Perspective

Winning in Retail ITIT Efficiency and Effectiveness Strategies for the Retail CIO

Tim BlansettNamit KapoorDenton NewhamMichael Horvath

Booz & Company

Contact Information

ChicagoNamit Kapoor Principal+1-312-578-4502namit.kapoor@booz.com

Michael HorvathAssociate+1-312-578-4519michael.horvath@booz.com

DallasDenton NewhamSenior Associate+1-214-712-6608denton.newham@booz.com

San FranciscoTim BlansettPartner+1-415-263-3707tim.blansett@booz.com

Booz & Company 1

EXECUTIVESUMMARY

Competitive pressures in the retail sector are increasing, and all retailers are looking for ways to improve their bottom lines. Success in the long term will depend on whether they can keep controlling costs while enticing consumers to stay loyal to the products and services they offer. That, in turn, will depend on their ability to develop technologies to please customers in every sales channel they serve.

To do so, retailers must rethink all of their IT operations. Long reluctant to outsource commodity IT services, they must analyze the areas in which they can save money and boost their strategic capabilities. Demand management offers the possibil-ity of significant savings, if retailers can efficiently allocate resources to business-critical needs. By rational-izing applications and infrastructure, retailers can significantly reduce their dependence on customized legacy sys-tems and save money in the process.

And by evolving toward a thin-model IT department, they can focus on delivering strategic technologies that will truly benefit the business.

To build the capabilities needed for future success, retailers should con-sider investing in five specific areas: business intelligence, next-generation in-store technologies, cross-channel integration, supplier collabora-tion, and pricing and markdown optimization.

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The retail industry is not for the faint of heart. It has long been a very low-margin business, and the margins it does produce are coming under increasing pressure. Consumer spending is likely to remain weak in the near term. Many markets have become overbuilt, making an already hyper-competitive environment even worse and reducing options for growth through store expan-sion. Meanwhile, the impact of the Internet continues to grow, encour-aging consumers to demand greater selection, better service, and lower prices in every channel. These pres-sures continue to take a major toll on retailers’ bottom lines.

The result: Retailers must become even more cost-conscious. That will require a major effort in every area of their operations, especially IT, where the role of the CIO must become even more strategic.

Information technology is becoming more critical to virtually every key strategic initiative, from improving the shopping experience and increas-ing customer loyalty to supporting cross-channel integration.

Yet IT budgets continue to be constrained, even as retailers’ technology portfolios grow increas-ingly complex. In this environment, creating and maintaining an IT func-tion that is both cost-efficient and effective is the dominant imperative for every retail CIO. The critical question: How can retailers leverage IT to keep customers happy without breaking the bank?

The pressure to cut costs and raise the competitive bar is by no means unique to retail. Yet the industry faces several very specific IT chal-lenges. Retailers must manage hun-dreds, if not thousands, of individual store locations, each with its own applications and technology environ-ments. This dispersed environment creates complexity, as IT depart-ments must integrate store-based point-of-sale (POS), store inventory, and workforce management applica-

tions with their corporate systems and with their growing number of alternative sales channels. Driving loyalty under these circumstances requires the intelligent use of tech-nology to build individual relation-ships with millions of customers across multiple channels—store, online, and catalog.

Retailers are also challenged by high levels of complexity in their application portfolios. Historically, they have relied on inefficient, custom-developed ERP systems to address retail-specific needs such as merchandising systems and price management, further increasing both complexity and costs. And the industry has not yet taken suffi-cient advantage of offshore delivery models for application and infra-structure services, thanks to its reli-ance on custom legacy software and real concerns about customer privacy and data security.

Given the industry’s highly competi-tive environment and the IT chal-lenges it faces, retail CIOs must find a way to continue to reduce costs while increasing their IT capabili-

THE RETAIL IMPERATIVE

Retailers must become even more cost-conscious in every area of their operations, especially IT, where the role of the CIO must become even more strategic.

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ties—to do more with less. To that end, we see four efficiency and effec-tiveness levers that retail IT depart-ments can pull to position themselves to compete (see Exhibit 1).

• Strategic sourcing can drive IT efficiency to new levels by taking greater advantage of the best skills and cost-saving techniques the market has to offer.

• Application and infrastructure rationalization can simplify appli-cation portfolios and infrastruc-ture, reducing complexity and cost.

• Demand management practices can focus discretionary spending on the highest-value projects.

• A thin-model IT organization can then concentrate on current and future technology priorities designed to add real value to the business.

Retailers can gain savings from each of these four levers—savings that can then be used to drive increased IT effectiveness by investing in key market-proven technologies, includ-ing the latest store systems and pric-ing optimization tools.

Lever 1: Strategic Sourcing

Strategic sourcing of IT services has long been a proven cost reduc-tion measure. Historically, however, retailers have been uncomfortable handing over large portions of their

application portfolios to an exter-nal service provider. Instead, most retail IT departments have opted to hold onto their extensive portfolios of custom application software to support back-office, supply chain, and store operations, either because they fear losing control over them or because they believe their portfolios are poorly suited to an outsourced delivery model. Retailers have also been concerned, rightfully, about the security and privacy of their customer data and compliance with payment card industry standards.

Recently, however, the tide has begun to shift toward outsourcing. Many large retailers are now outsourcing a significant portion of their infrastructure, application

Source: Booz & Company analysis

Exhibit 1 Typical IT Transformation Savings Potential

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PERCENTAGE OF POTENTIAL SAVINGS BY LEVER

Total potential savings of 30% to 40% of IT spending

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portfolios, and even business processes. In turn, service providers have embraced retailers by offering tailored and integrated solutions targeted to core retail operations, from planning to financial reporting to merchandizing and field services for IT. Furthermore, by providing clear and transparent detail on how costs vary by service level, they can help retailers make better-informed decisions on the appropriate fit-for-purpose service levels. Providing differentiated service levels based on need, rather than a one-size-fits-all high level of service, can achieve significant cost savings.

In addition to outsourcing infra-structure and applications, retailers can potentially make significant

efficiency gains by outsourcing field support, including such devices as POS machines, printers, scanners, and store servers. Most retailers lack sufficient economies of scale when it comes to building and maintaining the infrastructure and staff required to manage individual stores. Service providers can offer retailers increased savings potential by optimizing the number of IT support personnel per store and the geographic distribution of resources, and by spreading operational fixed costs over a broader base.

The best sourcing strategy mixes strong internal talent with appro-priate capabilities from service providers. The art, however, lies in understanding whom to partner

with, how to manage the relation-ship, and where to drive value. Don’t simply turn everything over to the outsourcer; instead, keep what is most strategic—and thus most valuable—to your business, whether it be merchandizing or pricing or architecture. Outsourcing certain phases of the application develop-ment life cycle, for instance, offers significant opportunities for savings, but the choice of what to outsource should depend on how strategic or transactional the activity is (see Exhibit 2).

To win, retail IT organizations must not only develop a sound sourcing strategy but also carefully plan the implementation of that strategy. Selecting the right delivery models

Source: Booz & Company analysis

Exhibit 2 Outsourcing Opportunities along the Application Development and Support Life Cycle

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- Business-critical knowledge stays with business consultants

- Business groups interact with a consistent set of people

Notes: Percentages are based on results gained by leading companies. Categorization and offshoring percentages are appropriate for a typical application and vary for specific applications in the portfolio. Other activities required for application development, such as vendor and project management, are high-touch and are not typically offshored

- Developing strong requirements capabilities

- Enforcing architecture & standards

- Onsite resources manage outsourced resources - Reduced operational costs for stable applications

- Consistent levels of performance for the business

- Vendors more effectively leverage junior staff for coding, debugging & unit testing

- Enforcing development and testing standards

- Selecting projects carefully - Maintaining knowledge of business process

“Highly Transactional” Activities“High-Touch” Activities

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PERCENTAGE OF COMPANIES OUTSOURCING EACH ACTIVITY

APPLICATION SOURCING OPPORTUNITIES AND CHALLENGES

Challenges

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Business Understanding & Requirements Gathering

Preliminary Software Architecture & Design

Detailed Functional & Technical Design

Build, Debug & Unit Testing

System, Integration & Acceptance Testing

Deployment User Support, Upgrade & Enhance

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and the right transition sequence for IT services is a critical but often neglected ingredient of a successful sourcing transaction. To ensure the successful execution of any sourcing plan, retail IT organizations must structure service provider relation-ships with the long term in mind. To capture the full value of any outsourcing arrangement, service-level agreements should include clear performance-based incentives, thus encouraging outsourcers to become strategic partners with the IT department.

Lever 2: Application and Infrastructure Rationalization

Thanks to overly complex opera-tions, heavy reliance on custom-developed applications, and long histories of mergers and acquisitions activity, retailers are commonly confronted with an IT environment characterized by fragmented applica-tions and infrastructure and poorly structured data. Such environments drive up the cost of maintenance, upgrade, break/fix, data centers, and personnel, while constraining the flexibility and responsiveness of IT. Application and infrastructure rationalization programs that focus on strict standardization to build consistency and reduce costs can significantly improve the efficiency and effectiveness of retail IT.

Historically, the availability of com-mercial off-the-shelf products for many core retail applications, includ-ing merchandizing and price/promo-tion management, has been limited. As a result, retailers have built large portfolios of custom-developed applications ranging from large-scale legacy systems to Microsoft Access and Excel–built tools, to provide critical business functionality. Many such systems have subsequently been expanded to support new businesses and product lines for which they were never intended. A drugstore chain may have developed its store inventory management system to support health and beauty products, for instance, and then extended the functionality of that system to manage food and alcohol, a dramati-cally different product type.

The reliance on custom-developed applications creates a fragmented, patchwork IT environment charac-terized by multiple applications run-ning on any number of technology platforms (see Exhibit 3, page 6). This lack of standardization drives up infrastructure and application support costs by creating unnec-essary redundancy and limiting economies of scale. Furthermore, to remain competitive, retailers depen-dent on custom-developed software must incur the full costs of develop-ing new capabilities—even capabili-

ties that have already been added to off-the-shelf software. Yet forgoing these new capabilities would create a misalignment between the current business operations and the support-ing technology, limiting a retailer’s effectiveness.

Recently, ERP vendors have intro-duced a variety of mature, retail-focused products that present a real opportunity for retailers to consoli-date away from fragmented legacy portfolios and onto a common platform that provides integrated retail functionality, from merchan-dising, warehouse management, and POS systems to human resources and financials. ERP implementations are notoriously costly and difficult to justify, but building a strong busi-ness case based on ERP’s many bene-fits—such as lower inventory levels, fewer out-of-stocks, better financial and supply chain planning, and lower IT complexity—is becoming more and more critical to retail suc-cess. That business case may be even stronger for companies that have grown through acquisitions and now face an environment riddled with overlapping applications both in core retail and in back-office systems.

Lever 3: Demand Management

Retailers typically struggle to allo-cate precious IT resources, spending

5

To ensure the successful execution of any sourcing plan, retail IT organizations must structure service provider relation ships with the long term in mind.

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too much time maintaining systems and putting out fires without giving sufficient consideration to how to manage scarce discretionary spend-ing. A strong demand management capability can effectively balance business demand and IT supply while managing costs by carefully controlling the allocation of IT funding and resources. Retailers can strengthen their demand manage-ment capabilities by improving processes, performance measures, tools, and accountability. CIOs should lead the effort to categorize, prioritize, and evaluate all demand for IT services at the enterprise level

and establish a strong governance model to support communication and to create transparency into the decision-making process. Rigorous project scoring, gated funding reviews, and tiered approval pro-cesses can ensure that IT is aligned with the highest-value projects.

To get the best return on discre-tionary investments, retailers should target two types of proj-ects. Quick-return projects—those with a payback period of less than one year—should concentrate on improving pricing and merchandis-ing systems, because ensuring the

performance of inventory invest-ments and the right promotional strategies is essential to the retailer’s bottom line. Funding such projects, however, often requires diverting resources from other initiatives designed to improve efficiency, such as enhancements to financial, human resources, and other back-office systems. At the same time, projects with longer-term strategic impor-tance, such as strengthening loyalty programs, building business intel-ligence platforms, and improving cross-channel integration capabili-ties, are fundamental to retailers’ future growth. Only by putting in

Source: Booz & Company client example

Exhibit 3 Application Portfolio Makeup Influences Costs and Flexibility

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Current State Future State

Financial Management System

Financial Planning Tools

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Administrative(finance, H.R., etc.)

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RETAIL APPLICATION RATIONALIZATION EXAMPLE

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optimization)

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place the right demand management and IT governance processes can retailers be sure that critical, urgent needs are met, while less essential projects are put on hold.

To further track and manage discretionary spending, retailers should consider segmenting the IT budget into “fixed” and “variable” categories during annual budget-ing and planning (see Exhibit 4). The fixed portion should be allo-cated to “keeping the lights on” activities, including break/fix, user support, and other critical day-to-day activities; it typically remains relatively constant from year to year. Unfortunately, discretionary spending is often hidden inside fixed

operating budgets, sometimes rang-ing as high as 20 to 25 percent of the total fixed budget. For retailers, this hidden discretionary spend is a product of a highly customized, highly complex application portfolio. Often, IT and business users alike perceive the resources used to keep applications running as essential, yet a detailed analysis will likely reveal that a high percentage of effort is being spent on lower-value discretionary tasks. To ensure that scarce resources are directed to the highest-value projects, retailers should carefully analyze how labor is allocated between discretionary and non-discretionary activities within the fixed portion of the budget.

Retailers should leverage the remain-ing variable portion of the IT budget to create an aggregated single pool of funding for IT projects. In con-junction with established demand management processes, this pool can create a healthy competition for dollars, which ensures that resources are directed to projects with the greatest potential for creating value. Without such a process, funding is too often allocated to individual IT departments based on historical levels of spending. This leads to poor allocation of discretionary dollars, as it assumes that the best projects are spread equally in each depart-ment every year. Rather, decisions to fund projects should be based on a careful scoring and ranking of

Source: Booz & Company analysis

Exhibit 4 Allocating Fixed and Variable Budgets

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IT Budget Composition Allocation Mechanism

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$ threshold)

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Minor Enhancements (discretionary)

Required Maintenance and Emergency Fixes

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project business cases with strong governance oversight. A flexible scoring model based on strategic fit, financial value, and operational risk will allow the company to adjust its funding criteria as the business environment changes.

Lever 4: A Thin-Model Organization

Given their dependence on complex, fragmented, custom-built legacy application portfolios supporting widely dispersed networks of stores, many retailers have built large-scale IT organizations whose members spend most of their time on “fire-fighting.” By radically streamlining IT organizations, however, retailers can take a significant step toward reducing complexity, cutting costs, and aligning IT much more tightly with overall business strategy.

The streamlined retail IT organiza-tion has a singular mission: to deliver high-value services at best-

in-class costs. This means building core capabilities, moving non-core work outside the organization, and making every activity leaner—all within a thin management structure. That thin model will demand major changes throughout the organiza-tion, using strategic sourcing to transform supplier responsibilities and leveraging demand management to change the way business clients behave.

The most dynamic change, however, involves how IT itself is organized and how it is managed and staffed. It is structured largely along expertise-based functions such as IT strategy, architecture, demand management, and vendor management, rather than by utility-based roles like help desk support and application mainte-nance. Proper governance, rules, and processes must be put in place to ensure that work gets done with a much smaller internal footprint.

Expertise-based staffing demands a dramatic shift in IT thinking. In the typical IT organization, most staff activity is utility-based, so most of the executive attention focuses on transactional activities. With the transformation to more expertise-based roles, however, retail IT executives can shift their focus to strategic, customer-centric issues, taking on the role of business enabler. And retail CIOs can begin building a small but highly skilled staff of IT professionals who are well versed in the business and IT challenges confronting today’s retailers. Rather than simply hiring technologists, CIOs should look for people with backgrounds in store operations, merchandising, e-commerce, and customer loyalty—and people who can translate today’s retail imperatives into technology solutions.

Rather than simply hiring technologists, CIOs should look for people with backgrounds in store operations, merchandising, e-com merce, and customer loyalty.

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The goal behind pulling the four levers described above is often to reinvest the savings into developing market-facing capabilities. When determining what areas to invest in, retailers should take a market-based approach, identifying key emerging trends that will deliver new value for their businesses. Broadly speaking,

we see five key trends in the market, three of them focused directly on the customer and two on improving execution. Leading retailers are making targeted investments in these areas to increase revenue, improve efficiency, and enhance the customer experience (see Exhibit 5).

TARGETED INVESTMENTS

Source: Booz & Company analysis

Exhibit 5 Retailers Should Consider Five Areas for Investment

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- Skills, knowledge, technologies, applications, quality, risks, security issues, and practices used to help a business acquire a better understanding of market behavior and commercial context

- Amalgamate data to support the strategic planning process of an organization

- Use existing data to better understand customer needs and to quickly identify shifts in demand

- Up-and-coming hardware and software POS solutions used by retail organizations

- A means to increase revenues and decrease expenses with the customer checkout process

- Improve customer experience through fast and simple transaction processing - Reduce the amount of time customers stand in line and decrease the number of walkouts

- The integration of customer transaction channels onto one platform

- The blending of operations applications and cross-channel interaction systems

- Coordinate customer experiences across all transaction channels (in-store/online/call center)

- Integrate back-office operation for all channels of interaction so customers can easily move between them

- The sharing of information between suppliers and merchants to augment supply chain activity

- Allocate inventory and capacity effectively through better coordination with suppliers

- Streamline the retailer/supplier relationship to make the supply chain more efficient

- The means of predicting the profitability of different price actions to drive incremental profitability

- Optimize product pricing to maximize profitability

- Mark down prices on seasonal merchandise to maximize profit

INVESTMENT AREA OVERVIEW CAPABILITIES

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Business Intelligence

Next-Generation In-Store

Technologies

Cross-Channel Integration

Supplier Collaboration

Pricing/Markdown Optimization

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Business intelligence: Retailers are investing heavily in systems and technology that can consolidate and aggregate the data needed to analyze customer behavior, closely monitor consumer spending trends, and analyze the effects of specific business decisions such as pricing, promotions, and new-product introductions. By developing a better understanding of customer behavior through advanced techniques such as consumer insights and predictive analysis, retailers can customize their product and service offerings to better meet the needs of their customers.

Next-generation in-store technologies: Next-generation retail systems will include advanced POS systems such as wireless POS/portable terminals, kiosks, and self-checkout terminals. These systems can reduce customer transaction times, integrate new customer management capabilities

such as loyalty programs and personalization features, and drive operational efficiencies through better transaction management and less handling of cash.

Cross-channel integration: The goal of cross-channel integration is to develop a consistent customer experience across all interaction channels—the Web, physical stores, call centers, and catalogs. Integration means more than creating a common brand identity and look and feel. By enhancing retail, supply chain, and back-office systems across the value chain—from merchandising and POS systems to business intelligence tools—integrating across every channel allows retailers to offer cross-channel loyalty programs, consistent online and in-store pricing, inventory visibility across channels, and advanced in-store kiosks and mobile commerce solutions.

Supplier collaboration: Retailers are investing in systems that foster tighter collaboration with suppliers to better manage supply chains. These systems include everything from merchandise planning, sourcing, and purchasing to replenishment and inventory management. Building information-sharing platforms that provide near real-time sharing of demand and supply information with suppliers in a secure environment is critical to the success of such systems.

Pricing and markdown optimization: Using sophisticated analytics and algorithms, retailers are moving toward a highly analytical approach to pricing and markdowns. Proper pricing of an item can be the difference between a profitable item and a loser. By integrating demand forecasts, promotional information, and regional/local variations, leading retailers are already making real gains in profitability.

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Pulling the Levers at a Fortune 50 Retailer1

The need to do more with less hit home with a large U.S. retailer in the fall of 2008, as the country’s economy went into recession and consumer spending declined sharply. To address these challenges, the company embarked on a wide-ranging cost, culture, and capabilities transformation initiative.

At the time, the company was spending about US$500 million annually on IT to support eight different IT organizations, each one often running its own portfolio of duplicate applications, infrastructures, and data. That made launching customer-oriented projects, adding new capabilities, and integrating acquisitions very difficult. More than 50 percent of the IT budget went to discretionary spending, much of it devoted to projects whose business value was not clearly understood. And the fragmentation created a perfect breeding ground for “shadow IT” projects.

In developing a cost management program for the retailer, we identified several efficiency opportunities across the four critical savings levers: strategic sourcing, demand management, application and infrastructure rationalization, and a thin-model organization. Altogether, the retailer hoped, the program would reduce total IT spending by 25 percent.

Most of the savings would come in the form of strategic sourcing of both infrastructure and applications. Savings from outsourcing a variety of infrastructure elements would total $10 million to $13 million annually, with the majority of the savings coming from outsourcing the help desk and data center activities. Savings from applications outsourcing would total between $40 million and $60 million a year, two-thirds of it from applications development and the rest from support.

A new demand management program, we estimated, would save approximately $40 million in discretionary spending. It included a strong governance process with a centralized project management office that instituted rigorous rules for project classification, approval, and phase-gate review. To better manage discretionary IT spending, the IT budget was segmented into

A happy customer is a profitable customer. IT offers the possibility of creating a truly customer-centric environment that can boost revenues and cut costs at the same time. Building those capabilities, however, means evolving to a lean IT organization, and using the money saved to leverage strategies that are truly focused on the customer. That requires both discipline and imagination, but the long-term benefits will be significant.

A FUTURE IN RETAIL

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fixed and variable components, and a single pool of money was created to increase the competition for project funding.

The company’s fragmented and inflexible IT portfolio also looked like a rich area for savings, through application and infrastructure rationalization. The retailer targeted 23 applications in five different areas for rationalization, anticipating total savings of $3 million. Rationalizing the infrastructure offered even greater savings—up to $10 million—in four areas: desktop and peripherals, data and voice networks, the infrastructure organization, and the data center.

Supporting the newly streamlined IT functions would require a hybrid thin-model IT organization. The corporate IT organization would provide shared IT services; develop and maintain corporate, retail, and multi–business unit applications; and provide all infrastructure services. Each business unit would maintain its own application group, responsible only for that unit’s specific needs. While the savings gained from this lever are not large—perhaps $4 million, primarily through a voluntary separation program—the gains in effectiveness would be significant.

We estimated that this retailer’s IT transformation would bring about overall annual savings of $110 million within three years. At a total one-time cost of $135 million, the program would pay for itself in about two years.

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About the Authors

Tim Blansett is a Booz & Company partner based in San Francisco. He specializes in IT strategy and transformation, trade promotion management, and organization model design for the retail and consumer industries.

Namit Kapoor is a Booz & Company principal based in Chicago. He specializes in large-scale IT and shared-services strategy formulation, design, and implementation.

Denton Newham is a Booz & Company senior associate based in Dallas. He specializes in IT strategy and strategic sourcing.

Michael Horvath is a Booz & Company associate based in Chicago. He specializes in IT demand management and ERP effectiveness.

Endnotes

1 See Booz & Company’s “Plan to Win” Perspective for an established approach to sourcing design and execution planning.

Printed in USA©2010 Booz & Company Inc.

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