While invention has often been defined as turning cash into ideas, "innovation" is sometimes thought of as turning ideas into cash. This model possesses an intriguing symmetry. But more interesting perhaps is the aspect of getting the cash to fund innovation in the world of information technology and, in particular, in banking.
Banking and financial services is the most technologically intense sector in existence today as measured by IT spending relative to revenue and operating expenses. The average bank spends roughly 6% of net revenue and 7.4% of operating expense on IT. However, at the extreme end of "IT intensity," investment banks spend 10% of net revenue and 16% of operating expense on technology. This has somewhat oscillated during the past few years of market fluctuations but is a good approximation of the gap between investment banking and retail banking.
If you divide enterprise IT spending by employee headcount, the average expense is about $23,000 per year per employee. At a typical bank, 9%-10% of total enterprise headcount is the IT headcount. Again, investment banks are a more intense IT life-form with spending as high as $120,000 per employee and IT headcount approaching 20% of total enterprise headcount.
With this data as a backdrop, the IT investment portfolio (IT spending to run, grow and transform the business — this is where innovation fits in) has exhibited a fairly stable pattern over the past five years, albeit with some pressure on the latter two categories, which are discretionary.
Run-the-business or keep-the-lights-on spending has held between 59% and 61% of total IT spend. At the same time, grow-the-business spending has ranged between 22% and 24%. Transform-the-business spending started at 17% five years ago, dropped to 13% during the financial crisis, and is now back at 17%.
But that needs to be taken in context. Innovation spending is 13% to 17% of the average of 6% of net revenue, which in turn translates to .78% to 1.04% of net. This level of investment is far below that of other sectors, perhaps by a factor of five.
In addition, the pattern of innovation spending itself reveals a disturbing and competitively dangerous behavior for banks. Although innovation might be one of the most powerful business forces that exists, it is treated as highly discretionary in rough economic times.
The bounce from 17% to 13% and back up again shows that in the worst of times the "first to go" in banking is funding for innovation.
It should be clear that effective technology economics to enable innovation is more than just a funding model. In fact, it is a portfolio model similar to that used in financial markets to guide investment strategy, manage risk, and hopefully target desired yields.
At the highest level, investments/spending should be categorized in terms of outcomes: growing revenue, protecting revenue, reducing cost, avoiding cost, and managing risk. The mechanism by which investments are transformed into such outcomes must also be charted (sort of like turning ideas into cash). More tangibly, IT investments are linked to these outcomes by three channels: increasing operational efficiency (or excellence), promoting customer intimacy and enabling product leadership. (The best reference on this is "The Discipline of Market Leaders" by Michael Treacy and Fred Wiersima.)
Using this framework, the technology economics of innovation is an "overlay." Innovation brings an invention to market. It represents a discontinuity in any or all of these channels to produce a suite of outcomes. Although this sounds simple and logical, the unique thing about invention and innovation is that you can't predict that it's going to happen. What you can plan for is the incubation of a continuing flow of innovation (and an innovation portfolio in itself) with the hope and expectation that a subset of the new ideas will come to market and have a major impact.
Hence, the technology-economics of innovation require that innovation is constantly funded and protected through complex times. These same economics require that innovation be viewed with an outcome focus and managed in stages like a venture. That is to say innovation cannot be managed from a cost-only perspective. It must be managed and funded from and outcome-risk/reward perspective.
Let's shift away from IT for a few moments and consider the national picture and U.S. competitiveness. As a nation it is clear that it is hard, perhaps impossible, to compete globally on labor cost competitiveness. National policy is focused on the innovation engine that is clearly a U.S. core capability and competency. Similarly in banking, this competency must be fostered and protected as part of technology-investment strategy even in the most pressing economic times.
With global technology spending approaching $5 trillion — equivalent to perhaps to the third-largest gross domestic product in the world — it should be evident that we are in a "technology economy."
Innovation is the heartbeat and change agent of that economy. With the intensity of technology in banking, it should be clear that the innovation "engine" of the sector must have continued funding and is the ultimate competitive focus.
