Eying IT expenditures

Long before the current economic slowdown, many companies had become more conservative with their IT spending. The latest technology can take a huge amount of capital, and more merchants are demanding a faster return on investment

That's not to say that merchants aren't investing in IT. Many are — especially in the e-commerce area. And the companies with aging order management legacy technology will certainly replace a system if they need to. But no one wants to spend money on technology without getting both short and long term benefits.

Should you be investing more in IT? And if so, how much? To answer these questions, it helps to know what other direct merchants typically spend on IT systems, as well as what applications have the highest ROI.

What they spend

We've found that the companies simply maintaining the status quo and supporting their users will spend less than 1.25% of net sales on IT. Marketers investing in new systems are spending in the range of 2.5% to 3.0% of net sales, when you take into account call center and order management systems, telephone systems and e-commerce IT hardware (not including expenses for e-commerce marketing personnel).

This 2.5% to 3% figure represents a blend of businesses. Companies with a higher average order might be spending a lower percentage of net sales. A higher amount per order means a lower percentage of net sales because you're spreading it over a larger sales base.

The flip side of this is that smaller companies, because they don't have as large a sales base, may have to spend a higher percent of net sales. A number of businesses making rapid changes to their systems may spend more than 3%.

Complicating matters is that many companies don't clearly identify IT costs, as they are accounted for as part of general and administrative expenses. Management uses these numbers in budgeting, but they don't have the visibility of gross margin percent or marketing expenses.

What are companies spending on IT? Here's an example of a large multibrand retailer with a direct division. The company, which sells apparel and accessories, has sales of more than $2 billion. The business includes a specialty retail chain with more than 1,000 stores and a print catalog; e-commerce accounts for more than 50% of direct sales. Due to its product line, it has a return rate exceeding 25%.

The retailer's centralized IT operation incorporates all IT expenses, including e-commerce and telephone systems. Its IT includes a mix of both internally developed systems for direct, and commercial retail packages. The merchant has a number of major projects going on to replace aging systems and maintain competitiveness. IT expenses here are 4% of net sales, reflecting its high merchandise return rate.

Another client is a business-to-business direct retailer of corporate gifts (hard-goods items) with sales of less than $100 million. E-commerce accounts for more than 20% of its direct sales.

The company's IT expenses are mostly for inhouse technology, with limited commercial systems. Expenses include e-commerce, telephone systems and graphics systems for special orders, which are 10% of volume. This merchant's total IT expenses are 3.2% of net sales, with 40% of expenses supporting special orders.

Looking at these examples, it would appear that the apparel company has a higher expense for IT. But its 25% return rate is what creates the incomparability. If you reviewed the two companies on a gross sales basis, the apparel merchant would be spending 3% of gross sales — just about the same as the hard-goods business marketer.

The chart “IT cost breakdown by category” (page 46) shows roughly how we see the money being spent. Note that more than half of the expenses (51%) are for labor — including management, help desks, operations and programming. How does your company stack up?

If you're pondering an investment in technology, first consider these questions:

• Are you meeting or exceeding management's IT expectations? How can IT facilitate change as a higher percentage of sales moves to e-commerce?
• Where can IT improve the synergy between channels?
• What investment is required to stay competitive in the e-commerce channel?
• Where can you make an IT investment that reduces costs and improves productivity?
• What systems improvements will manage inventory more profitably and provide higher customer service?
• What are your company's requirements in terms of flexibility and scalability of applications?
• As your business changes rapidly, how does IT need to help facilitate the change?

Keep in mind that some applications have higher ROI than others. Here are a few more things to think about.

Build vs. buy

One of the key variables that determines your IT cost as a percent of net sales is whether you develop your own systems or use commercial software. Many merchants today take a hybrid approach to build-vs.-buy.

For example, one of our $3 billion direct clients is taking on commercial systems for call center, warehouse management and POS, yet the company has more than 150 IT personnel on staff.

We believe more than 50% of direct businesses are internally developing and/or maintaining order management systems to some degree, but this is changing. Most accounting applications are commercial systems, while e-commerce solutions are a split between commercial systems and inhouse development.

Even companies with commercial systems have added a person or two with an IT background, often to write specialized functions in a user-controlled library in conjunction with the commercial system. These staffers also write reports, train users and maximize the use of the system.