Owning Innovation: Risk Management in IT-Enabled Transformation Projects

This Perspective lays out how to approach the problem of risk in large-scale, innovation-heavy IT transformation projects; how companies can address any gaps they may have in the capabilities needed to succeed at such projects; and why taking ownership of innovation is the right decision.

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Jens Niebuhr Volkmar Koch Saibal Chakraborty

Owning Innovation Risk Management in IT-Enabled Transformation Projects

This report was originally published before March 31, 2014, when Booz & Company became Strategy&, part of the PwC network of firms. For more information visit www.strategyand.pwc.com.

Contact Information Beirut Ramez Shehadi Partner +961-1-985-655 [email protected] Chicago Mike Connolly Partner +1-312-578-4580 [email protected] Delhi Suvojoy Sengupta Partner +91-124-499-8700 [email protected] Düsseldorf Jens Niebuhr Partner +49-211-3890-195 [email protected] Frankfurt Rainer Bernnat Partner +49-69-97167-414 [email protected] Volkmar Koch Principal +49-69-97167-412 [email protected] London Greg Baxter Partner +44-0-207-393-3795 [email protected] Saibal Chakraborty Principal +44-0-207-393-3540 [email protected]

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Companies have long turned to information technology to speed up processes, implement company-wide systems, and reinvent entire businesses. Yet large-scale IT transformation projects have always been risky—sooner or later, most of them run into trouble. And when companies decide to implement truly innovative technologies—which are often immature and untried—the risks only multiply. To manage these risks, companies need to rethink how they deal with their technology partners, especially small boutique development outfits, which often have very promising technology but also prove to be the weak link in largescale, multiyear transformations. In such cases, we believe that companies should consider going beyond “normal” contractual relationships and look at options that give them a greater stake in the process, even potentially buying out the small technology firm entirely. This Perspective lays out how to approach the problem of risk in large-scale, innovation-heavy transformation projects, how companies can address any gaps they may have in the capabilities needed to succeed at such projects, and why taking ownership of innovation is the right decision.

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IT-enabled business change comes in a variety of flavors. Many involve little more than small, low-risk, incremental changes to existing processes. Others require large-scale implementations of company-wide systems, usually in partnership with big vendors or systems integrators. And some involve real transformation— the development of truly innovative information technology to support entirely new business models. Most large companies are familiar with the risks and rewards of incremental business technology changes and even large-scale system implementations. In today’s highly competitive business environment, however, everyone is looking for an edge—the kind of competitive advantage that often can only be found through innovations in both business models and technology.

Developing the cutting-edge IT solutions needed has long presented companies with significant risks. Few non-IT companies have the internal skills needed to develop truly innovative IT solutions. Turning to large software vendors or systems integrators to develop innovative, custom solutions from scratch has also proven to be fraught with peril. A further strategy in such cases involves finding and working with a boutique technology firm that has already invested several years in developing the sort of innovative IT solution needed. How can companies looking to gain a competitive advantage through truly innovative technology get a better understanding of their exposure to the risks involved when embarking on major business transformation projects?

Developing the cutting-edge IT solutions needed has long presented companies with significant risks.


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When looking at such risk exposure, we distinguish two risk dimensions for technology-enabled transformations: There are the demand-side challenges, those issues that the transforming company faces in determining how risky any particular project might be. And there are the supply-side challenges, which include the difficulty of actually delivering the technology required. Three primary risk criteria lie on the demand side: the scope of the project (single or multiple business units or geographies); the project’s time line and resulting delivery pressure; and

the degree of innovation and resulting operational risk for core processes and functions. On the supply side, the risk criteria include the degree of precedence (whether the technology has been implemented at other organizations of comparable size); the availability of proven technologies; and the availability of adequate in-house capabilities or a mature supplier base. Exhibit 1 lays out the resulting four categories of transformation. The first three categories are relatively well known and, in our experience, adequately managed using traditional sourcing and delivery approaches:
S - How will key orga - How will industry - Will there be shift



PepsiCo Kimberly-Clark

ConAgra Foods Unilever

Nestlé Size of Bubble = Revenue 60 80 100

Lee 20 40

Exhibit 1 Transformation Categories and Degree of Demand- and Supply-Side Challenges

- Example: Multi-business-unit, multi-country ERP or CRM rollout - Delivery strategy: Traditional (prime) contracting model with an established supplier (typically a large systems integrator or large software vendor)

- Example: Cross-country rollout of smart metering services - Delivery strategy: Take strong control of technology owner (through joint venture or buyout) to ensure control over innovation and to manage risks effectively

High Commodity Transformation Innovative Transformation

Demand-Side Challenge - Example: Incremental changes to existing applications or addition of small new applications to a stable IT landscape - Delivery strategy: Businessas-usual IT releases done fully in-house or using vendors, depending on lower cost of delivery Business-as-Usual Change Low Low Supply-Side Challenge High Pilot/Controlled Experimentation - Example: Travel company piloting dynamic packaging technology with one small business unit - Delivery strategy: Contract with technology owner and execute on an “incremental,” prototype-based design and delivery approach

Source: Booz & Company analysis

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• Business-as-usual change: This category is made up of small, incremental changes to existing applications or the addition of small new applications to a stable IT landscape. In such cases, the scope is typically restricted to a few business or geographic units, and the number of unknowns is minimal; consequently, the delivery challenge is not significant. Most large organizations manage such projects in-house or through long-term vendor contracts such as application development or management outsourcing agreements, often with one or more large systems integrators. • Commodity transformation: This includes large-scale technology transformations that typically involve multiple business units and geographies. While the demand-

side challenge can be high, the core technologies are well known and the transformation process itself has been successfully accomplished in similar organizations many times before. Examples include a major ERP transformation through a vendor such as SAP or the rollout of a market-leading customer relationship management (CRM) solution from Oracle. Large systems integrators including IBM and Accenture already have proven methodologies for delivering these types of transformations; traditional (prime) contract arrangements with established suppliers such as large systems integrators usually work well in these situations. • Pilot or controlled experimentation: This category includes small-scale pilot

projects of new technologies. The supply-side risk is high, since the technology involved is typically immature and there are few suppliers to choose from. But the demand-side risk is low, given that the narrow scope of the transformation (typically a single small business unit) and the relatively small investment make the number of variables, and consequently the risk of failure, manageable. Companies engaging in such projects often work with small boutique firms, but the risk can be mitigated through careful project management and an agile development approach. The small scale of these projects often makes appointing a prime contractor to manage them unnecessary; instead, companies often choose to contract directly with the boutique.

Companies engaging in small pilot projects often work with boutique firms, mitigating risk with careful project management.


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It is the fourth category—large-scale transformations employing new, often untested, highly innovative technology for which both the demand- and supply-side challenges are high but the potential rewards are great—that requires the most careful consideration on the part of transforming companies. One potential path is to contract directly with a software boutique to develop the necessary technology. Such firms typically excel at dynamic technology innovation driven by small teams. But creating a large project for a big corporation usually requires significantly larger delivery teams, much more mature software development processes, and largescale project management skills. Our experience has shown that it is always a considerable challenge for a small boutique to deliver the required functional and technical improvements to its product while at the same time significantly ramping up capacity and improving process maturity. Moreover, most boutiques lack the fiscal stamina to survive multiyear programs if the payoff comes only after a long period of development,

and especially if the program gets delayed. Contractual safeguards work well when commodity IT solutions are being procured from large providers. But enforcing penalty clauses against a boutique already struggling for cash is likely to be counterproductive, potentially setting up a vicious circle of failure. For example, a leading international healthcare company looking to expand into new markets recently turned to a small software boutique that was developing a new healthcare solution on a new technology platform but lacked the scale to successfully penetrate the marketplace. So the company decided to work with the boutique to develop the new solution. Unfortunately, the project soon ran into trouble. The boutique did not have the scale to adequately deal with changing requirements or deliver a stable release. And the company could not effectively inflict penalties without threatening the boutique’s financial survival. By giving the boutique too much control over the development of the solution, the company ultimately lost control over the project, and it was terminated.

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Many companies have therefore turned to prime contractors such as systems integrators to manage transformations involving small software boutiques. All too often, however, the results of this approach have also failed to meet expectations. The reasons are many: No matter how experienced and capable the prime contractor is, it cannot guarantee successful delivery by the boutique without exerting direct control over its delivery processes and schedules. But the typical boutique’s owners and management will resist this effort, as they don’t want to lose control over their key product and likely most important contract. However, merely sharing project management best practices and providing coaching is not sufficient if the procedures cannot be enforced. Furthermore, giving a prime contractor control over the technology owner’s innovation engine often leads to an end product that is not deeply tailored to the company’s objectives. This can seriously undermine the hoped-for benefits of the transformation.

The presumed deep pockets of the prime contractor are also unlikely to help. Given the stringent require ments of these programs and large integrators’ internal risk manage ment processes, chances are that any penalties accrued either will not be paid or will require protracted legal proceedings. At the same time, a penalty clause alone will not compensate companies that are critically dependent on innovation for their core businesses for losses from go-tomarket delays or project failure. Finally, by effectively “outsourcing” to a prime contractor the responsibility for the innovative transformation—and the risk involved in managing the boutique—companies frequently gain a mistaken sense of certainty regarding the project’s progress, even as the systems integrators are pushed to the limits of their capabilities with the challenge of successfully completing the project. Either having a direct contract with a boutique firm or having a prime contractor manage the boutique creates a potential loss of control over the project that is all too likely

to lead to failure—a scenario we have seen repeated numerous times. In one case, an established player in the transport industry was looking to develop a new business model to react to changes in customer demand. With no mature IT solutions in the market fitting its needs, the company contracted with a boutique with strong industry-specific skills and then hired a large systems integrator as a prime contractor to oversee the work, in hopes of mitigating the risks. The integrator was brought in to provide greater protection against financial risk and tighter project management, testing, and quality assurance support. Three years later the project was still incomplete, and the work that had been completed was not up to the company’s expectations. The situation improved only after the company took full control of the boutique’s intellectual capital, code, and key talent, and appointed a new systems integrator to manage the solution delivery using its own much more mature development processes and staff.


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In a nutshell, we believe that the best way to successfully manage the risks involved in working with small technology owners is to exert as much control over the development process as possible. To that end, once a company finds a boutique nurturing the desired technology, we recommend that it put some “skin in the game” in order to bring the innovation to scale and integrate it into its process and IT environment. This will require taking an equity stake in the boutique—and thus a higher degree of ownership and direct control over its intellectual property rights, architecture, and code; its developers; and its software development processes. It could require buying out the boutique completely. Greater control allows the transforming company to embed best-practice, at-scale processes within the technology owner. It provides deeper insight into any potential architectural problems

with the product at an early stage, as well as the ability to put in place proactive planning, tracking, and risk management processes. And it allows for closer customization of the product to the transforming company’s business requirements, allowing it to be a really effective source of competitive differentiation. At the same time, the transforming company will be sharing the project risk with the boutique, rather than “outsourcing” it to a prime contractor, and thus must exercise control over the boutique primarily through its own in-house team. Its management will need to get in the driver’s seat, even injecting additional management capabilities and capacity when necessary. If the size of the project requires an outside partner—to provide additional experienced development staff and more mature development processes, for instance—any arrangement must ensure that each involved party fully shares the risks.

To manage the risks involved in working with boutiques, exert as much control over the development process as possible.

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As anyone who has been through the process knows, major IT business transformations can be a daunting prospect. When done right, however, the rewards can be significant. No project comes without risk—especially those that require new IT solutions that cannot be built in-house and that can be found only at small, innovative, independent boutique players. Companies can best reduce the

risks inherent in such projects, and maximize their chances of success, by maintaining a high level of control over the development and implementation of the technology. And the most efficient way to ensure the necessary level of control is to acquire some kind of an equity stake in the software developer—whether it be a joint venture or a full buyout—to “own the innovation.”

The most efficient way to ensure the necessary level of control over innovative projects is to acquire an equity stake in the software developer.


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About the Authors Jens Niebuhr is a partner with Booz & Company based in Düsseldorf. He focuses on IT strategy and transformation for large enterprises and leads the firm’s European IT activities in the communications and utilities sectors. Volkmar Koch is a principal with Booz & Company based in Frankfurt. He has significant experience in large-scale business and IT transformation projects and primarily serves clients in the airline and travel industries. Saibal Chakraborty is a principal with Booz & Company based in London. He focuses on IT strategy, cost management, and value assurance for large-scale transformational change in industries including financial services, the public sector, oil and gas, and utilities.

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