ITO and business and senior management; it can help the CIO explain the value of IT investments to senior and line-of-business (LOB) management. By showing the expected benefits against current costs (e.g., purchase, installation, upgrade, hiring, training) and then showing how those purchase and installation costs will decrease over time as the price of technology drops and the technology, personnel skill sets, and processes improve, the CIO can chart the point at which each investment is justified based on business value. These charts can be invaluable in winning business management buy-in for IT- and LOB-sponsored investments.

Trigger setting based on business achievement (revenue generation or increased market share) can also help the CIO explain longer-term value by showing the expected business benefits against current cost. Diminishing returns may help prioritize investments, offset new technology hype, and generate performance metrics to create realistic ROI estimates.

ITOs must realize that successful portfolio management requires fiscal, process, performance engineering, and project management disciplines. When management is not able to quantify the business values of a project (e.g., CRM), it is an indication of poor performance and ROI metrics. Similar to requiring good activity-based costing and project management, rigorous portfolio management relies on applying a balanced set of measures (e.g., balanced scorecard) and a logically transparent internal rate of return. These quantifiable benefits must be captured, communicated, and known through a corporation's value management processes. In lieu of a compelling value statement, the project in question and the entire IT portfolio of investments will revert to purely cost measures. After all, one of the benefits of portfolio management is retiring non-value-added systems.

While balanced measures and robust internal rates of return provide meaningful guidelines, experienced portfolio managers have found that sound judgment is still required for effective change. Business sponsors, project leaders, and end users have tendencies not to terminate expensive activities even when presented with clear and logical documentation (e.g., cost overruns, vendor bankruptcies).

User Action: CIOs need to adapt the methods of portfolio management, at a level of sophistication appropriate to their organizations, to increase the rigor of investment analysis. Applied reasonably, this technique will also improve an ITO's financial flexibility to respond to sometimes unforeseen financial, market, and technology events throughout the year. Portfolio management also frames the entire IT budget process in business language, giving the CIO a vocabulary and tools for presenting the budget that business management understands. This will greatly increase senior management's confidence in the ITO in general, moving the CIO and ITO along the senior management perception chain from trust through respect to agent of transformation.

META Group analysts Doug Lynn, Al Passori, Louis Boyle, Karen Rubenstrunk, Hollis Bischoff, Kevin Cooley, Jonathan Poe, Dale Kutnick, Val Sribar, David Cearley, William Zachmann, and Jack Gold contributed to this article.

Editor's Note: This article is the second part of a two-part series on META Group's IT and business portfolio management model. Click here to read Part 1.