In many ways IT is a victim of its own success. Legacy systems keep attracting investment because they are usually already successful and it seems simpler to extend a functional system than to build one from scratch. The result: Financial industry spending on legacy systems has increased from just over half of all IT spending in 1985 to nearly three-quarters in 2001.
By contrast, spending on new development has shrunk from more than 40% of total expenditures two decades ago to less than a quarter today. Legacy spending is crowding out new IT investment.
The increasing emphasis on getting the most out of previous investments in legacy technology causes IT management to concentrate largely on "running the bank" at the expense of new initiatives. Worse, many of these systems are taken for granted as merely representing a cost of doing business - a utility like electricity or energy that cannot be managed for shareholder value. Consequently, those who determine a financial services firm's true future value and potential (equity analysts, rating agencies, supervisors, and so on) take little account of the competitive advantage of information technology.
My company recently conducted research about the linkage between IT expenditures and shareholder value. The study focused on financial services firms, a group that accounts for $490 billion in technology spending worldwide. The research also showed that only a few firms were deriving significant value from IT investments, representing no more than 10% of the financial services industry by value.
A few large processors, which rely more on scale than on innovation, and diversified titans like Citigroup and IBM, whose broad spectrum of activities extends into processing, hold most of the value in this sector. Many such large financial services firms are considering "lifting out" entire back-office operations to create stand-alone companies, following the lead of American Express and Fidelity.
The 10% mentioned above falls into two categories lying at opposite ends of the IT spectrum: scale factories and information specialists.
Scale factories, such as Bank of New York and State Street, rely on high market share and compete by providing at the lowest cost in subsectors such as global custody and check processing. They are technology specialists that extract value from scale and automation of business processes.
By contrast, information specialists such as Capital One, Reuters, and Fair Isaac sell or analyze information as a way to generate sustained value. They may use the information directly, to add value though better customer management, or indirectly, by selling it to other companies that in turn use it to add value to their own businesses.
The vast majority of firms (or, equivalently, the vast majority of IT expenditures) are not as easy to classify, and most do not aspire to either technology or information specialization. The question for these institutions is how to unlock the value available from their investments in information and technology in order to buoy valuations. They need to identify areas in which they cannot plausibly achieve scale, or conversely to pick out areas where they can generate sustainable value through information science.
The key to controlling unproductive legacy spending is to benchmark technology investments against the outside world. Conventional controls over technology investments tend to be introverted, focusing mostly on the variance of timings and costs from an initial project plan. This may provide helpful insights for tactical management, but fails to capture the strategic implications of changes in the operating environment that may render the investment unproductive or pointless. Without this reality check, it is hard to tell when a firm is just keeping up with the market, and when it is racing ahead. Market developments can swiftly turn today's technological innovations into tomorrow's legacy systems, in a process known as commoditization.
Only a few specialists, dependent on economies of scale, can make a living by processing commodity products; a company that is not likely to become such a specialist needs to spot that moment before it arises and plan accordingly.
The same logic also applies retrospectively, to the infrastructure supporting products or services that have already commoditized. It is important that maintenance expenditure be normalized according to front-office operating margins and adjusted for variations in business mix, front-office headcount/productivity, and capital productivity rather than purely on the basis of operating costs at a particular point in time.
The outcome of this analysis can identify processing areas where competitive scale advantages exist and IT infrastructure areas that could be turned into stand-alone businesses. Conversely, the firm should seek to quit or outsource those businesses and functions that provide it no realizable competitive advantage.
The battle for competitive advantage in financial services IT has shifted from improvements in hardware and software to more intelligent exploitation of data, analytics and knowledge management.
