Aligning strategic decisions with investment horizons

Firms typically consider a baseline five-year investment horizon as representative of the useful life of a solution when looking to refresh business architecture. It is also not uncommon to have a shorter target payback period, which may even be aligned with a single budget cycle. This may be well suited to opportunities for incremental change, but it seems fundamentally inconsistent with strategic decisions where technology choices often remain in production for 15 to 20 years.

The key question is how the cost of ownership of a given solution will behave outside of the typical five year window on which a specific decision is based. Where the useful life in the organisation has extended well beyond this, frustration with operating capability and associated levels of efficiency is compounded by the realisation that multiple solution components based upon these types of decisions are now well past their intended reset dates.

Furthermore, there is a tendency to disqualify ‘non-financial benefits’ from financial scrutiny and subordinate their role in the decision-making process. This approach was originally intended to ensure that investment decisions remain objective, but in fact has often resulted in a bias towards incremental shorter-term decisions under which potentially substantial competitive value is overlooked.

Examples of non-financial (but certainly not insubstantial) benefits are the speed, agility and reduced operational risk that can arise from simplification of the operating model, as well as reduced inertia associated with change initiatives. There is also the reduction in risk and costs associated with change initiatives that can be realised via simplified business architecture and reduced data movements, reconciliation and remediation overheads. Many organisations also fail to consider the fact that costs associated with time allocated to change projects by business resources would be incurred by an organisation regardless of whether or not the project is actually undertaken.

A necessary condition of change

The majority of decisions to invest in improvements to, or replacements of operating infrastructure and related technology are motivated by a perceived opportunity or need to dramatically improve operational efficiency. This has been exacerbated by the fact that recently, commercial objectives have been placed under pressure by a combination of market and competitive shocks and stresses – the global financial crisis and ongoing regulatory upheaval being the most obvious examples.

The impact of this approach to the investment decision-making process is becoming increasingly evident as organisations compete in a low margin climate. To exploit innovative efficiency opportunities fully, organisations now need to be able to better measure the value of non-financial items in their investment decisions. Businesses also need to plan for more extreme scenarios that effectively stress test their business models against potential revenue shocks, such as an unanticipated change in market conditions or competitor behaviour.

Investment committees considering investment proposals for business transformation must therefore look beyond the financial analysis presented within an individual business case and understand the context of how this initiative will strategically position the business under future operating scenarios that may include such shocks.

In the absence of such a clear assessment, a perfectly logical series of incremental investment decisions (or projects) conducted using the common practice of business cases primarily based upon a five year financial analysis can systematically lead a business to a sub-optimal or even business threatening operational outcome.

Only with effective assessment of the strategic implications and opportunities embedded in investment decisions can funds managers unlock the new level of efficiency that is often sought but frequently believed to be out of reach.