What's in Your Portfolio?

One of the best parts of blogging is having the liberty to decide who else's writings I want to showcase on my blog. By including other's work, I'm exposing my blog readers to articles they may not have already seen. That benefits the author of the original article. It also benefits me, the blogger, because I'm able to edit out the best portions while also occassionally making minor changes in phrasing or presentation style. If the readers' attention was piqued by my edited version, they can always click on the link to access the original article.

Given the above preface, I obviously now want to introduce you to another person's writings. The article I'm referencing originally appeared in the February 5, 2005 edition of CIO Insight. It was a column written by John Parkinson entitled 'Leveraging Your Project Portfolio for Better Returns.'

                                

Edited excerpts appear below:

Modern market theory states that markets are so efficient that no one can perform much better than the market average for very long. Transparency -- the notion that everyone can see what the winners are doing -- will rapidly drive copycat behavior, forcing a rapid regression to the market's mean performance level.

It's also conventional wisdom that, because there are really many "markets" for different classes of investments, you should spread your capital across the different areas where markets are made. This lets you balance risk (that you might lose everything if a single market crashes) with reward (that you might get rich if you somehow bet exactly right).

This is the basis of asset-allocation strategies.

Judging by these theories, rather than try to pick winners, your portfolio should be as much like the market (and everyone else's) as possible. In the financial world this often means following an index (or a collection of indices) that mirror the structure of the market.

If you want to beat the market theorists, you only have three tools:

1. concentration
2. turnover
3. leverage

In investment terms this means:

1. fewer but larger bets
2. shorter time horizons for the bets to pay off
3. using borrowed capital to make the (bigger) bets

The basis of your bets is that you can find enough opportunities that the overall market has missed (and hence undervalues), cash in quickly before the market catches on (as theory says it must, eventually), and then move on to the next opportunity.

Notice that this is a very different approach from asset-allocation models that urge diversification across several uncorrelated asset classes, low turnover (to reduce trading fees), and periodic rebalancing of the portfolio as different asset classes go through cycles of performance.

What's all this got to do with IT -- and how does it affect the CIO?

Think of the typical IT organization as a kind of specialized investor employing an asset-allocation strategy. Using other people's money (business unit capital), the CIO makes bets that investments in technology will generate returns for the business via automation-powered leverage of various kinds -- mostly to do with productivity, time to market, low cost of compliance, or cost-effective scalability.

The CIO puts together a "portfolio" of systems that are similar to various classes of assets -- core business automation, specialized capability, personal productivity and so on. Each of these asset classes has a required investment cycle (build or buy, deploy, support and enhance, retire) and a "yield profile" that should provide the basis for a return on the investment.

The challenge for the CIO -- just as it is for the manager of financial assets -- is in maintaining a balance among the asset types, most of which have very different yield profiles. Spend too much on core automation efforts and you won't be competitive in emerging areas. Ignore "infrastructure" and your operational costs will increase as changes in technology drive new cost-effectiveness opportunities that you can't take advantage of. Ignore the basics in order to do only innovation-driven projects, and core capabilities suffer. Getting the balance right isn't easy or obvious, but it is critically important.

Most CIOs opt for an IT version of "efficient-market theory," in part because they have limited discretionary investment capital these days. As a result, most IT portfolios look pretty much the same, making truly differentiated technology capabilities quite rare.

Add in the fact that most portfolios also have low "turnover" -- new systems tend to be added to older systems rather than replacing them -- and corporate IT takes on a "mature" (and complex) look. In financial investment terms the portfolio looks like a risk-averse, infrequently rebalanced 401K.

Let's look at how the three "beat the market" tools -- concentration, turnover and leverage -- might apply to managing an IT portfolio.

Concentration

In most big IT shops, there is still more diversity of technology and platform components than there needs to be. Simplification, standardization, and consolidation have had a big impact, but a lot more could still be done.

CIOs don't like to be too dependent on a single supplier (they fear "lock-in" and a lack of pricing leverage), while bemoaning the cost of integration and support across multiple products and platforms. A more concentrated strategy does have risks (supplier viability among them), but a simpler, more standardized approach also lets you use our second tool -- turnover -- more effectively.

Turnover

Turnover affects the IT organization in two ways:

• Shorter life-cycle stages gets you to the available benefits of new technology sooner, and allows you to change course (if and when you need to) more frequently -- frequent, small course adjustments are much better from an investment optimization point of view than large, infrequent course changes.


• Shorter life cycles requires a shift from an ROI model based on costs to one based on returns. In essence, you can choose between increasing ROI by decreasing the cost for a given level of return, or by increasing the return for a given level of cost. This might seem a minor distinction, but in practice very different investment strategies (and mind-sets) are required to make the different approaches work. IP telephony is a good example. Once you have gained the cost savings from switching, your attention should be focused on all the other (information-powered) applications that you can base on the new IP telephony devices and capabilities.

Leverage

Leverage means using "borrowed" capital to make investments so bets can be bigger. We've already noted that CIOs use business units' capital for investments in technology. Yet, capital from one set of users can create capabilities that benefit others, such as common infrastructure investments.

It's tough to know whether to spend $20 million on one large project, $2 million on ten small projects, or something in between. This is another aspect of balancing the portfolio: You want a mix of:

• moderate risk but certain yields
• high risk but less-certain yields

Not all the projects bearing higher risks will come out right, but the mix, if managed correctly, will give you the aggregate yield you need. And you don't want anything that has a low and certain yield -- unless you have no choice. Most of all, you don't want guaranteed losers -- and it's amazing how many portfolios actually contain a few.

If you accept the mixed-portfolio notion, you'll have to periodically dump investments that don't meet your yield criteria and replace them with ones that do. That means killing projects or platforms that don't work out, and that's always hard to do in IT.