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While technology is quickly transforming the nature of business, technology investment processes have not always kept pace. How can CIOs rethink traditional technology budgeting?
Technology plays a central role in helping companies develop and capitalize on new business models. As the role of technology shifts, budgets and the investment process are subject to increased scrutinization—and are ripe for evolution.
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This CIO Insider uncovers trends in technology budgets and examines the spending habits of companies that are more advanced than their peers. It also explores the impact of IT operating model changes on technology funding and makes recommendations for rethinking the traditional technology budgeting process.
Reflecting the importance of technology and its role in value creation, the majority of companies have consistently experienced budget increases over the last four years, according to participants in Deloitte’s ongoing series of global CIO surveys (figure 1). Still, a considerable percentage of participants continue to report budgets are decreasing or remaining the same.
IT budget as a percentage of revenue—a time-tested benchmark that’s useful for comparing industries—ranges from nearly 8 percent in banking and securities to less than 2 percent in construction and manufacturing, with an average of 3.64 percent for all industries (figure 2).1
As technology and business strategies merge, IT’s emphasis on service delivery is giving way to a focus on value delivery. Maintaining business operations is still critical, but it’s equally important for technology teams to work hand-in-hand with business functions to cocreate value.
Yet many CIOs describe a significant gap between business leadership’s expectations of IT and corresponding financial support.2 Seventy-two percent of CIOs say projects that are most appealing to CEOs and executive leadership are those that generate revenue or focus on innovation and emerging technology.3
Yet the average IT department invests more than half (55 percent) of its technology budget on maintaining business operations and only 19 percent on building innovative new capabilities.4 Industry differences exist; for example, technology and telecommunications, insurance, and banking and securities companies are spending more on innovation as they rapidly build new business capabilities and engage customers. Similarly, healthcare and energy companies have historically lagged in technology spending but are now investing more in innovation as their industries go through technology transformations (figure 3).
The latest CIO survey found that organizations identified as more digitally advanced, known as digital vanguards, have four spending habits that distinguish them from their peers, known as baseline organizations.
CIOs have long been challenged by the perception of IT as a cost center. The merger of technology and business strategies can give CIOs the opportunity to swap out an emphasis on reducing costs, for an investment mindset that prizes strategic spending to increase revenue, growth, stock price, or other measurements of business and shareholder value.
As the technology function takes on a more high-profile role, CIOs may need to address important considerations regarding core modernization, cloud business models, investment governance and value measurement, incompatibility of fixed budgets with Agile development, and automation’s impact on the workforce.
Complex choices about core modernization. Many CIOs recognize that legacy core systems lack the agility needed to develop and scale innovative and disruptive new technology solutions—more than a third (34 percent) identify the complexity of technology systems and environments as the top contributor to project failure.8 Gartner predicts that through 2020, for every dollar invested in digital business innovation, enterprises will need to spend at least three times as much to continuously modernize the legacy application portfolio.9
That could be why 43 percent of CIOs say core modernization is the technology area expected to have the most impact on the business in the next three years.10 Organizations saddled with legacy systems can rehost, replatform, rearchitect, rebuild, or replace them—strategies that vary in impact, cost, risk, and value.
But core modernization should be evaluated as a technology investment alongside other investment choices. The CIO of a large distribution company decided to hold off on a modernization effort and redirected the funds to a custom warehouse management application that gave the organization a competitive advantage. The return on investment (ROI) of the warehouse management system was much higher than that of the modernization effort.11
Impact of cloud business models on opex/capex. Lured by ease of use and deployment, business and technology functions have embraced cloud solutions with open arms: Ninety percent of CIOs surveyed say their organizations are using cloud-based services.12
The cloud can drive innovation and encourage experimentation because it eliminates the burden of buying and maintaining technology infrastructure. Seventy-five percent of survey respondents say they use cloud services because they increase scalability, which can be important where market demand is uneven, uncertain, or volatile. Nearly as many (72 percent) say it improves business agility, allowing for faster time to market. For these and other reasons, CIOs surveyed spend an average of 22 percent of the IT budget on cloud-based services, an amount they expect to double (44 percent) in the next three years.13
But every investment has risks, and cloud is no different. Because cloud shifts technology investments from the capital expense column to the operating expense column, moving to cloud too quickly could substantively impact company financials. Finance and technology functions can work together to classify these costs appropriately and assess and optimize the impact of cloud investments. Many CIOs and CFOs are already employing strategies for depreciation and capital allocation to offset this impact.
Other risks associated with widespread adoption of cloud and software-as-a-service (SaaS) business models are the ungoverned adoption of cloud services and improper management and oversight of cloud investments, which can occur in the absence of a strong governance process for procuring cloud services. This can leave companies at risk for cloud sprawl—the unplanned, uncontrolled proliferation of disparate, and sometimes duplicate, cloud services across an enterprise.14 Cloud sprawl can impact technology budgets by increasing operational complexity and creating unchecked cloud consumption.
Consistent investment governance and value measurement. Appropriate oversight of technology spending can help CIOs, CFOs, and other executives prioritize technology investments, align with corporate strategy, and ensure transparency. Yet, only a little more than a third of survey participants (37 percent) say they manage investments using well-defined processes or business case templates.15
Similarly, IT and business alignment on budgeting is uncommon. Thirty-six percent of CIO survey participants report a lack of business ownership and accountability as the top challenge in securing funding. And as previously discussed, most organizations have not fully embraced a joint IT-business function ownership of technology investment decision-making and measurement processes (figures 5 and 6).16
Technology leaders can strengthen the ability to build credible business cases that accurately forecast technology project ROI and evaluate the performance and value of each investment. A dedicated finance staff tasked with modeling, managing, and measuring the value of IT investments can be helpful, but only 20 percent of CIO survey participants report having such a person on their staff.17
Taking such steps can help reduce the perception that the technology function is an inscrutable black box, make it easier for technology leaders to justify expenditures, and help them build stronger relationships with CFOs.
Incompatibility of fixed budgets with Agile development. Agile and other flexible delivery styles are on the rise—the CIO survey found that 56 percent of CIOs expect to implement Agile, DevOps, or a similar flexible IT delivery model to increase IT responsiveness.18
But these efforts could be stymied by traditional budgeting processes, which aren’t optimized for the Agile development environment. Rather than promoting cross-functional teaming, iterative sprints, and the customer- and product-oriented mindset—the hallmarks of Agile development—fixed IT budgets are typically structured to provide incremental annual increases and encourage functional silos, inflexible requirements, and a project-focused mindset. Agile’s laissez-faire approach to project scope and requirements dictates more flexible timelines, processes, and financing, which fly in the face of the fixed annual budget’s insistence on predictable costs and resources.
CIOs can manage the investment portfolio in the same manner as venture capitalists, but only if funding models are adjusted to encourage Agile, product-focused environments. A flexible budgeting process can give product teams the creativity and accountability needed to deliver business value.
The impact of automation on the workforce. The ability of automation and robotics to streamline and speed up IT delivery is changing the way technology and business teams work, collaborate, and create value. Nearly three-quarters (72 percent) of CIOs surveyed in Deloitte’s 2019 Industry 4.0 study say autonomous technologies will augment the efforts of human workers, while 28 percent believe that these technologies will increasingly replace human workers.19 Jobs will morph into “superjobs” that merge different aspects of traditional jobs to create integrated roles that take advantage of technology-driven increases in productivity and efficiency.20
As more and more technology work is performed by a mix of humans and machines, technology budgets, as well as the budgeting process, will likely evolve. For example, nearly half of the CIOs who participated in the Industry 4.0 study (48 percent) say that over the next five years, their organizations plan to significantly increase hiring of gig workers, which could result in significant changes to talent funding.21 And as automation enables teams to trade manual and repetitive tasks for those requiring higher-order skills, better workflows and different resource requirements could drive up productivity, output, and reduce operational costs and errors.
These seven principles can serve as the foundation of a sound technology investment decision-making process.