My last post on this theme A Market-based Approach To Valuing Data, introduced the idea of establishing an internal data economy as a way to value and manage data assets. Here now is a specific scenario for how this could work. I apologize in advance for the length of the posting, so please bear with me. The level of detail is necessary to demonstrate how an internal market can function in a practical manner.

Let’s say the Customer Information Investment Center (IIC) sees a business opportunity for leveraging a consolidated 360-degree view of customer data by creating a master repository that includes relevant customer data from multiple operational systems. The IIC approaches the business functional groups to determine what sorts of consolidated data would have business value, and how much they would be willing to pay for it. The US marketing group values a collection of 100 data attributes about each customer that includes purchase history, demographics, relationships and external market data and they would be willing to spend $1M per year if the data was constantly refreshed. The European marketing organization focuses mostly on commercial customers, so they also would be interested in most of the same data, but the type of demographics they want is very different and they also want regulatory information included in the external market data – the business value they place on this is $500K per year. The customer servicing organization wants some of the same data, but they also want a complete history of all orders, payments, credits, and returns – they would pay $2M per year since it would help reduce outstanding receivables and reduce operating costs. The sales organization also sees value in customer master data, but they would only be willing to pay $200K per year since they already have access to much of the data through an existing sales management system. The list goes on and the IIC indentifies a total of 10 potential internal consumers that are willing to collectively pay $10m per year. This is called market research – albeit for an internal market.

The next step is product development and figuring out the time and cost in order to serve the market. The IIC approaches the IT cost centers to understand what data is available, in which systems, and how easy/hard it would be to load it into a customer master data repository. It turns out that 90% of the data is relatively easy to secure for an initial investment of $5M and an annual operating cost of $1M. The remaining 10% would cost at least $10M and is of interest only to the business consumers, so the IIC decides to not pursue it since there isn’t sufficient demand in the internal market. The next step is to raise the $5M capital to build the master data repository.

The IIC prepares a business plan, and approaches the corporate investment review board to make the case. The business plan shows the projected annual revenue stream from the business functions. If the business plan meets the financial hurdle rate and required payback period and if there aren’t other even more compelling investment opportunities available, then the project is approved.

The IIC then goes on to build the solution (by subcontracting much of the work to IT cost centers) and finalizes the sales agreements (service level agreements) with the business units. No “real” money changes hands in all these transactions, instead, the accountants use transfer prices to move costs from one accounting unit to another- IT costs are transferred to the IIC on a cost-basis while the IIC transfer prices to the business units are based on “market” prices (i.e. what they are willing to pay for). The difference between the two is the “return” on the investment.

To continue with a typical real-world issue, let’s say that the data turns out to be of poor quality so most business units decide not to pay for it in the second year because they are simply not receiving sufficient value. The second year revenue drops to $2M and as a result the manager is replaced. The new manager develops an investment plan to clean up the data, improves internal marketing, rebuilds relationships with the business units, finds new opportunities to use the data, and after a few years rebuilds the Customer IIC to a $12M annual return. The manager uses some of the funds to re-invest in the business to create additional customer master data – thereby growing customer data asset and the value to the organization over all. The financial statements for the IIC in this scenario would look something like this Financial Summary Statement (right click to open the image in a separate tab).

The cost center financials at the top of the chart provide little useful management information; all you know is that 2007 has a slight cost increase which came mainly from an increase on contractor fees.  Cost financials say nothing about the value that is created; is the group underfunded and struggling, is it overstaffed and wasting corporate resources, or is it valued by the rest of the organization?

The profit center financials in the second chart provide additional information.  The drop in revenue in 2007 is very significant and reflects a change in demand for the services of the group (either because the need has gone away or because the unit isn’t meeting the needs). From a profit and loss perspective the unit is still making a positive contribution (albeit a marginal one) to bottom line profit.

The investment center financials at the bottom of the chart paint the most complete picture. When the after tax cost of capital is factored into the equation, the IIC destroyed economic value in 2007 to the tune of about $300,000. It is only when you combine the ongoing operations along with the initial investment that it becomes clear that the unit is having a negative impact on corporate financial performance. This was the trigger for replacing the manager.

The new manager (blue shading in the chart) makes a case for investing an additional $2M in 2008 for data quality infrastructure and turns the IIC business around with dramatic revenue growth and year over year increases in Economic Value Added. Note that Return on Net Assets increases more rapidly as the original capital investment becomes fully depreciated. The true value of the asset however is reflected in EVA which makes it clear that the value of a 360-degree view of the customer is increasing in value to the business – not decreasing.

The first major milestone is in 2009 when the cumulative EVA ($7.1M) exceeds the cumulative capital investment ($7M). 2011 marks the second major milestone for the IIC; the $1M expense to upgrade the IT infrastructure is funded by transfer prices as opposed to a capital investment.  After a rocky start followed by three years of success, the unit has become self-funding. In other words, it is able to sustain its operations and continue to grow the value of the information assets entirely through the value that the organization gains from the assets.  In financial terms you can think of this as equity financing. Once the organization reaches this level of maturity, it is truly managing information as an asset on a sustainable basis.