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Tech Industry

Technology after the bubble

Information technology will rise again--but only if providers learn how to help their customers make money, according to experts at McKinsey.

    The great corporate information technology glut is over, and not a moment too soon--at least from an IT buyer's perspective.

    Having spent more than $1.2 trillion on information technology in the United States alone from 1995 to 2000, companies now want to wring the elusive productivity and bottom-line gains from this massive outlay. If buyers are glad to end their spendthrift ways, IT providers of course have a different perspective: After years of heady sales growth, they are now engaged in bare-knuckle competition as the industry confronts sated customers and overcapacity.

    With too much of almost everything--sales reps, manufacturing capacity, engineers, managers--these companies must now accept more reasonable near-term projections of demand than they had anticipated during the years of overbuilding and overhiring. To make matters worse, they can expect stronger price pressure from customers, who have shifted their focus from new investments--currently regarded with considerable skepticism--to the maintenance and management of their IT systems already in place.

    The mounting pressure from customers whose budgets are falling and the more intense competition will continue to bear down on the IT vendors' margins. Merely getting leaner won't suffice. When corporate demand for technology revives, within the next 18 to 24 months, the requirements for success in IT will be different from those of the boom years. In the profligate 1990s, vendors got by on somewhat theoretical return-on-capital analyses.

    Now customers are more likely to demand that any case for investment not only take into account the business realities they face and their existing IT investments, but also demonstrate the top- and bottom-line impact of the products and services on offer. The vendors must also learn from companies that have made their IT investments pay and show less successful companies how to emulate them.

    The mounting pressure from customers whose budgets are falling and the more intense competition will continue to bear down on the IT vendors' margins. Merely getting leaner won't suffice.

    Obtaining this know-how won't be easy. It will force vendors to acquire deep business-process or vertical-industry expertise and a better understanding of their customers' deployed systems and configurations, to say nothing of the associated economics. To lead in the postbubble era, IT providers that entered the boom as leaders will have to shed, we estimate, an average of half or more of their current business portfolios over the next eight to 10 years. And they must start preparing for the future immediately.

    Succeeding now
    The requirements for success will change for two reasons, both related to the failure of most companies to derive value from their IT investments in the late 1990s. First, less successful companies will push IT vendors to help them realize near-term results from the money they have already spent on technology. Then, having seen the benefits enjoyed by the prescient few companies that did obtain a competitive advantage from IT, the less successful ones will put longer-term pressure on the vendors to help them reach or push beyond the best-practice frontiers opened up by the leaders.

    Both developments have challenging implications for the IT providers, which will have to focus their products and services on assisting customers in the quest to create value.

    Learning from companies that got IT wrong
    During the boom years, from 1995 to 2000, companies installed massive enterprise-resource-planning packages; upgraded their equipment as costs for PCs, servers and storage hardware fell; and tried to tie together their hardware and software by investing heavily in connectivity, including technology to support the leap to the Internet. They also shelled out large sums of money, often on expensive new applications to replace old ones, anticipating Y2K problems.

    Technology vendors reaped the bonanza. Yet few companies benefited from this orgy of investment--as the gap between spending and productivity, at both the sector and the corporate level, clearly demonstrates. There were several reasons for these failures. Many companies abandoned newly purchased systems when implementation trouble arose or when the cost of implementing them outweighed their economic benefits. Some companies automated only parts of their business processes and found that their failure to achieve end-to-end automation significantly diminished the payback.

    Others didn't focus their investments on the areas that would have had the biggest top- or bottom-line impact. Still others failed to transform their business processes or to reorganize their functions and activities in order to take advantage of their expensive new IT systems--a rather serious mistake, for to realize the full value of enterprise applications, such as supply-chain management and enterprise-resource-planning systems, companies must change their business processes significantly.

    Most IT buyers must now cope with complex IT environments burdened by too many systems, too many applications and underutilized capacity. Many of these customers are skeptical about the ability of IT to have a positive effect on productivity. Meanwhile, overall corporate budgets are now tight. As a result, most companies have dramatically reduced their IT expenditures and decided to focus on managing and maintaining their existing IT systems and on efforts to improve the capacity utilization of their IT infrastructure.

    These customers will be hard bargainers in future negotiations for IT services and products, and any new investments they make are likely to be piecemeal. They will demand shorter time frames for a return on their investments and for improved productivity, and they will be asking IT providers to help them find near-term value in the investments they have already made. Besides learning from what went wrong during the great IT glut, technology providers must learn from companies that got it right--and use those lessons to help less accomplished companies achieve similar benefits from their IT investments.

    Some companies did reap tremendous value from their technology spending in the late 1990s. Charles Schwab, Dell Computer, Wal-Mart and other leading businesses made not only huge IT investments but also process changes that enabled them to influence the productivity levers that really count in their industries. Higher productivity led to higher margins, which were used to create value for customers. Many of these productivity leaders are better prepared to weather the storms of the next year or two.

    The most successful companies did five things. First, they developed their technological innovations and the complementary managerial innovations in tandem. Second, they focused their technology investments on cutting the interaction costs that most affect productivity. These interaction costs are quite specific to a given vertical industry, and the investments of most IT leaders had a strong vertical focus.

    Third, the leaders clearly understood the specific productivity levers of the sectors (and subsectors) in which they do business. They disproportionately focused their IT investments on programs that had the highest possible impact on those levers--and thus an impact on the top and bottom lines. Fourth, these companies made their investments in the right order, to build IT capabilities in sequence over time. Finally, they retooled their business processes and transformed their organizations to leverage their managerial innovations and IT capabilities.

    Besides learning from what went wrong during the great IT glut, technology providers must learn from companies that got it right.

    The history of business shows that technological innovations are typically of little use until complementary managerial innovations bring them to life. That is no less true now, when leading companies use IT to create differentiated business models and to reach new performance heights. Dell and Wal-Mart are good examples of this approach. For example, Wal-Mart's innovations in supplier relationships were developed in tandem with its RetailLink information system and its collaborative purchasing systems. Its innovations in the day-to-day replenishment of its stores were developed along with its applications for warehouse automation, cross-docking and inventory tracking. Custom micromerchandising applications complemented the company's innovations in store formats.

    By contrast, some IT investments in retail banking, to cite just one industry, had less impact than they should have, because they weren't accompanied by the managerial innovations needed to unlock their value; technology investments in online banking, for instance, have been undermined by the failure to implement the kind of multichannel-management effort that would help customers migrate from high-cost branch systems to the World Wide Web.

    Companies can put IT to uses that are almost too numerous to list; aggregating management data, providing administrative support and integrating operations are only a few of the many possibilities. Yet leading companies invariably focus their IT investments in one area: reducing interaction costs, which in most businesses consume 40 percent to 60 percent of the staff's time. Coordinators, expediters, order-entry clerks, schedulers, customer service representatives, and scores of other specialists flourish in the gaps between systems within a company, and between its systems and those of its suppliers and customers. These jobs add delay, cost and error--all enemies of productivity.

    Modern companies undertake many internal and external interactions. Different economic sectors have unique performance drivers that are based on the products they sell, the customers they sell to, and the costs associated with conducting business in that sector. In retailing, for example, technologies that facilitate supply-chain activities, such as managing warehouses (thereby increasing the utilization of labor) can be great levers for productivity. But in retail banking, comparable technologies, such as those used to run call centers and to automate branches, have affected it very little. Companies that deployed IT successfully not only clearly understood the productivity levers important to their sectors, but also used technology to achieve step-change improvements in these levers.

    For more insight, go to the McKinsey Quarterly Web site.

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