The Hierarchy of Value

In the last couple of weeks, I had numerous conversations about what I call the hierarchy of value. A good friend of mine, I call him Jeff, a private equity investor coined this term to me a few years ago. He used this model to decide which improvement projects to invest in and which to pass on in his companies. He wanted simple rules to help his management teams that go beyond hard value and soft value. He even used it in his personal life to decide what to buy and what not to buy. I keep coming back to the simplicity of the model whenever we discuss the value of digital transformation. So what is this hierarchy of value and why does it matter for digital projects?

Transcript

In the last couple of weeks, I had numerous conversations about what I call the hierarchy of value. A good friend of mine, I call him Jeff, a private equity investor coined this term to me a few years ago. He used this model to decide which improvement projects to invest in and which to pass on in his companies. He wanted simple rules to help his management teams that go beyond hard value and soft value. He even used it in his personal life to decide what to buy and what not to buy. I keep coming back to the simplicity of the model whenever we discuss the value of digital transformation. So what is this hierarchy of value and why does it matter for digital projects?
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Before we talk about the hierarchy of value, let's back up a minute. Whenever I bring up value creation in IT, someone predictably will argue that it’s impossible to measure the value of IT projects. Most CIOs admit they have challenges with value measurement. 
Why is it so hard to have clear value metrics in digital projects in IT? This is a huge topic in itself, so we need to come back to it in the further episodes I’m planning. 

But for now, here is my working hypothesis. After all these years studying the value of technology I came to this realization. The biggest issue in IT value creation is that the most value accrues outside of IT. What does that mean?

Well, if you are running operations and want to create value, take costs out, improve capacity, reduce capital assets, it is all within your control and most benefits will accrue to your cost center or P&L. The same is true for a sales leader. Improving sales efficiency, pipeline management will result in higher revenues and bookings which you are measured on. 
This is not so true in IT. The vast majority of value impact in IT comes from improving operational, sales, supply chain, and other business systems. As they get more efficient, the value of that efficiency will benefit those business areas and not IT. No business I have seen comes back to IT and says, listen the digital experience platform you put in place increased our revenue conversion by $10 million. Here’s your share…

Attribution of IT value is the biggest challenge I believe in digital value creation. So companies solve it one of 2 ways. Either measure IT only on value created within the IT function. Like reducing IT spend, outsourcing IT functions, reducing hardware investments, and the like. This results in marginal benefits. Most IT organizations represent a fraction of the company’s cost base and these savings will pale in comparison to value creation potential in operations, sales, or marketing. 

So before you worry about the hierarchy of value and ranking your digital projects, make sure the total value attributed to that project gets measured inside and outside IT.

Now about this hierarch of value bit. This model is disarmingly simple. 
Jeff used to carry with him a list, his value hierarchy. It had 4 sections on the hierarchy. Every time someone had a new project idea, he wrote it on the list in one of the 4 sections, above or below other projects he already had. 

He believed everything valuable gets you closer to your business goals of growth and profitability. There are many ways to accomplish that and given limited resources so you have to pick the project that gets you there most efficiently. 

His 4 sections of the hierarchy and the essence of his value creation thinking was this: 
- The highest value section in the hierarchy had projects that **improved revenue growth**. He ranked his growth projects by how efficiently they produce the result, meaning how much it costs and how fast they produce the result. His core belief was that growth is everything in business and solves all other problems.
- His second section was projected that **improved the efficiency** of an existing process. Either it reduces cycle time, cost or improves capacity. These could be projects improving supplier performance but also investing in engineering talent that accelerates product development. Projects in this section had to have a bankable impact within a year. This means, supplier costs are reduced, new products are sold and shipping time is reduced.
- His third section had projects with **longer term value** or those that did not directly align with the company strategy. Jeff was skeptical about long-term projects. Way to many things may change over several years. He didn’t mind multi-year projects but wanted them to produce incremental value every year.
- His fourth section he called the **discard pile**. Projects with no clear value measurement. Those with unclear impact on the goal of the business. Projects with wishy-washy objectives and limited executive support. He almost never approved projects in this section. Unless someone in the executive team stood up and signed up to a dollar target for them. And this often included attribution of value to an IT project that created value outside IT. 

With these sections in place, Jeff demanded from each project measurable value targets and an ongoing, annual reporting of value generated. He called that his value run rate report. Jeff claimed to have over 20% compounded return from the projects his companies undertook.

Jeff’s hierarch of value represents to me something most companies lack. Consistent and clear definition of the project value. His list had more detail to guide his board and managers but this was the essence. 
If you wanted your project to make his list, you knew exactly what to do. 

And the clarity of value continues to be critical to guide digital transformation or any other project.

I hope you create your own version of the hierarchy of value and get the benefits Jeff has gotten. 

Talk Soon.