Last year I wrote a piece on legacy modernization initiatives. Among the points I made was that legacy modernization is at best a break-even proposition: modernization is simply trading something old for its modern counterpart, getting the same capabilities in return. Of course, there are first order benefits to legacy modernization. Additional or more comprehensive capabilities that come standard with a new COTS product; lower labor intensity and less dependency on costly knowledge workers required to sustain legacy assets; and reducing systemic fragility (e.g., production downtime) are all very real economic benefits that have P&L impact. But by and large, these benefits at best cover the costs for a modernization effort: the new assets will come with a cost to acquire and customize, a cost to migrate, a cost to integrate with other systems, and annual costs to maintain, support and evolve. Software ain’t cheap to buy, implement and live with.
But one thing I did not point out in last year’s blog is that a legacy modernization - even a sweeping one - falls into the category of utility tech not value-generative tech.
A value-generative investment is a roll of the dice that, say, a new market opportunity can be developed or a cost efficiency can be made where none was possible before. There is some uncertainty whether a market opportunity can be converted or a cost efficiency can be realized because of factors outside of anybody’s control: that buyers will see the company as a provider of a new category service it has never offered before, that a problem space is sufficiently consistent enough to allow for systemic improvements, that the technology exists to perform the task in the environments and conditions where it must perform, and so on. A value-generative investment is the pursuit of something that may not have been necessary or possible, and therefore could not have been done before. A value-generative investment is an exercise in deploying risk capital through IT in the pursuit of extraordinary benefit that yields competitive advantage.
This does not describe legacy modernization. Investments in utility capabilities are the pursuit of improvements in the way things are done, because at present they are inadequate by contemporary standards. The risks in a legacy modernization investment are entirely to do with execution of the investment itself, not how well the investment performs post-production. For legacy modernization benefits to be realized, the assets must be built to be reliable and low-maintenance; and customization, conversion and cutover costs must not spiral out of control. The proximate causes for utility investment failure are all within the confines of the execution of the investment itself: that the people doing the work are competent in the domain and technologies; that there is low staff turnover for the duration; that the team is not creating an entire project phase of execution (in the form of unanticipated late-stage integration and testing) to solve problems entirely of its own making; and so forth. True, there are unknowns in the business domain and in the legacy systems, and such uncertainty does create the risk for costs to increase. However, uncertainty of this kind is generally covered by cost contingency in the investment proposal. Even in the extreme cases where legacy assets are completely unmaintainable, legacy system modernization is still the replacement of one known domain of capabilities with another.
The nature of the uncertainty in the investment matters because it changes the nature of the capital allocation question put to an investment committee. For value-generative investments, the investment committee is asked whether it wants to gamble some of the firm’s capital in the uncertain pursuit of extraordinary benefit. By and large, only the investment capital itself is at risk, because an investment committee can terminate an underperforming value-generative investment with little reputational and operational blowback. However, for utility investments, the investment committee is asked whether it wants to tie up corporate capital for an extended period of time to improve the quality of services within the firm. Utility investments tend to be all-in commitments, so the investment committee is also underwriting the risk that additional capital will be necessary and that it will be tied up for a longer period of time to make good on the modernization investment.
Hence these are two very different types of capital allocation. One is to bet some pocket change at a casino table with something less than 100% expectation of a full payoff, and perhaps any payoff at all. The other is to prepay for two years for a health club membership in the anticipation that regularly using the health club will result in lower insurance premiums. In capital terms, the prior is equity, the latter is debt.
The justification for each investment is markedly different. The upside potential - however remote - for a value-generative pursuit will eclipse its cost. The upside potential for a utility pursuit will be break-even at best. Even the most thorough of cost-benefit analyses will not make a utility investment a no-brainer. Look, even a value-generative pursuit that fails yields a good story for the CEO to tell the board, provided it wasn’t an outsized gamble of scarce corporate funds. But many a C-level exec has been fired for cost overruns on utility investments.
A compelling value-generative tech proposal gets the investment committee to ask, “we accept the possibility, how probable is the payoff and how long is the window of opportunity?” Yet even the most compelling utility tech proposal gets the investment committee to ask, “we accept the need to do this, but do we have to do this right now?”
The question that a cost-benefit analysis for a utility tech investment must frame is, “why should we do this right now?” We’ll look at what that analysis consists of in a future post.
