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McKinsey: Stand-alone IT Investments Are a Strategic Mistake
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December 03, 2001 (Computerworld) -- Forget one-year IT project wonders. Boosting productivity, cutting costs and generating positive business payback on IT investments require a comprehensive action plan sustained over several years by multiple business units and departments beyond IT, according to a recent study by New York-based management consulting firm McKinsey & Co.
Indeed, McKinsey found that IT was only one of several factors that contributed to an upward surge in U.S. labor productivity between 1995 and 2000, when productivity grew at an annual rate of 2.5%. Between 1987 and 1995, the rate was 1.4%.
For pointers on how to effectively improve productivity, look to the retail, wholesale, securities, telecommunications, semiconductor and computer manufacturing industries. McKinsey calls these six industries "jumping" industries because they accounted for almost all of the productivity growth in the U.S. economy between 1995 and 2000.
In stark contrast, the industries that make up the other 70% of the economy—and that also happened to be among the biggest buyers of IT during the same period—recorded a mix of small gains and losses that offset each other.
In fact, according to McKinsey, some of these so-called paradox sectors, such as the hotel and retail banking industries, have experienced almost no productivity growth over the past 14 years.
"Two things are surprising to us from this research. The first is how large the benefit is if companies get all of the [business] factors aligned with IT," says Mike Nevens, an analyst at McKinsey. The other big surprise, he says, "is how few companies are actually able to do it."
Among the companies that are succeeding is Wal-Mart Stores Inc., which over the past decade or so has applied the bulk of its IT investments and made big business-process changes to improve basic operations, notably inventory and warehouse management. The result: By 1999, the Bentonville, Ark.-based retail giant had captured 30% of its market, up from just 9% in 1987.
What has differentiated Wal-Mart's IT/business plan is its long-term application of technology to core business activities, such as inventory, rather than support functions, says Nevens.
Moreover, IT was just part of the retailer's overall business strategy. Along with implementing technology, Wal-Mart changed the layout of its stores, shifted merchandising techniques based on what it learned from mining customer data and changed its concept of the distribution chain.
"It was by attacking a piece of their business that's a core activity—picking and packing as opposed to automating the invoicing process—that changed the game competitively," says Nevens.
Catching On
Subsequently, other retailers caught on and adopted many of Wal-Mart's IT/business innovations by the mid-1990s, including electronic data interchange and wireless bar-code scanning in warehouses.
Wal-Mart raised the bar even higher by increasing its own efficiency another 20% between 1995 and 2000. Still, with Wal-Mart setting a fierce competitive pace, the retail industry became one of the most productive users of IT during that period.
At the other end of the spectrum are the retail banking, long-distance data transmission and hotel industries, which the McKinsey study ranks among the least-productive investors in IT.
For example, McKinsey found that hoteliers have funneled a lot of money and effort into using IT to discern what their customers want. But in the end, it's made little to no difference in actual occupancy rates.
Among the industry's biggest investments were Web sites where customers could make their own reservations electronically instead of having to telephone a live—and more costly—reservations agent.
"Companies got all excited about building a Web site which would have relatively lower variable costs," acknowledges Gino Giovannelli, director of e-commerce at Minneapolis-based Radisson Hotels & Resorts. "But one of the reasons they haven't realized huge savings is that they always underestimate the cost of building the Web site."
Another big factor contributing to the low productivity rate of Web sites thus far is that for most hotels, including Radisson's, less than 5% of all business comes in over the Web.
The bottom line: "Every additional reservation we get online still dramatically reduces our variable costs, but there's not a lot of online reservations to divide that big fixed cost of the Web site," says Giovannelli.
Looking ahead, McKinsey estimates that companies in the six jumping industries can maintain at least half of the productivity results they achieved from 1995 to 2000.
But overall, its analysis shows that between now and 2005, the U.S. economy isn't likely to revert to even pre-1995 productivity growth rates.
IT Investments and Productivity: An Unbalanced Yield
1987 - 1995
1995 - 2000
Growth in IT investment
11%
20.2%
Growth in labor productivity
1.4%
2.5%
Proven IT Strategies for Boosting Productivity
APPLY NEW TECHNOLOGY to core operations first, before support activities.
INVEST IN TECHNOLOGY to leapfrog, not match, competitors’ capabilities.
CALCULATE INVESTMENTS in IT the same as for other capital assets.
Productivity Winners and Losers
WINNERS
Retail
Wholesale
Securities
Telecommunications
Semiconductors
Computer manufacturing
LOSERS
>Hotels
Retail banking
Long-distance data transmission
Source: McKinsey & Co., New York
Related stories:
- Security ROI calculations pose challenges for users, Nov. 5, 2001
- What to Count? July 16, 2001
- Productivity Falls for First Time in Six Years, May 10, 2001
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