Proving Grounds

A company's quest for greater operational efficiency and cost savings historically has justified its IT investments. For example, a company would purchase a human-resources-management system from PeopleSoft Inc. to handle HR data more efficiently or even to replace some full-time employees.

But in the E-commerce world, IT investments are more about top-line growth than cost savings. A company might invest in IBM's WebSphere sell-side E-commerce platform to drive $500,000 in sales via a new Web-based channel.

The fact is, whether you use IT to reduce operational costs while holding revenue constant or to increase revenue while holding costs constant, the net effect is the same: improved bottom-line profits.

Thus, companies should view their IT operations as profit centers, rather than cost centers. If businesses weigh the costs and profitability of an individual system, such as an E-commerce system, they can also apply this strategy to the entire IT organization.

But companies must first overcome the fundamental challenge of tracking the performance of their investments over time. I recommend two strategies.

First, abandon the legacy of cost accounting, the infamous charge-back system. Under cost-accounting plans, IT--or system-related costs, usually people and time--is distributed to line-of-business profit centers according to some grand scheme, usually based on the amount of activity or use.

As a result, the value created by IT is dispersed and typically marginalized as it's commingled with other noncontrollable expenses for the business unit. Even the best charge-back systems--those that let business units prioritize their needs and actively manage expenses--have difficulty handling infrastructure investments that actually serve overall corporate needs and don't have narrowly defined beneficiaries.

Second, treat the IT organization as a standalone business unit. This profit-and-loss center will have its own income statement and balance sheet, as well as a structure that lets the organization measure and monitor investments over multiple years.

Many large companies are moving in this direction by establishing separate IT companies under their corporate umbrellas. They require these companies to operate like true services firms by negotiating with other business units, billing for their time, and turning a profit.

Unfortunately, even when IT is considered a profit-and-loss center, the profits are typically distributed back to the business units at the end of the year, when all accounts are zeroed out and the process starts again with the next year's budget. With a requirement to work and show profit within a 12-month window, IT managers may not face the same opportunity--or accountability--over time that they would face under other structures. And given the complexity of many implementations and the increased overall level of investment, this short-term perspective dilutes an organization's ability to create a long-term, sustainable competitive advantage.

Where possible, IT companies should be allowed to reinvest their year-end profits in ways that will enhance their ability to serve other business units. Using a balance sheet to track progress will let businesses quickly and accurately measure the level of investment and return on investment over multiple years.

To turn your IT organization into a profit center, capitalize it with assets and liabilities, sufficient working capital, and a profit-and-loss sheet. Then challenge IT managers to make investments in resources they think will give them a competitive advantage in servicing the other business units. Remember to give IT managers, who generally haven't had to use traditional measures, some training in thinking about investment alternatives and return over time.

Most importantly, your line-of-business managers must be willing to let their IT counterparts operate at an initial loss and realize that benefits may take several years to accrue. However, when they do, your company will have a balance sheet in place to objectively measure their progress.

James K. Watson Jr. is CEO of Doculabs, an analyst firm that helps companies choose technologies and strategies for E-business. He can be reached at [email protected], http://www.doculabs.com, or 312-433-7793.