The great corporate information technology glut is over, and not a moment too soon—at least from an IT buyer’s perspective. Having spent more than $1.2 trillion on information technology in the United States alone from 1995 to 2000, companies now want to wring the elusive productivity and bottom-line gains from this massive outlay.

If buyers are glad to end their spendthrift ways, IT providers of course have a different perspective: after years of heady sales growth, they are now engaged in bare-knuckle competition as the industry confronts sated customers and overcapacity. With too much of almost everything—sales reps, manufacturing capacity, engineers, managers—these companies must now accept more reasonable near-term projections of demand than they had anticipated during the years of overbuilding and overhiring. To make matters worse, they can expect stronger price pressure from customers, which have shifted their focus from new investments—currently regarded with considerable skepticism—to the maintenance and management of their in-place IT systems. The mounting pressure from customers whose budgets are falling and the more intense competition will continue to bear down upon the IT vendors’ margins.

Merely getting leaner won’t suffice. When corporate demand for technology revives, within the next 18 to 24 months, the requirements for success in IT will be very different from those of the boom years. In the profligate 1990s, vendors got by on somewhat theoretical return-on-capital analyses. Now customers are more likely to demand that any case for investment not only take into account the business realities they face and their existing IT investments but also demonstrate the top- and bottom-line impact of the products and services on offer. The vendors must also learn from companies that have made their IT investments pay and show less successful companies how to emulate them.

Obtaining this know-how won’t be easy. It will force vendors to acquire deep business-process or vertical-industry expertise and a better understanding of their customers’ deployed systems and configurations, to say nothing of the associated economics. To lead in the postbubble era, IT providers that entered the boom as leaders will have to shed, we estimate, an average of half or more of their current business portfolios over the next eight to ten years. And they must start preparing for the future immediately.

Succeeding now

The requirements for success will change for two reasons, both related to the failure of most companies to derive value from their IT investments in the late 1990s. First, less successful companies will push IT vendors to help them realize near-term results from the money they have already spent on technology. Then, having seen the benefits enjoyed by the prescient few companies that did obtain a competitive advantage from IT, the less successful ones will put longer-term pressure on the vendors to help them reach or push beyond the best-practice frontiers opened up by the leaders. Both developments have challenging implications for the IT providers, which will have to focus their products and services on assisting customers in the quest to create value.

Learning from companies that got IT wrong . . .

During the boom years, from 1995 to 2000, companies installed massive enterprise-resource-planning packages; upgraded their equipment as costs for PCs, servers, and storage hardware fell; and tried to tie their hardware and software together by investing heavily in connectivity, including technology to support the leap to the Internet. They also shelled out large sums of money, often on expensive new applications to replace old ones, antici-pating Y2K problems.¹ Technology vendors reaped the bonanza.

Yet few companies benefited from this orgy of investment—as the gap between spending and productivity, at both the sector and the corporate level, demonstrates clearly. There were several reasons for these failures. Many companies abandoned newly purchased systems when implementation trouble arose or when the cost of implementing them outweighed their economic benefits. Some companies automated only parts of their business processes and found that their failure to achieve end-to-end automation significantly diminished the payback. Others didn’t focus their investments on the areas that would have had the biggest top- or bottom-line impact. Still others failed to transform their business processes or to reorganize their functions and activities in order to take advantage of their expensive new IT systems—a rather serious mistake, for to realize the full value of enterprise applications (such as supply-chain-management and enterprise-resource-planning systems) companies must change their business processes significantly.

Most IT buyers must now cope with complex IT environments burdened by too many systems, too many applications, and underutilized capacity. Many of these customers are skeptical about the ability of IT to have a positive effect on productivity. Meanwhile, overall corporate budgets are now tight. As a result, most companies have dramatically reduced their IT expenditures and decided to focus on managing and maintaining their existing IT systems and on efforts to improve the capacity utilization of their IT infrastructure. These customers will be hard bargainers in future negotiations for IT services and products, and any new investments they make are likely to be piecemeal. They will demand shorter time frames for a return on their investments and for improved productivity, and they will be asking IT providers to help them find near-term value in the investments they have already made.

. . . and from companies that got IT right

Besides learning from what went wrong during the great IT glut, technology providers must learn from companies that got it right—and use those lessons to help less accomplished companies achieve similar benefits from their IT investments.

Some companies made not only huge IT investments but also the process changes that enabled them to increase their productivity

For some companies did reap tremendous value from their technology spending in the late 1990s. Charles Schwab, Dell Computer, Wal-Mart, and other leading businesses made not only huge IT investments but also the process changes that enabled them to influence the productivity levers that really count in their industries. Higher productivity led to higher margins, which were used to create value for customers. Many of these productivity leaders are better prepared to weather the storms of the next year or two.

The most successful companies did five things. First, they developed their technological innovations and the complementary managerial innovations in tandem. Second, they focused their technology investments on cutting the interaction costs² that most affect productivity. These interaction costs are quite specific to a given vertical industry, and the investments of most IT leaders had a strong vertical focus.

Third, the leaders clearly understood the specific productivity levers of the sectors (and subsectors) in which they do business. They disproportionately focused their IT investments on programs that had the highest possible impact on those levers—and thus an impact on the top and bottom lines. Fourth, these companies made their investments in the right order, to build IT capabilities in sequence over time. Finally, they retooled their business processes and transformed their organizations to leverage their managerial innovations and IT capabilities.

Developing managerial and technological innovations in tandem. The history of business shows that technological innovations are typically of little use until complementary managerial innovations bring them to life. That is no less true at the present time, when leading companies use IT to create differentiated business models and to reach new heights of performance. Dell and Wal-Mart provide good examples of this approach. Wal-Mart’s innovations in supplier relationships, for example, were developed in tandem with its RetailLink information system and its collaborative purchasing systems. Its innovations in the day-to-day replenishment of its stores were developed along with its applications for warehouse automation, cross-docking, and inventory tracking. Custom micromerchandising applications complemented the company’s innovations in store formats.

By contrast, some IT investments in retail banking, to cite just one industry, had less impact than they should have, because they weren’t accompanied by the managerial innovations needed to unlock their value; technology investments in on-line banking, for instance, have been undermined by the failure to implement the kind of multichannel-management effort that would help customers migrate from high-cost branch systems to the World Wide Web.

Focusing on interaction. Companies can put IT to uses that are almost too numerous to list; aggregating management data, providing administrative support, and integrating operations are only a few of the many possibilities. Yet leading companies invariably focus their IT investments in one area: reducing interaction costs, which in most businesses consume 40 to 60 percent of the staff’s time. Coordinators, expediters, order-entry clerks, schedulers, customer service representatives, and scores of other specialists flourish in the gaps between systems within a company and between its systems and those of its suppliers and customers. These jobs add delay, cost, and error—all enemies of productivity.

Targeting specific productivity levers. Modern companies undertake many internal and external interactions. Different economic sectors have unique performance drivers that are based on the products they sell, the customers they sell to, and the costs associated with conducting business in that sector (Exhibit 1). In retailing, for example, technologies that facilitate supply chain activities such as managing warehouses (thereby increasing the utili-zation of labor) can be great levers for productivity. But in retail banking, comparable technologies (for instance, those used to run call centers and to automate branches) have affected it very little. Companies that deployed IT successfully not only clearly understood the productivity levers important to their sectors but also used technology to achieve step-change improvements in these levers.

The key interactions often vary even within a given sector. For general-merchandise retailers, the activities with high interaction costs involve managing inventory turns and moving large numbers of items efficiently. Wal-Mart’s RetailLink system, for example, enables the company to connect itself to its vendors and to provide them with frequent, timely, and store-specific sales information. Meanwhile, the company has used its enterprise data warehouse (which tracks company-wide information) to identify purchasing trends and successful formats and to replenish its stores with the right products in the right quantities. Quicker reactions in turn let Wal-Mart offer more product categories in the larger stores while driving its labor and inventory costs to levels below those of competitors. Companies that specialize in the retailing of apparel, by contrast, must handle many products with a short shelf life, since customer demand is fickle. In this subsector, raising productivity therefore means using technology to cut obsolescence and inventory-holding costs.

Many companies spent heavily on technology but didn’t gain the hoped-for benefits, because they tackled levers that didn’t count

But unlike the leaders, many companies that spent heavily on technology didn’t gain the benefits they anticipated, because they tackled levers that didn’t count and too often used new technology to support unchanged ways of doing business.

Getting the sequence right. The example of Wal-Mart also reveals the importance of properly sequencing IT investments to capture their full benefit. Wal-Mart created value by first installing software applications to direct the flow and storage of products through its network of suppliers, warehouses, and distribution centers. Only then did the company turn its attention to better coordination with its suppliers—coordination that leveraged the automated product flow it had previously established. Better coordination made it possible to invest effectively in tools that help Wal-Mart plan the mix and replenishment of its merchandise. Only after these investments had been made and integrated into the business could Wal-Mart build a data warehouse to handle complex queries by using information pulled from various sources at various levels of aggregation. Exhibit 2 explores the way retailers should sequence their investments to get the best value from IT.

Exhibit 3 shows a similar example, from the securities industry. In this case too, getting the sequence right was the key to unlocking value. The focus of the company’s IT investment moved from back-office automation to platform integration to front-office automation—all with an escalating effect on productivity gains.

Retooling business processes. After making major investments in IT infrastructure and applications, the leaders reengineered their business systems and processes to take advantage of the new IT capabilities. In some cases—banks, for example—back-office systems were consolidated; in others, standard processes, such as call-center support, were relocated offshore. In the wholesale sector, some companies leveraged their new IT capabilities by reengineering all of the processes involved in warehouse management and by reorganizing their functions and activities.

Imperatives for providers

When corporate demand for information technology returns to historical levels, IT providers will face a number of challenges, some more urgent than others but all requiring substantial change in the way they do business. One great fact is common to all of the challenges: these companies must give better value to their customers.

Future winners in the technology sector will have to master five imperatives. All are firmly grounded in the lessons, positive and negative, that emerged from the boom years, and all require the vendors to ensure that their technologies can help customers create economic value. Some of the imperatives will force technology companies themselves to use IT as a way of cutting their interaction costs and to push more aggressively for year-on-year productivity growth. The imperatives will also require such companies to develop strategies for dealing with continuing innovation in the underlying technologies—such as the emergence of standards and of cost-competitive new technologies and platforms—and to contend with changes in the structure of industries and the emergence of low-cost offshore alternatives. And these imperatives will force technology providers to be global in scope yet sufficiently close to customers to help them improve their performance through technology.

1. Find value in sunken IT investments

Many companies that have yet to derive real value from their IT investments may be missing just one final piece of integrating technology. For some companies, it could be an industry-specific application that ties their systems together, dramatically slashing cycle times, inventories, or costs, or that lets them offer their customers valuable new services. Other companies need technology to help them improve their customers’ most important operating and financial levers. Still others need deeper business knowledge to understand how they can reshape their organizations, policies, and processes to lead their industries.

First, postbubble IT vendors must develop products and solutions to help their customers turn around unsuccessful technology deployments; second, they must articulate and deliver a clear value proposition. Unless they do both, their customers will be less likely to accept big up-front costs for software and hardware in the future. A vendor that doesn’t show its customers how its offerings fit in with their existing or contemplated IT investments will probably meet with a chilly reception.

2. Innovate—selectively

Although technology is changing substantially, one thing won’t: technology-driven innovation will remain essential in products, services, and business processes. The large infrastructure investments many customers have made over the past five to eight years will force them to insist that new products and services leverage the assets they already have, so de facto or de jure standards will have greater importance. In this more standards-driven environment, the scope for innovation will narrow and the time available to copy innovations will shrink. Rapid reactions will be vital.

3. Get the know-how

The postboom years are proving that technological innovation is a necessary but not a sufficient condition for success. To build a real investment case for prospective customers, the IT providers must not only become more knowledgeable about their own products and services but also know how to use their technology to improve their customers’ business. The focus will have to be squarely on interaction costs. Whether the IT providers are helping to improve retail supply chains, to cut the processing time for insurance claims, or to reduce errors in hospital lab work, they will have to master the skills needed to raise their customers’ productivity. In some cases, this know-how will be embedded in products such as software; in others, it will be delivered as a service. In every case, managerial innovation will be needed to unlock the value in technological innovation; providers must help retailers, for example, use software to manage changes in the merchandising process.

Although it will cost tens or hundreds of millions—or even billions—of dollars to acquire this know-how, the cost of deploying it in each instance will be quite small. The scale curves will therefore be steep, and the rapid deployment of these intangibles around the globe will create substantial financial returns.

4. Partner to learn

The importance of know-how and the high cost of acquiring it imply a need to seek out new talent and partnerships to help customers improve their businesses—including partnerships with customers themselves. For much of the skill required to improve their productivity, an IT provider should seek out companies that can wrap necessary services around its products or help to define and develop its software. Providers lacking expertise in particular industries might, for example, form partnerships with smaller, industry-specific independent software vendors and systems integrators to customize products and build customized modules for core applications. Working with smaller partners allows a bigger provider to combine its more general horizontal expertise and the partner’s vertical expertise. Moreover, collaborating instead of competing with other IT vendors increases the size of the pie for everybody, much as seamless integration among the applications of different partners will make customers less resistant to new purchases.

Given the importance of this new source of added value, new business arrangements will likely emerge among IT providers and their partners and customers—the better to share gains and risks. Winning companies will be smart innovators in that dimension as well.

5. Focus to win

Supplying all kinds of products to all kinds of customers will almost surely be a losing proposition. The cumulative demands of innovation and globalization, as well as the need to leverage installed IT platforms and to understand the industries in which customers compete, will force IT providers to "rightsize" themselves by focusing more sharply than ever—in particular, on their own productivity. Those with too many offerings will find the resulting complexity impossibly hard to manage, with mediocre execution the likely result. The good news for providers is that the difficulty of making the hard choices that confront them will be offset by the outsized rewards from focusing their products, services, and business systems on well-defined customer segments whose performance they can really improve.

If IT providers are once again to be performance leaders, they must specialize, free capital and capacity for new product and service lines, and shed outdated systems they can’t afford to upgrade. They will have to make many decisions: should they target the markets in which they were previously most successful or stake claims in underserved industries or geographies, stick with their existing distribution systems or use the services of third parties and influencers in hopes of achieving global reach, concentrate on core product features for a variety of markets or combine products and services for narrowly defined sets of customers, and focus on getting new customers or try to raise the revenues they generate from existing ones?

When IT spending revives, in the next couple of years, the providers will be happy to find that the industry can achieve the high single-digit or low double-digit growth it now craves. But the next upturn in IT will take place in a dramatically reshaped landscape. After getting burned by technology, buyers are now more wary—and will make winners of only those IT pro-viders whose technology delivers lower interaction costs and productivity gains that promote competitive advantage and the creation of value.