IT DOES Matter: The New Technology Economics Dr. Howard Rubin CEO Rubin Systems/Rubin Worldwide MIT CISR Research Associate Professor Emeritus City University of NY Senior Gartner Advisor April 16, 2009 Version 5.0

2 All Rights Reserved. Dr. Howard Rubin Prologue “My argument is not that you don't need IT or that it's not important, but that it doesn't matter strategically and doesn't provide one company with a way to distinguish itself in any meaningful way from its competition” -Nicholas Carr “Those companies that have optimal Technology Intensity (the best mix of IT investment to grow and protect revenue while reducing and avoiding costs at a managed level of risk) outperform their peers by 3-5% of pre-tax margin. The most opportunistic time for technology investment is during an economic downturn; it is the only area in which investment can change the operating profile of an organization – doing so effectively can create an insurmountable competitive gap. Bad IT economics will put you on the wrong side of this gap and may even be creating advantage for your competitors. IT DOES Matter – It is strategic and meaningful if managed wisely.” -Howard Rubin

3 All Rights Reserved. Dr. Howard Rubin Prologue: When IT DOESN’T Matter When there is no differentiation among competitors with regard to IT Cost of Goods (or if there is, it doesn’t impact Total Cost of Goods) Where there is no leverage or return from IT investments to Grow Revenue, Protect Revenue, Reduce Cost/Avoid Cost (Operational Efficiency) or Manage Risk. When the Technology Spending Tsunami overtakes growth in Revenue and Profitability (see above) When your IT investment portfolio underperforms – a cluster of peers with the same technology intensity and no profitability differentiation

4 All Rights Reserved. Dr. Howard Rubin Prologue: When IT DOES Matter When there is a major spread in IT Cost of Goods and business performance is enhanced and the gap goes right to the bottom line When ROIT is a multiplier that shows up in revenue growth/protection or operational efficiency or risk management or all of these When your Tsunami swamps the competition When your IT investment portfolio outperforms the market – at your level of technology intensity you outperform peers.

5 All Rights Reserved. Dr. Howard Rubin Prologue: Key Points to Follow 1.Technology spending has collided with current economic conditions as IT organizations have failed to enact agile IT economics. The pressure is on to cut IT. 2.In 2009, the U.S. Fortune 500 for example will have perhaps $10T of Operating Expense and $500B of Tech Expense. Operating Expense dwarfs the cost of IT. 3.The single biggest opportunity for organizations is to reduce Operating Expense is through targeted technology investment. If IT was “free” it would barely provide the needed lift for the global economy. 4.Business consolidation driven by current economic conditions is resulting in a new scale of business. Companies that can attain the new scale economics of IT will gain insurmountable competitive advantage. IT DOES matter.

6 All Rights Reserved. Dr. Howard Rubin Topics Why IT DOES Matter The IT Economic Climate IT Spending Trends The Impact of Industry Consolidation on Scale: Infrastructure and Business Process The Importance of IT Economics: IT Cost of Goods and Profitability The New IT “Value” Meal The IT Management Mandate Conclusions

7 All Rights Reserved. Dr. Howard Rubin Why IT DOES Matter  The current global economic environment has driven significant merger/consolidation activities in the financial services sector.  As a consequence, enterprises of new scale are being created.  The largest of these organizations will have access to information technology (and business process) economies of scale that have never been experienced in the industry.  The scale gap between firms will become a competitive lever for those that can harness such benefits.  This scale gap is most apparent and can be most quickly leveraged in the area of IT infrastructure.  Current analyses indicate that scale-economic cost reduction by 2010 for IT infrastructure may be as much as 40%-60% overall (relative to 2007 baseline costs).  This level of cost take-out has the potential to reshape the technology cost of goods for business products in the financial services sector. (e.g. cost per trade, cost per ATM transaction, cost per customer, etc,)  Those firms that do not have access to such economics will inherently be non-competitive unless they can develop ways to access the economics of their largest competitors.  The impact of scale economics will be further amplified with effective demand management and heightened virtualization which will enable new levels of IT infrastructure efficiency (supporting even larger enterprises with less physical resources.  Overall, in an industry where infrastructure costs typically were ~ 3% of Net Revenue in 2007 we are looking toward a future where the operating model may be ~2% or less. Similar reductions are expected in business process costs.

8 All Rights Reserved. Dr. Howard Rubin The IT Economic Climate Current high fixed cost of IT in most companies is preventing required economic agility to respond to business revenue volatility Conventional IT cost cutting models have “hit the wall” under the new pressures of spending reduction Current high fixed capacity IT in most companies is preventing required “plant” agility to respond to business volume volatility Conventional capacity management and sizing models have “hit the wall” in the face of unprecedented downward business volatility Current IT spending is viewed as high an in most companies and is in the process of being cut Conventional wisdom is to cut IT in times of business stress – in fact IT is the only lever left where investment can decrease operating costs. Current consolidations are creating new scale economies – the formerly tactical task of infrastructure and business process consolidation now has intense strategic value!

9 All Rights Reserved. Dr. Howard Rubin The “IT Bailout” (of Business) Targeted investment in IT can have a major impact during current economic conditions Fact: Overall IT costs are only 5.9% of Operating Expense which means that 94.1% of Operating Expense is the greater opportunity area. Fact: Each $1 of new investment in IT between 2003 and 2005 had helped drive $1.47 of Gross Profit in 2006

10 All Rights Reserved. Dr. Howard Rubin Technology and the Economy: Technology Eras and the GDP Historically ( a short history ), there appears to be a linkage between technology eras and GDP trends. Mainframe Computing Distributed Computing Internet/Pervasive Computing

11 All Rights Reserved. Dr. Howard Rubin Technology and the Economy: Tech Spend and GDP There appears to be a linkage between technology spending and market trends. Mainframe Computing Distributed Computing Internet/Pervasive Computing

12 All Rights Reserved. Dr. Howard Rubin Technology Economics: Historical Perspective National productivity has accelerated through the “technology era” US Non Farm Business Productivity Change The Mainframe Era The Client Server/Distributed Era The PC/Emerging Internet Era 2001-Current The Pervasive Computing/Pervasive Access Era Percent Change Over Period Correlation Between Non Farm Productivity Change and IT Investment Change I T I n v e s t m e n t C h a n g e Non Farm Productivity Change y = x R =

13 All Rights Reserved. Dr. Howard Rubin Technology Economics: Historical Performance Superior technology investment strategies have enabled superior business results. Top performers have driven higher pre tax margin for a given level of technology investment. Pre Tax Margin Vs. Technology Intensity – Top 10 Investment Banks T e c h n o l o g y I n t e n s I t y Top 10 Investment Banks 25% 27% 29% 31% 33% 35% 37% 39% 41% P r e T a x M a r g I n IT as % of Revenue IT as % of OpEx Technology Intensity Pre Tax Margin Vs Technology Intensity (Banking)

14 All Rights Reserved. Dr. Howard Rubin By 2006, a 26% increase in cumulative absolute Tech Spend in the U.S. had helped drive a 114% in absolute Gross Profit; The 13% increase in relative Tech Spend had helped drive a 60% increase in relative Gross Profit Each $1 of new investment in IT between 2003 and 2005 had helped drive $1.47 of Gross Profit in 2006 The opportunity to continue this trend and increase IT business value through IT cost optimization (economies of scale and focus via sourcing) is still apparent…. Technology Economics: Historical Perspective

15 All Rights Reserved. Dr. Howard Rubin At the same time the IT Cost of Goods has continued to rise as all sectors have become more technology intense. Technology Economics: Historical Perspective

16 All Rights Reserved. Dr. Howard Rubin Technology Economics: Current State Technology Spend has collided with current economic conditions as IT organizations have failed to enact agile IT economics and make their value proposition transparent. For 2009, the F500 will have perhaps $10T of Operating Expense (exclusive of IT) and $511B of Tech Expense. The BIG opportunity is to reduce Operating Expense through targeted technology investment.

17 All Rights Reserved. Dr. Howard Rubin Technology Economics: Current State Technology Intensity varies across sectors

18 All Rights Reserved. Dr. Howard Rubin Cross Industry Overview: Current State Computing needs in support of revenue vary widely by industry

19 All Rights Reserved. Dr. Howard Rubin Cross Industry Overview: Current State Cost of Mainframe and Server resources per $1M revenue

20 All Rights Reserved. Dr. Howard Rubin Financial Services 2009 “Size of Plant” Trends: Scale is increasing as a result on industry consolidation By the end of 2009 there will likely be 3-4 companies with scale of over 100,000 MIPS and 55,000 servers; there will be at least 1 with over 200,000 MIPS and over 80,000 servers. Scale Economics: Infrastructure

21 All Rights Reserved. Dr. Howard Rubin X = 2007 Competitors and Y = 2009 Competitors in terms of placement on the scale economics curve and do not represent actual competitor unit costs X X X X X X X X X X X X X X X X Y Y Y Y Y Y YY Y Y Y Y Financial Services 2009 Scale Economics Trends: As a consequence of increased scale as a result of consolidation, the largest firms will have access to never-before-experienced scale economies Being an average performer at “scale” or best in class at “scale” will not be competitive Scale Economics: Infrastructure

22 All Rights Reserved. Dr. Howard Rubin Financial Services “New Math” of Infrastructure Cost: With the new economics of consolidation scale and Moore’s Law at work, the same set of infrastructure services that cost ~$500M+ in 2007 will likely be delivered by the most efficient companies for ~$200M in Note: See last panel the DataCenter SuperCenter and the IT Value Meal Scale Economics: Infrastructure

23 All Rights Reserved. Dr. Howard Rubin Scale Economics: Business Process Retail Banking provides an excellent window into the potential of business process scale changes as a consequence of consolidation.

24 All Rights Reserved. Dr. Howard Rubin Scale Economics: Business Process The shifts in scale are similar to those for IT infrastructure

25 All Rights Reserved. Dr. Howard Rubin Scale Economics: Business Process Consolidation will differentially impact business process scale economics as a function of business mix – retail branches.

26 All Rights Reserved. Dr. Howard Rubin Scale Economics: Business Process Consolidation will differentially impact business process scale economics as a function of business mix – ATM’s and ATM transactions

27 All Rights Reserved. Dr. Howard Rubin Scale Economics: Business Process Consolidation will differentially impact business process scale economics as a function of business mix – credit card accounts

28 All Rights Reserved. Dr. Howard Rubin Scale Economics: Business Process Consolidation will differentially impact business process scale economics as a function of business mix – online users

29 All Rights Reserved. Dr. Howard Rubin Scale Economics: IT Cost of Goods and Profitability The Post Consolidation cost structure of basic transactions will be driven by economies of scale and can reshape the profit structure of the industry.

30 All Rights Reserved. Dr. Howard Rubin The New Model: Fixed Vs Variable Cost Conversion Category Captains It is commonplace for one particular supplier into a category to be nominated by the retailer as a Category Captain. The Category Captain will be expected to have the closest and most regular contact with the retailer and will also be expected to invest time, effort, and often financial investment into the strategic development of the category within the retailer. In return for this, the supplier will gain a more influential voice with the retailer but must be careful never to abuse this or fall foul of any antitrust laws. The Category Captain is often - but not always! - the supplier with the largest turnover in the category. Traditionally the job of Category Captain is given to a brand supplier but in recent times the role has also gone to particularly switched-on Private label suppliers.[13] antitrustbrandPrivate label[13] Soft Vs. Hard Landing Controls Enabling “Agility”: Using a “model” company today only 36% of IT expense is variable (can be “shed” within 90 days). By changing the IT operating model, perhaps up to 60% can be made truly variable (though there may be some premium to pay for this conversion). Model Company Tech Spend$M % Variable Today % Variable Future State Model Total Tech Spend$5,000 36%60% Compensation$1,800 50%70% Contractors and Sourcing$ % Hardware Depreciation$600 0%33% Hardware Maintenance$400 25%50% Software Expense$500 25%50% Software Capitalization$500 0%50% Telecommunications$300 25%60% T&E$50 50% Recruiting$50 100% Facilities/Rent$300 10%33%

31 All Rights Reserved. Dr. Howard Rubin The New IT Value Meal The current global economic environment has driven significant merger/consolidation activities in the financial services sector. As a consequence, enterprises of new scale are being created. The largest of these organizations will have access to information technology (and business process) economies of scale that have never been experienced in the industry. The scale gap between firms will become a competitive lever for those that can harness such benefits. Current analyses indicate that scale-economic cost reduction by 2010 for IT infrastructure may be as much as 40%-60% overall (relative to 2007 baseline costs). Those firms that do not have access to such economics will inherently be non- competitive unless they can develop ways to access the economics of their largest competitors. The impact of scale economics will be further amplified with effective demand management and heightened virtualization which will enable new levels of IT infrastructure efficiency (supporting even larger enterprises with less physical resources. Companies that can attain the new scale economics of IT will gain insurmountable competitive advantage. IT DOES Matter

32 All Rights Reserved. Dr. Howard Rubin The New IT Value Meal “New Math” of Infrastructure Cost: With the new economics of consolidation scale and Moore’s Law at work, the same set of infrastructure services that cost ~$500M+ in 2007 will likely be delivered by the most efficient companies for ~$200M in 2010.

33 All Rights Reserved. Dr. Howard Rubin The New IT Management Mandate The foundation is a set of principles learned from companies that have had superior performance through recessions: Cut the right costs Migrated to variable costs Increased automation Identified and focused on key customers Marketed to growth areas Invested when competitors didn’t Source: Study of 400 companies during the last recession by Diamond Management and Technology Consultants

34 All Rights Reserved. Dr. Howard Rubin Technology Economics: The New Mandate The new technology economic mandate is to: Optimize, Resize, and “Give it up” Leverage the marketplace and take advantage of the rapid commoditization IT services of non strategic core business functions; “Give it up” if a provider can do it better/more efficiently; Engage in transformation sourcing (virtualization, re-hosting; virtual desktop; “cloud”) Remove “poison pill” service levels that undermine your mass cost structure Own less; build less Zero population growth – Servers/People/Other resources Consider “The Commons”.. Internal and with external firms to provide new scale economies Realign, reclaim, and reinvest – rethink the RTB/CTB model and portfolio strategy – while managing risk Enable agility -- fixed versus variable costs and capacity; Leverage the supply chain -shift costs to vendors with new supply chain management models Fund IT forward and “follow the money” – the business money that is. Strategically engage the business and become an IT Savvy enterprise

35 All Rights Reserved. Dr. Howard Rubin Conclusion: IT DOES Matter  Technology is a competitive lever – a driver of operating efficiency, product leadership and differentiation, effective customer/market intimacy and information, and agility. It is the most critical lever your business has at this point in time.  Scale economics will reshape the industry and provide bottom line benefits to those that can control it.  Engineer your technology economy – your mix of fixed and variable costs -- to create agility (and avoid “hard landings”)  Time is of the essence – you need external partners that understand scale, that understand rapid transformation, that understand the global economy. The most opportunistic time for technology investment is during a technology recession (or depression) – doing so effectively can create an insurmountable competitive gap. Bad IT economics will put you on the wrong side of this gap and may even be creating advantage for your competitors. IT DOES Matter

36 All Rights Reserved. Dr. Howard Rubin Q&A Thank you