The Polyvalence of Knowledge (Pt I): how financial ratios can influence system choice Reply

In this, the first part of, “The Polyalence of Knowledge” we examine the use of financial analysis to inform system choice.  In particular, back-office business systems and not operational systems.  Operational systems, such as the software used to tip a smelter are best analysed through NPV.  Back-office systems, however, cannot in any way be directly linked to the increase or decrease in revenue/cash flow.  These investments are much harder to appraise because there are few ways of determining exactly how much value they add to a business.  This blog looks at how to analyse financial statements in order determine exactly which systems are needed.

Does One Size Really Fit All?

Modern systems can be described as multi-valent.  One system can act on a number of critical functional areas but does one size really fit all?  Business and ICT believe they are achieving good value for money by purchasing a single inexpensive system to achieve multi-faceted roles.  However, what ends up happening is the system achieves little in each area and becomes a costly white-elephant.

What prompts the one-size-fits-all solution?  The primary cause of many of these implementations is (a) multiple business units have problems, coupled with (b) an inability by ICT to develop precise, accurate and complex business cases directly supporting the improved financial performance of the business.  In many cases a senior executive becomes nervous about the security of information, a separate business unit voices their frustration with their inability to collaborate and co-ordinate information and ICT says that it can solve both problems with one system.

Firstly, what are the primary back-office systems, what are they used for and what are their financial benefits?

  •   Electronic Document & Record Management Systems.  EDRMS are designed for the storage and retrieval of high-value records, such as contracts, patents and other documents containing intellectual capital which is hard to replace.  The loss of such material would be considered a security breach and would compromise current and future operations.  EDRMS, unfortunately, are usually only fully implemented in back-office units which have a culture of compliance and are therefore the least likely to need it.

Due to the nature of mature documentation EDRMS typically support contracts and supply chain & vendor management.  These systems assist in the search and retrieval of framework agreements for procurement as well as operational information.  A business with a well embedded EDRMS and developed supporting business practices could expect to have lower costs in their supply chain.  Supply chains themselves tend to be capital intensive and so a high-performing supply chain will empower a greater Return-on-Assets ratio, i.e. better better contract and supply chain management tends to support higher capital utilisation.  Service companies tend not to have capital intensive supply chains and are not, therefore, significant users of EDRMSs.

  •   Business Intelligence Systems.  BI systems exist in a variety of forms and have promised much over the years.  They can be as simple as reporting tools for standard data warehouses or may be implemented as complex artificial intelligence over multiple operational systems.  BI holds the power to reduce complexity in decision making making and good BI therefore holds the power not only to reduce management staff (overhead) but also to increase a company’s Information Productivity index (a ratio showing ‘value of information’, i.e. SG&A-2-Revenue, accounting for the cost of capital).  Good BI equals good Information Productivity index. Ultimately, if a company uses its BI systems well then it will show in their Information Productivity index.
  •   Project Management Systems.  PPM systems are designed to speed the efficiency and accuracy of resource allocation across a distributed enterprise as well as contribute to better project cost control measures.  Fluctuations in resource efficiency are not usually felt in the overhead but rather in project cost and schedule overruns.  It is important to note that PPM systems are only perfect when perfectly used.  This is to say that none are effective for significant analysis or project optimisation.  However, if a distributed enterprise does not have a PPMS then the likelihood of cost and schedule overrun increase significantly beyond the standard 30% risk factor.

It should be noted that I class CRM systems as a hybrid of project and risk management systems.

  •   Messaging & Email.  Little should be said about ubiquitous messaging and email systems other than that they are merely a cost of doing business.  Costs of these systems should be seen as sunk costs because the modern business simply cannot afford to do without them.  When building business cases for modern messaging firms could actually look further valuable social networking applications for the following reasons:
  1. The structure of SN groups of interest already provides valuable metadata to automatically tag messages for archive, search and retrieval.
  2. Parceling conversations by subject, group and associative images works more similarly to human memory than standard systems.
  3. The development of Communities of Interest (COIs) along with the web-based structure and storage of documents/non-critical records is both easier and more secure.

For these reasons and more companies should seriously look to SN apps to replace standard email systems.  More importantly, the security and storage issues taken on by SN apps remove the necessity for the rollout of the plethora of inappropriate SharePoint implementations.  In these latter cases greater attention could be paid to the development of more focused operational systems.

  •   Enterprise Resource Management Systems.  ERPS reduce the clerical burden of processing payroll and human resource transactions.  The value of ERPS is in the amount of overhead (finance and HR) labour they can remove from a business.  Good implementations of ERPS should show in reduced labour and lower SG&A costs.
  •   Knowledge Management Systems.  KMSs exist to store the non-critical knowledge capital and intellectual assets of a firm.  These may simply be the records and materials one needs for daily work.  For instance it has been estimated that it costs a law firm $100,000 in lost knowledge when a partner leaves.  Alternatively, KMSs may also store the accumulated knowledge capital of a firm, such as frameworks and intellectual property.  Businesses which use KMSs well have a higher Knowledge Capital value which is the difference between market value and shareholder equity, less estimated good will.
  •   Collaboration Systems.  Collaboration systems or team sites are generally smaller, simpler and locally managed KMSs.  MS SharePoint is one such example and also shares functionality with PPMSs.  Any financial benefits will be similar to standard KMSs.
  •   Enterprise Risk Management Systems.  xRMSs exist to reduce a broad spectrum of risks across the enterprise.  They provide a database for the documentation of risk although they offer little analytical capacity.  Separate systems often must be used for this.  xRM effectiveness will normally only show in reduced project cost and schedule overruns.  However, a large company may also be able to reduce its risk premium through the effective management of financial risk.

Why haven’t back-office systems increased information productivity, knowledge capital and asset utilisation?  Simply, the ICT and Finance functions do not generally work together to support cost reduction or revenue growth strategies.  Largely, back-office systems are implemented to satisfy the whims of personal functionality, security or broad-based compliance issues.  In addition, current financial ratios focus almost entirely on capital rather than information yet it could be said that the former is neither the scarcest nor most expensive anymore.

Read more in the next instalment of this blog to see how to analyse the financial systems in order to determine what applications the business requires.

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