Saturday, March 18, 2006

Slight of Hand in IT Measurements

Hi Andrew. That was a fun magic show we went to see the other day. The marvel of 'How did he do that!' is a great experience to share. I still don't know how these guys do their magic even though I know one of the fundamental tricks of their trade - slight of hand. What they do is get your attention on one hand while they actually are staging the trick in the other hand. In other words, they misdirect your attention away from what is really happening.

What has been really interesting lately is that I have found this attention misdirection stuff happening at work. It's not intentionally mind you, but it causes people to spend a lot of time and energy focusing on the wrong things. For example, I see people making decisions on what appears to be reasonable measurements, but these reasonable measures have misdirected their attention away from other measures and actions that are more meaningful and impactful. The most recent case in point I have seen is IT Efficiency Ratings. Let me explain.

The Goal for any corporation is to manage itself in such a way as to earn bigger profits. The following statements illustrates one way the banking industry often measures profitability:

"It takes the bank $.60 expense to earn every $1.00 in revenue. We need to get this down to $.45 where our competitors are."

So Andrew, did you notice a misdirection of attention in the statements above? Don't feel bad if you didn't catch it - I didn't catch it the first 100 times (that's a hint) I saw this either.

Okay, so take a closer look to see where your attention went. What numbers are you focused on? I'll bet you are looking at $.60 and $.45. The $1.00 seems to be there just for convenience sake, to make the other numbers into a consistent comparison of expense against revenue. And notice how the $1.00 eventually disappears from the second statement above. As a result, you don't even consider the $1.00 as significant and therefore you don't focus on it.

But what is wrong with focusing on the $.60 and $.45 numbers? These numbers are operating expense related numbers and you do get a greater IT Efficency Rating by reducing your operating expense.

Well, maybe. Let's say you reduce your operating expense by 10% without adversely affecting your revenue. This will result in the following IT Efficiency Rating:

($.60 - 10%) / ($1.00) = $.54 / $1.00 or an IT Effeciency Rating of $.54

That looks like greater profitablity so let's cut expenses even further! Let's say we reduce expenses by 25% now. But this time it affects our ability to generate revenue by 25%. This is what it would look like:

($.54 - 25%) / ($1.00 - 25%) = $.405 / $.75 or an IT Efficiency Rating of $.54

Ouch! That was a lot of cost cutting and it didn't have an impact on our profitability. If you continue with further cost cutting you will get to a point where your cost cutting will eventually 'cut into muscle' and you begin to have a detrimental affect on revenue generation. The biggest problem with this is you don't know that you have cut into muscle until it is too late, when your quarterly corportate reports show your profitability going down. And rebounding from this mistake will take more than a couple of quarters to fix.

Okay Andrew, take a deep breath and let's get back to the original statements above. What is the number that we have been misdirected from? That's right, it is the $1.00 of revenue. So, what if we thought of the IT Effeciency Rating like this:

"How can I optimize my $.60 per $1.00 revenue to generate more than $1.00?"

Using this new approach, let's say that we find a constraint in our software development processes and breaking this contraint allows us to increase revenue by 20% through optimization. That would give us an equation that looks like this:

($.60) / ($1.00 + 20%) = $.60 / $1.20 or an IT Efficiency Rating of $.50

That's a pretty nice improvement. Now, let's cycle back through the software development process again and find the new constraint that has popped up. We break that constraint to get us an even better IT Efficiency Rating. And then we cycle back again...you get the point.

As you can see from this example, it is easy to get misdirected to numbers that drive you to cost cutting. It takes a little ingenuity to applying the principles of Lean, Agile and Theory of Constraints to software development and a lot of disciple to stay focused on optimization but the gains are much more significant.

3 Comments:

Blogger mgelbwaks said...

This is a valuable approach and I think it could be used quite effectively to help organizations see fallacy in their attempt to derive value proposition. It is probably worth revisiting Throughput Accounting and honing the mathemathics - perhaps work with your clients and establish a case study with real figures behind the maths.

March 19, 2006 at 12:24:00 PM PST  
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November 12, 2009 at 5:44:00 AM PST  
Anonymous viagra online said...

Yeah it's nice when you can see how they made it, because like many things you see them and know their purpose but you don't have an idea of how they were made it.

May 12, 2011 at 8:53:00 AM PDT  

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