Networks in Action

This has been the attitude of many business executives; they see telecommunications as a cost to be controlled. They appreciate its business necessity, just as much as most of us consider our phone a necessity. They want to minimize the cost of that necessity, especially because it has grown far more rapidly in recent years than other business costs. Ten years ago, just before the divestiture of AT&T took effect, most companies had no idea what they spent on telecommunications, which was confined primarily to telephone and telex expenses. These expenses were scattered over many budgets, and companies had little reliable knowledge of their costs. International telephone calls and telexes were charged to overhead budgets and were not consolidated. At that time there were no local area networks beyond simple PC LANs, so as far as most business unit managers were concerned, telecommunications could be left to the administrative group that handled operations; in turn, this unit was concerned mainly with costs and efficiency. Telecommunications services were provided by AT&T and had a very narrow range of customer options. The only large capital expenditure was for PBX equipment to provide an internal switchboard.

When costs of telecommunications began to rise in the 1980s, mainly stimulated by growth in data communications and by an even more rapid increase in the use of phones for marketing, customer service, and the like, the demand from users was, naturally, for cost control. Large organizations were able to exploit private networks, which gave them a substantial discount over dial-up public links; telecommunications managers aggressively exploited the competition among AT&T, MCI, and Sprint to get the best price. Toward the end of the 1980s, business units began to install LANs, and cost was one of the main drivers for this move. The installation of LANs snowballed, with more and more efforts to replace high-cost mainframes and WANs with low-cost workstations, servers, and LANs. Executives began to question whether their firms should try to run their own equivalent of a phone company or outsource it. They questioned, too, why central corporate expenditures in information technology had grown so fast, when there was often no evidence of any real financial payback; the terms "downsizing" and "right sizing" entered the vocabulary of IT.

All these cost-driven forces made it very difficult to justify investments in infrastructures that do not directly and visibly reduce expenditures, especially in a business environment that has become very harsh for almost every industry. The typical answer to the question "Why spend money on telecommunications?" then becomes "Because we have to-and we make sure we spend as little as possible."

A better answer to the question is "Because investing in telecommunications will offer the organization a very good deal indeed. "How to create and present that very good deal is the topic of this chapter. These skills are crucial for telecommunications designers, and without them, dialogue with business clients will be very much restricted. Of course, designers and implementers should always exploit opportunities to reduce costs, but they must also be able to think and talk in broader terms about the values of telecommunications. In just about every textbook on telecommunications that views it as a technical resource to be assessed by technical criteria, discussion of the value of telecommunications is absent.

As a result, many telecommunications professionals admit with frustration that they do not know how to argue the case for investments they believe are essential to their company. In viewing telecommunications as a business resource, they need a framework for assessing it according to business and economic criteria. The telecommunications services platform map, presented in Chapters 3 and 11, provides the business criteria. The network design variables worksheet provides the base for specific choices of technical features and tradeoffs among them; this core aspect of network design helps keep the technical aspects of design separated from the purely business ones. In applying the business decision sequence, the main design parameters of the network must be made clear before it is possible to make the economic case, but in learning the decision sequence, we feel it is more helpful to address step four before step three. This helps put step three, network design, in its full business context; this step is framed by, at the front end, the business logic of choosing opportunities and defining the criteria for technical design, and, at the back end, by the economic logic of justifying the chosen design in terms of its contribution to a firm's financial health.

This fourth core framework of Networks in Action defines the economic criteria for assessing the investment in telecommunications-either an investment in building or extending the platform, or an investment in a specific application that uses the platform-of which cost and benefits are elements. The focus, however, is not on the cost of telecommunications but on its impact on the costs of doing business, including the costs of ensuring quality and service. Obviously, management then must decide whether these improvements in costs of doing business, plus any revenue-related benefits, justify the cost of the telecommunications investment.

In this way, a designer can often show that telecommunications is not just a good deal, but one of the best deals a firm can get anywhere. One piece of evidence for this position is that the companies best known for service in a number of industries are frequently both leaders in the use of telecommunications as a business resource and low-cost producers with everyday low prices. Examples include Wal-Mart, Dell, Lands' End, Federal Express, and USAA. It is very rare to find that the service leader in an industry is either not making substantial use of telecommunications in ways that the average firm does not or has higher costs of providing its services than its main competitors. If the client and designer can show this and the implementer can make good on the promise, then telecommunications is not an overhead cost but a business resource.

The caveat here is that to effectively make their case, the client and designer must present a convincing economic model-in the language of business, not of technology.

Competitive Advantage Is Not A Convincing Economic Model

In the early to mid-1980s, the most popular tactic to justify major telecommunications investments was to cite the promise of telecommunications as an opportunity to create a competitive edge for a company. This approach generally sought an increase in revenues and market share. Many managers now groan when they hear this line of argument, partly because too often a competitive edge does not emerge. But even if it did, gaining "competitive advantage" is not a convincing economic justification in and of itself. After all, a firm could get a major edge just by halving its prices and giving a free Mercedes to anyone who spends $10,000 on its products. This example is, of course, absurd, but the point it makes is not; many of the claims made for computers and communications - that they provide a source of differentiation or create new strategic systems - ignore the price tag. Very few cases of competitive successes-Merrill Lynch's Cash Management Account, Citibank's rise to prominence in the late 1970s through electronic banking, ATMs, and credit cards-addressed the issue of the profitability of the strategies versus the growth in revenues and market share. Citibank, the exemplar of the 1980s, became a disaster story of the early 1990s, with a loss of $800 million in a single quarter. Merrill Lynch gained huge deposits through CMA but failed to control its cost base. Innovation is not the same as economic gain.

There are no reliable figures on the exact amount of money the best-known exemplars spent to gain their competitive advantages; some of them spent hundreds of millions of dollars. Almost by definition, their tactics were neither cheap nor simple and quick to implement; if they were, they would be quickly imitated by competitors, which would negate the advantage. A number of commentators argue that this is exactly the situation that is created even by successful investments in telecommunications. The leaders gain a clear edge, forcing their rivals to catch up. Catching up may take several years, at the end of which every firm's cost base has increased, but not the size of the market; the customer may gain, but not the industry. The example most often cited is automated teller machines in banking. Led by Citibank, major banks built their own proprietary networks. Within a few years, however, consortia of banks and third parties had built shared networks, and customer pressures pushed for banks to allow other banks' cards to be used on their network. Now there is no competitive edge in owning a proprietary ATM network, and the industry as a whole might have saved a great deal of money by cooperating instead of competing.

Some commentators question whether there ever was a real competitive advantage in the first place, except for a few special situations. As a result of the overselling of claims about IT and competitive advantage, there has also been a growing skepticism in business about the payoff from telecommunications. Study after study by academics and consulting firms shows that productivity has not been improved in financial services or white-collar work as a whole by the massive investments made in telecommunications, office technology, and electronic banking. Given the disastrous condition of the banking industry in the early 1990s, many business executives have closed their ears to the claims. Many of them are looking for ways to outsource networks and computer operations and to drastically cut costs.

In this context, it is clearly vital for telecommunications designers to present a convincing business case that clearly shows where and how the proposed investment will contribute to increasing profitability and efficiency, or reducing staffing levels and expenditures. Without a convincing case, designers will be frustrated by the unwillingness of clients to listen to proposals that offer business opportunities but no "hard" and immediate cost savings. In turn, clients will be frustrated by the inability of technical professionals to demonstrate real business value.

This chapter relates telecommunications to the main economic concerns of today's business managers, in their terms. To be listened to, a telecommunications designer must address the following economic issues:

Profit as the "top line" in terms of management priority, not the bottom line of business priority. How can telecommunications help maximize profits, or get the most value from budgets in the case of public-sector organizations? Businesses are being squeezed in terms of margins, competition, and pressures to react quickly to new demands and trends. How can telecommunications managers help spot those trends, avoid waste, and react to problems and opportunities quickly?

• Cost structures. Virtually every organization in the United States is worried about costs: staff wages and salaries, health care, overhead, administration, pension obligations, and many other elements of the cost base. How can telecommunications make a significant contribution?
  
  
• Quality and service. The single new transformation in both business and many aspects of governments is awareness that quality and service are basic requirements, not special favors or something customers are willing to pay for. How can telecommunications help provide firms a service and quality premium without also adding to costs?
  
  
• Infrastructures. Telecommunications is one of the infrastructures of modern business. How can designers help position a firm to maximize the cost-effectiveness of its overall operations, enable future expansion and innovation, and reduce the cost of essential telecommunications investments?
  
  
• Sources of new revenues that offer adequate margins. Can a telecommunications platform pay for itself by adding new sources of revenue at low incremental cost?

Previous chapters of Networks in Action provide many cases and examples that answer these questions, including the following:

• Profit as the "top line". Frito-Lay's management alerting systems and leading retailers' systems driven from point of sale help managers spot a trend in as little as three days; American Airlines's yield management systems are an entirely new approach to pricing and managing inventories that is spreading across other industries. One of the most far-reaching contributions of telecommunications to management is alerting instead of reporting.
  
  
• Cost structures. Location-independence through telecommunications allows firms to bring in skilled labor from anywhere at a reasonable cost; EDI cuts administration staff by a factor of 2 to 20; providing direct access to information and eliminating administrative intermediaries can remove two layers of management in some instances. 
  
  
• Quality and service. 800 numbers and voice messaging services, EDI, ANI, image processing, and many other contributors to reach add convenience, speed, and service and reduce errors. Databases and processing systems add range and thus add prompt and accurate response to questions and requests. Network management systems and backup and recovery facilities add responsiveness and hence reliability. 
  
  
• Infrastructures (platforms). The exemplar companies in the use of telecommunications have all made technical integration and the creation of a multi-use platform a priority. USAA in financial services and Texas Instruments in manufacturing addressed the following questions: (1) Will an integrated platform ensure that we can meet business priorities more effectively and cost-efficiently than case-by-case applications approach? and (2) Will such a platform substantially reduce our long-term costs, including those in telecommunications? American Airlines' preeminence in its industry can be shown to depend heavily on its integrated set of applications. 
  
  
• Sources of new revenue. British Airways added international hotel reservations to its airline reservation system and McKesson became a leader in insurance claims processing, both through piggybacking; the incremental revenues that accrued did not involve either large capital investments or operating costs. Although the revenues may be relatively small, the margins are high. The best revenues are those that exploit infrastructures that are already in place and paid for, whereas those that decrease margins may increase absolute profits but do not promote long-term economic health.

Clearly, a designer must make a systematic analysis of a firm's specific opportunities and whenever possible should quantify the expected benefits. The point here is that the quality profit engineering framework allows a designer to explain telecommunications payoff in a language businesspeople can understand.

Quality profit engineering is not the same as profit maximization, or total quality management, or business process reengineering, although it is fully consistent with their premises. It makes sense because firms now face increasing pressures on margins at a time when they must provide ever-improving levels of quality and service without being able to charge a premium for them. In this context, revenue growth may not lead to profit growth. The term downsizing relates to this; it adds up to "We can't afford these revenues-they are hurting our profits."

The next section looks at the economic context that the quality profit engineering framework is designed to address: the "Cruel Economy," the toughest business climate since World War II.

Profit as the Top Line

The economic reality of the 1990s for U.S. and European corporations is increasing margin erosion; for public sector organizations, it is increasing budget pressures. As a result, profit is the top line of management concern. Operating profit margins, not sales revenues, drive almost all companies' concerns today.

Historically, profits were a by-product of revenues. We call profit "the bottom line" for the commonsense reason that it appears at the bottom of a profit-and-loss report. If a firm increased its sales and kept its costs reasonably well under control, profit flowed to the bottom line. Inventory was an asset; if you made something, you could expect to sell it. Revenues drove growth, and business cycles were fairly long. Companies often spent several years to test-market a new product, check the results, update their marketing plans, and launch the full product.

In this economic model, the supplier set the terms of business, using advertising, promotions, and sale prices to move inventory. The economy was sales-driven. Much of business practice was highly oligopolistic, with the U.S. car manufacturers of the 1970s frequently cited as examples of how a small group of large firms with limited foreign competition moved sluggishly to innovate. Large firms were considered to have an advantage just by being large; they could use their size to attain economies of scale in manufacturing and distribution, could afford large expenditures on R & D, and had ready access to capital. But the model organizations of the 1970s and 1980s became the failures of the early 1990s, as flexibility and nimbleness replaced size as the edge in increasingly competitive markets. Established companies were challenged by new entrants, by foreign firms and reinvigorated large companies that were able to offer more innovative products, better quality, and better service, all at a highly competitive price.

The new realities of competition have made profitability the driver, rather than revenues, in a context in which profits must be earned through lower, not higher, prices. The leading firms in the airline, retailing, car rental, supermarket, telecommunications, and banking industries are increasingly shifting toward an economic model that emphasizes yield management rather than merely sales. The term was invented by the airlines and refers to the operating margin of a flight. Airlines frequently discount fares-which decreases unit revenue-in order to maximize profits. They can do this only because their technology base-telecommunications-centered reservation systems-provides the means to monitor market performance and trends and update prices in real time. In 1986, when Continental Airlines launched its Maxsaver discount fares, industry prices dropped by over 40 percent, and profits of the top airlines increased by 36 percent. This is how to manage profit as the top line. The leaders in yield management, most obviously American Airlines in the United States and British Airways in Europe, monitor every individual flight for a year, fine-tuning prices as traffic patterns become apparent. They use complex mathematical techniques to balance the risk of selling discounted seats too early (thus losing the opportunity to sell them to full-fare passengers) versus having unsold seats left over. The reservation system is the base for anticipating and monitoring what is occurring in the marketplace as it happens. On-line alerting systems allow rapid adjustment instead of late reaction.

The same shift to on-line profit management alerting systems is apparent among retailers. In the 1970s Sears stood out as the dominant force, mainly through its massive purchasing power; central buyers negotiated contracts with suppliers, and decisions about stocking individual stores were made centrally and/or regionally. In the early 1980s, Kmart led its industry through low prices, again with central merchandising and stocking. By the late 1980s,Wal-Mart had used superior networked logistics to overtake Kmart, creating one of the main success stories of modern business. The individual store became the focus of both operations and information. Point-of-sale technology ensured up-to-the-minute data on inventory and purchasing patterns, up-to-the-minute pricing adjustments, and daily information for central buyers, product line managers, and business unit executives.

By the mid-1980s, Wal-Mart had a lower gross margin than Kmart, offered lower prices, and had far higher operating profits; telecommunications and point of sale were key factors in optimizing its information, pricing, merchandising, purchasing, and distribution operations. Through 1991, Wal-Mart's gross margin per unit of revenue was 5 percent lower than Kmart's, but it sold an average of $250 per square foot of store space, versus $190 for Kmart. Retailers with networked logistics are able to have the right goods on the shelf at the right time. In the recession of the early 1990s, profit growth continued for the networked leaders, including Wal-Mart, Toys "R" Us, the Limited, and Dillards, even though revenue growth was flat or two to three times lower than profit growth.

Time-based competition makes time the driving factor in reporting, stocking, distribution, and pricing. It also makes telecommunications crucial in all these areas, because it is the least time-dependent mechanism any business can use. Fax is faster than mail. Point of sale tells managers what goods are selling faster than the accounting system can report the figures. Electronic data interchange matches inventory to purchase patterns as fast as the point-of-sale system can update the relevant databases. Customer-supplier ordering and delivery systems similarly match stocks to sales and/or production, reducing or eliminating inventory and often removing the need for intermediaries in the supply chain.

The technical aspects of profit management systems can be very complex in a system that captures data at the point of event, where profitability is determined, and moves it quickly to the decision makers who need it. Every company known for its profit management alerting systems has a telecommunications platform with comprehensive reach, range, and responsiveness. Figure 12-1 shows examples.