(William T. Budde is vice president of sales and marketing for Instec)
The annals of IT history are littered with project failures. The Standish Group, which has been collecting data on IT development projects since 1985, consistently reports that only about 30 percent of projects are successful, which is defined as on budget, on time, and with all planned features. Annual estimates of "failed" projects run about 25 percent, with about 45 percent "challenged"—inundated with cost or time overruns or not delivering the desired business functionality.
The cost of these failures is staggering, with estimates ranging from $50 to $75 billion annually. The Harvard Business Review, which studied the cost of IT project failure, reported that as many as one in six projects are "black swans" that fail spectacularly, with cost overruns of 200 percent or more and schedule overages of at least 70 percent. Those losses impact the bottom line, and some are severe enough to drive companies into bankruptcy or out of existence.
What is surprising after decades of project experience is not that developments fail, but that insurers continue to ignore the costs of failure in the initial planning and budgeting and throughout the project lifecycle. Insurance companies have the tools, the experience, and the history of risk management expertise that should allow them to accurately calculate costs and determine contingencies and risk mitigation factors. But, just as the cobbler's children have no shoes, the same companies that are successful at calculating risk posed by policyholders often do a poor job of assessing their own operations, putting themselves at tremendous risk.
Cost Impacts
Catastrophic project failures make headlines, but there are other increments of failure along the spectrum that are more subtle but no less crippling over the long term. In the insurance sector, that includes projects that didn't live up to their full promise; often replacement efforts that didn't completely eliminate the targeted platform, resulting in multiple systems and complex integration webs. It includes projects where cost overruns constrain the ability of the business to pursue new opportunity, or where late-delivered capabilities neuter a company's previous competitive advantage.
Insurers are experienced in calculating the hard-dollar costs of projects—hardware, software, and internal resources. Unfortunately, those finite numbers often lead to tunnel vision where the concept of failure and its soft costs, which are more difficult to measure, are not considered soon enough, if at all. Instead, companies continue to push on in failing projects, seeking ROI that will never be achieved because they lack awareness of and insight into all the costs they are incurring.
Failure costs fall into four key areas:
- Continuing expense of old systems. With 75 percent of the IT budget attributed to maintenance at most companies, there can be significant incentive for insurers to upgrade to modern platforms. However, when projects don't deliver on their promise to eliminate old systems, not only does this cost continue, but it is compounded by being added to the maintenance cost of the new system implemented.
- Lost investment. Failed projects leave insurers on the hook for the expense of software, hardware, and other infrastructure costs. Additionally, the resource investment in integration, configuration, and customization work is similarly lost.
- Operational costs. Projects have anticipated operational improvement returns. When those projects fail, not only are those benefits not realized, but processes may be made worse and more costly. Even more troubling, failures can increase both operational expenses and enterprise risk by creating regulatory and reporting challenges due to integration problems, data errors, or other newly introduced limitations.
- Opportunity costs. The reduction in revenue or negative impact on time to market caused by project failure can be severe. While the hard numbers may show that an initiative took twice as long (and cost twice as much), resources of both personnel and time that were allocated to a failed project were also unavailable to be used elsewhere. Unfortunately, opportunity cost is also difficult to measure because it requires insurers to assess the impact of what they could have done if projects had turned out differently.
In just one example of these compounding costs, a regional P&C insurer came to us after it had spent tens of millions of dollars—300 percent over budget—on a project that had gone nowhere despite exceeding the timeline by 18 months. They fired the vendor and obtained the source code, essentially re-starting the project from scratch. Not only did this create additional cost and time to bring a viable system on line, but it prevented the company from moving into several planned new states because resources were allocated to the struggling project—representing substantial opportunity cost.
Calculating the Costs
Projects of all size create risk, but the riskiest an insurer will undertake is a core system replacement—policy administration, claims administration, CRM, or billing. Those projects are done infrequently, carry a high price tag, take a long time to complete, and directly impact core business operations.
Novarica studied policy administration replacement projects and found that the average cost of replacement was over $4 million at midsized insurers and nearly $11 million at insurers with over $1 billion in revenue. Large insurers took 20 months to complete their initial rollout and 40 months to deploy the full project. Over one-third of midsized insures took longer than 40 months.
Industry resources, including the Project Management Institute and the Department of Defense, have developed effective tools for calculating costs of failure on core system and other projects. But equally important—and often overlooked—is the insurance industry's own expertise.
Every day, insurers write surety bonds for customers that must offer financial guarantees against failure, and underwriting those bonds does not happen in IT. In underwriting their own policyholders, insurers take a deep dive into risk of failure—financial, operational, and regulatory. They analyze data to make informed projections about the future and the likely frequency and severity of failure. They take steps to guard their profits, including risk transfer, redesign of processes, and other loss control measures.
The same mechanisms and expertise that insurers use to assess the operations and capabilities of road construction firms, commercial builders, and general contractors should be applied to their own project development process, and it should lead to a similar strategy of risk management. An insurer could obtain a bond or demand that additional risk be transferred to vendors and contractors. It could develop predetermined back-up or back-out strategies to provide a clear path to recovery at early stages of trouble. It could put control processes in place to prevent a project from becoming "too big to fail" long after it has effectively failed. In some cases, it might determine the project is simply too risky to undertake given the circumstances.
When a project is undertaken, transparency is essential to good governance and to measure ongoing project costs against expectations. It can be all too easy for initiatives to fall behind the curtain of IT with little ongoing budget reporting. Transparency includes regular acceptance testing to ensure that projects remain on the critical path. Transparency also helps avoid what the Harvard Business Review calls the "fat tail" syndrome, where changed requirements and delayed acceptance increase project costs and deliverable time.
Insurers should consider utilizing an impartial "umpire" to guard against failure. When IT is the champion of a project and the business is not engaged, the worst failures often occur because internal staff with a vested interest in the project has a natural unwillingness to admit when an initiative has veered irreparably off course. A third-party umpire is helpful to perform impartial assessments and facilitate business-IT alignment, and is also more likely than internal staff to invoke a backup or back-out plan when needed.
While many insurers are well-versed in calculating the hard-dollar budgetary cost of a project, few also take into consideration the far-reaching costs of failure. Risk management tools and techniques, along with insurers' own underwriting and loss control expertise, should be leveraged to understand exposure to failure, increase the likelihood of project success, and minimize the impact of projects that do fail to deliver.
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.