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Potential Impact of IT on Company Value (Article)
Date: Jan-2012 Sector: News
Few companies operate successfully in the modern business world without a significant degree of dependence on their IT systems. These systems may be customer-facing or internal, revenue-generating or administrative, internally or externally located – the common denominator is that if they are unavailable or sub-optimal the performance of the business will be impaired. Given the ubiquity and impact of such IT systems, it is almost always the case that they make a material contribution to the value of the business and the thoroughness with which they are assessed and the effectiveness of how they are subsequently managed can either enhance or diminish that value.
A study published by McKinsey & Company (‘Understanding the strategic value of IT in M&A’ – January 2011) estimated that 50 to 60 per cent of the initiatives intended to capture synergies are strongly related to IT but reported that most IT issues are not fully addressed during due diligence or the early stages of post-merger planning. A full understanding of the IT systems within a business is an important consideration both in deal valuation and portfolio management and the effectiveness with which this is addressed varies widely. In this article Intuitus summarises the key learning from its work as the leading IT Due Diligence provider to UK mid-market private equity investors.
Due Diligence – From Risk to Opportunity
Conventional IT Due Diligence was for many years viewed as an adjunct to financial due diligence, often reflecting the role of the Finance Director as the member of the Board with responsibility for IT, and as a consequence it was often an exercise in assessing IT-related risks and confirming that there were no ticking time bombs that were likely to explode after completion of the acquisition. This was reflected in an approach that was essentially a check-list to be reviewed, covering things like security, backups, licence compliance, etc. These remain important but while they are necessary they are by no means sufficient to assess the current and potential future contribution of IT systems to the value of a business.
Most investors now expect and demand an approach to IT Due Diligence that delivers a rounded picture of the IT systems in place, including a realistic assessment of the opportunity to add value through IT as well as minimising the risk of loss. This demands a combination of skills that were not required for the checklist approach as it requires a strategic outlook, strong real-world experience of IT implementations and operations and sector knowledge that can identify and assess opportunities for value enhancement through IT.
Covering the Bases
In most cases ensuring that potential threats to company value have been identified and mitigated effectively is the foundation upon which value creation will be layered. Intuitus has developed a comprehensive analysis of risk categories related to IT including a summary of the potential value impact, guidance on warning signs and success criteria that indicate when an area of risk is under control and being managed effectively. These risk categories are summarised briefly below:
1. Business Continuity/ Disaster Recovery Plans
Without a carefully considered, documented and tested Business Continuity Plan or IT Disaster Recovery Plan, the company’s business activities will be at significant (and greater than necessary) risk from unplanned, disruptive events. There may be significant business impact and lost revenues if IT systems are suddenly out of action and in some cases, the company itself may fail as a result of a major systems failure.
2. IT Strategy and Budgets
The absence of an IT Strategy and associated budget will result in a lack of alignment of IT investment with business priorities and the likelihood that strategic business initiatives are delayed or supported poorly by the IT systems with a consequent failure to realise the maximum potential return on investment.
3. Major Systems Replacements
Poor execution of IT systems replacement projects is a common cause of failure to drive increases in company value. The whole project lifecycle from initial selection through to full benefits realisation must be planned and executed effectively in order to achieve the business outcomes that are projected.
4. Security and Data Management
Failings in IT security or the management of data have the potential to cause significant financial or reputational loss as a result of lost business, potential liability or loss of customer confidence.
5. Intellectual Property
In those companies in which software development has been carried out, the resulting product(s) may be a significant, or even the major, component of company value. Poor management of IPR risks diminution or loss of the value associated with the asset. Alternatively, inappropriate use of the IP belonging to another party can result in legal action and financial penalties or restraints to trade.
6. Key Person Dependencies
It is common that in small to medium sized companies the IT systems are implemented and maintained by a very small number of individuals, either within the company or at a third party supplier. The absence of these people may result in immediate issues in the event of system failure or the inability to change systems in response to changing business requirements.
7. Software Engineering
Internal software development has the potential to deliver significant competitive advantage if it brings about genuine innovation but the processes underlying the development are of critical importance in ensuring that the resulting systems are robust, secure and maintainable.
8. Software Licensing
It is common in smaller companies that software licences have been acquired in a piecemeal fashion with the result that it can be difficult to ascertain whether all licensing requirements have been satisfied. The potential penalties for breaches of software licensing requirements can be material and will inevitably represent unexpected and unplanned for expenditure.
9. Management Information Systems
Lack of accurate business information inevitably diminishes the quality of business decision making. Scattered information and the use of many manual tools and processes make it very difficult to get and maintain a complete and up to date view of the performance of the business.
10. Third Party Supplier Arrangements
Every company has a degree of dependence on third parties in relation to its IT systems – poor performance on the part of those suppliers has the potential to result in wasted expenditure, requirements of the business not being met or an inability to change at the rate demanded by the business.
11. Scalability of Systems
The underlying rationale of a private equity investment is usually to add value by growing the business faster and more effectively than had been the case prior to the investment being made – this is likely to result in additional demands being placed on the IT systems and if they are unable to cater for those additional demands this may place a fundamental constraint on the growth ambitions of the business.
12. Legislation compliance
Failure to comply with Data Protection and other IT-related legislation can result in financial loss, reputational damage and business disruption.
Further detailed analysis of these risk factors is available from Intuitus on request.
Moving onto the Front Foot
The time and effort expended in analysing and mitigating the risks identified above is necessary and prudent but it is important that attention to IT matters is maintained beyond this as value creation through IT is the way to ensure that the IT systems, processes and people play their full part in contributing to the overall value of the business. There are a number of categories in which IT can be used to enhance business value. The relevance of each depends on the individual company and its business strategy but they should all be assessed as part of the creation of an overall IT Strategy for the business.
1. Standardisation of IT systems
In companies without a guiding strategy for IT it is common to find that there is a mixture of systems of different age and capability. This is particularly likely if a company has been a party to mergers and acquisitions, with different parts of the business having acquired systems over time as independent entities. While standardisation of the IT systems will bring about cost savings, the greater benefit is the improved communications and efficiency within the company and the greater responsiveness to change that results from the removal of the need to plan complex and heterogeneous activities to update or maintain systems. Reducing the amount of time and money that has to be spent on routine maintenance of systems frees both money and management capacity to focus on differentiating and value-adding IT investment. IT projects are faster to implement, lower in cost and more likely to be delivered successfully if the starting point is a well-defined and well-understood systems environment.
One trend that relates to this is that an increasing number of companies are choosing to standardise on external cloud-based services for many of their commodity IT requirements such as email, document sharing and other basic IT functions. By their nature these are standardised systems with little or no scope for variations being made.
2. Innovate where it matters
At all levels of IT systems there are choices to be made about what should be implemented and how. At every point there will be an opportunity to select a newer, better, faster option. In reality, and particularly at lower levels in the systems stack, in many cases the difference between different options will not make a material difference. A good choice well-implemented will always be better than a perfect choice. The real value of innovation in IT is where customer experience will be enhanced, process efficiency will be improved or information availability enables faster and better decision making. The higher the proportion of IT investment that goes into these areas, the greater will be the contribution to value.
3. Build a platform
Many investment cases are based on a buy and build strategy. If this is the case then a critical enabler of this will be the ability to integrate acquired businesses quickly and effectively. This will be essential both to realise the benefits of synergy as quickly as possible and to ensure that the enlarged business can operate effectively and transparently. The most successful serial acquirers make a deliberate investment early in the process to prepare their systems and processes for rapid, effective migration and integration of data and processes from the acquired company.
4. Look before you leap
Given the statistic quoted above, where 50-60 per cent of benefits are dependent to some degree on IT systems, early assessment of a target’s IT systems delivers significant benefits in being able to plan migration processes for early implementation and in understanding the timelines and costs that will be associated with this process. As with building the systems platform, a well-defined process for assessment and planning will both accelerate the delivery of benefits and reduce the risk of delay or outright failure.
5. Decide early and act quickly
IT systems that have been in place for many years are inevitably accompanied by staff who have become familiar with them and comfortable using them over those many years. As a result it is common for there to be considerable resistance to change when those systems are to be changed, as a result of a business improvement project or a merger or acquisition. Experience shows that the best outcome usually results from making and communicating a decision as early as possible and communicating this clearly at the outset. In situations in which there is a choice between two systems as to which will be retained one may be clearly superior to the other, in which case the choice is simple, or it may be a close call with little to choose between them, in which case the outcome is likely to be affected more by how well the migration and integration process is planned and executed than on which system is chosen. In the process of moving from two systems to one the worst place to be is half way through the process, so a pragmatic mindset that favours faster progress over, for example, including more historical data in the transfer, is likely to yield the best overall result.
Positioning the Company
There is no single strategy that is appropriate for all companies, even within a single industry. The technology adoption curve described by Geoffrey Moore identifies six broad categories of customer for technology solutions depending on their propensity to seek out and/or adopt new technologies. Companies should be clear about where IT is differentiating for them and in those areas consider an early adopter or early majority approach, whereas in the relatively commodity areas of IT an early to late majority approach, or even in some cases a laggard approach may be more appropriate.
The key requirement in making such decisions is to understand where IT has the real potential to add value and where it is merely a necessary cost to be minimised. The objective should be to achieve the lowest possible cost of sustain and maintenance activities in the non-differentiating areas of IT and to invest as much as the company can afford in those areas that will set it apart from competitors. In these latter areas, where they exist for a given company, effectiveness in specifying, procuring and implementing the solution is indeed a core competence for a business. The proportion of IT-enabled projects that are delivered late, with lower business benefit or not at all remains distressingly high. Few small to medium-sized companies have the expertise and experience to lead substantial IT implementation projects – best practice does exist and the application of well-proven strategies and techniques can increase significantly the probability of success. Intuitus offers services to assist with such projects and has an extensive track record of assisting organisations both in systems replacement projects and in the successful planning and execution of M&A-related integration of IT systems.