What you should know: I am currently working for Nordcloud as Cloud Advisor, but any posts on this blog reflect my own views and opinions only.

In a world fixated on immediate returns and quarterly reports, a recent paper by Chinese researchers throws a cold bucket of realism on the overheated promises often associated with cloud computing. Don’t get me wrong; as someone who has spent years advising customers in their journey to cloud, I’m as enthusiastic about the cloud as anyone. But let’s strip away the hype for a moment and confront a sobering fact: The full benefits of cloud adoption typically take years to materialize on your balance sheet. Yes, you read that right—years.

Now, before you toss aside those ambitious cloud migration plans or question the credibility of this indispensable technology, let us make a reality check. Cloud computing isn’t a sham; it’s an investment. It’s akin to planting a vineyard; you don’t harvest the grapes next month. You nurture it, you invest in it, and then you reap the rewards over a long period of time. In today’s hyper-competitive business environment, we often lack the patience for strategies that promise a delayed payoff. However, a focus on immediacy can lead to a myopic view of technology adoption.

It’s time for a more nuanced conversation, one that moves beyond the lift and shift narratives and the seductive simplicity of cost-cutting promises. This blog post is an invitation to reframe how we evaluate the time horizon of ROI of cloud technologies.


Value of Cloud: Efficiency and Innovation

Let us first take a step back and look how cloud computing actually can accelerate creating value. By leveraging the capabilities of cloud technologies, organizations can optimize their IT infrastructure and processes, create new value propositions, and transform their business models to stay competitive in today’s fast-paced digital economy.

Cloud computing contributes to an organizations’ performance by leveraging two mechanisms: exploiting the potentials of IT and processes to reach higher levels of efficiency, and by exploring the innovation potentials for adapting the ways the organization is creating value. In the cloud value rocket framework, the focus on efficiency maps to the stages of IT Infrastructure Transition & Consolidation and IT Transformation. The focus on innovation is represented in the stages of Value Delivery Transformation and Business Transformation.

In the IT Infrastructure Transition & Consolidation stage, cloud computing allows organizations to consolidate their IT resources into a centralized and scalable infrastructure. This leads to cost savings, improved resource utilization, and increased operational efficiency. By leveraging cloud technologies such as virtualization and automation, organizations can streamline their IT processes and reduce the time and effort required for infrastructure management.

In the IT Transformation stage, cloud computing enables organizations to transform their traditional IT infrastructure and services into more agile and flexible models. Cloud-based platforms and services provide on-demand scalability, rapid provisioning, and self-service capabilities. This allows organizations to respond quickly to changing business needs, improve time-to-market for new products and services, and accelerate digital transformation initiatives.

On the other hand, with a focus on innovation in the Value Delivery Transformation stage, cloud computing can play a crucial role in enabling organizational agility and flexibility. Cloud-based platforms and services provide the foundation for lean and flexible processes, allowing organizations to quickly adapt to market changes and seize new opportunities. By leveraging cloud technologies, organizations can scale their operations, collaborate across geographies, and rapidly integrate new technologies and capabilities into their business processes.

The Business Transformation stage involves exploring new ways to create value for customers and stakeholders with digital business models. Cloud computing offers organizations access to a wide range of innovative technologies and services, such as artificial intelligence, machine learning, big data analytics, and IoT. By leveraging these technologies, organizations can develop and deliver new, innovative products, services, and business models that differentiate them from competitors and create new revenue streams.


Some Insights from Research

After this recap of how cloud can create value, let’s explore empirical research that scrutinizes the dynamics of value creation in cloud adoption and broader digital transformation efforts. These studies serve as a critical reality check, shedding light on the often-overlooked lag between investment and realized gains in transformative IT initiatives.

Short-Term Pitfalls in Cloud Adoption

A study conducted by a Chinese research group delves into an exhaustive analysis of cloud adoption initiatives deployed by 253 Chinese firms between 2010 and 2019. These enterprises were matched with a comparable control group to evaluate the true impact of cloud initiatives.

To quantify the outcomes, the researchers employed a robust set of six financial metrics, spanning a period of up to five years. These included Return on Assets (ROA), Return on Equity (ROE), Return on Sales (ROS), as well as ratios of Operating Income to Assets (OI/A), Operating Income to Sales (OI/S), and Operating Income to Employees (OI/E).

The results are both revealing and sobering. In nearly all of these key financial indicators, the study found an initial downtick in performance following the implementation of cloud initiatives. This observation is not an isolated case; it resonates with previous academic contributions in the field. A corroborative study by also identified a similar short-term decline in Return on Assets (ROA) among Swedish companies undergoing digital transformation.

What these findings collectively underscore is that the promise of cloud adoption is not without its pitfalls, especially in the short term. The decline in financial performance should not be viewed as an anomaly, but rather as part of a larger, more intricate narrative that unfolds over a longer timeline.

Transformative IT initiatives like the adoption of cloud computing will have a negative impact on the bottom line in the short run. The Chinese study did not find any empirical proof for positive impact of cloud computing within the first five years.

The IT Productivity Paradox

So, what’s the underlying reason for this short-term dip in financial performance post-cloud adoption? This phenomenon isn’t new; it echoes a debate that has been ongoing since the 1980s, often referred to as the IT productivity or performance paradox. Pioneered by scholars like Brynjolfsson and reinforced in subsequent studies, the paradox posits that IT investments don’t readily translate into immediate gains in productivity or fiscal metrics.

One of the main factors contributing to this paradox is what’s known as the ‘lag effect.’ Simply put, the benefits of IT investments, including cloud adoption, often don’t manifest until several years have passed. A study by provided empirical support for this, finding that it took a span of 3 to 4 years for companies in their study to exhibit noticeable positive impacts from their IT initiatives.

Given that these companies were already high achievers in their respective fields, it stands to reason that for the average enterprise, the waiting period could extend even longer. Therefore, the lag effect is not an anomaly but a feature of this transformative journey, serving as a cautionary note for organizations expecting rapid financial windfalls from their cloud or digital transformation efforts. Patience, strategic planning, and a long-term perspective are essential for navigating this complex landscape effectively.

It takes multiple years for transformative IT investments to become visible at the bottom line.

The Diverging Paths of Cloud Initiatives

Revisiting the Chinese research, a compelling facet emerges that adds another layer of complexity to our understanding of cloud adoption impacts. The researchers introduced an additional dimension to their study, distinguishing between cloud initiatives aimed at improving operational efficiency and those focused on fueling innovation. The categorization of the initiatives investigated was done through a qualitative analysis of publicly disclosed information.

Diagram showing the results of the model analyzed in taken from the paper by Li et al.
Diagram taken from the paper illustrating the model’s outcomes.

A differences-in-differences (DID) analytical technique was employed to uncover intriguing patterns that diverged significantly between the two categories. Although all performance indicators exhibited a downward trend post-cloud adoption, there was a marked disparity between the two groups. Specifically, initiatives aimed at innovation faced a more pronounced decline compared to those focused on incremental efficiency gains.

In simpler terms, while all types of cloud adoption resulted in initial drops in financial performance, the plummet was more drastic for initiatives primarily centered on innovation. This suggests that pioneering projects inherently carry greater short-term risks, albeit with the potential for longer-term rewards that are likely more transformative.

Supporting this idea is that the trend of negative performance change reverses much faster for initiatives focusing on innovation, soon exceeding the levels of initiatives focusing on efficiency again. Even though the study did not find any positive impact of cloud computing within the time frame of the study, one can imagine that an extrapolation of the effects would lead to a substantial positive effect in the long run.

Cloud adoption initiatives focusing on innovation lead to a more severe decline in short-term performance than those focusing on efficiency improvements. But on the other hand, the negative trend reverses sooner and stronger for innovation initiatives.

So if there might be a long-run potential for substantial positive effects from adoption of transformative cloud computing initiatives that is not visible within the first few years, what are possible causes for this?


Causes for the Performance Lag

The performance lag effect of IT investments is a complex issue that can be attributed to a variety of factors. It is crucial to have a clear understanding of these factors in order to effectively manage and navigate this effect. Therefore, let us examine some of these factors together.

One of the major contributing factors to the performance lag effect is the learning curve associated with new technologies. As organizations invest in IT, they often encounter serious mistakes, duplication of effort, and inefficiencies as they learn to manage the new technology. This learning process can slow down the rate at which the desired improvements are achieved, thereby increasing the size of the investment lag in the early years.

The operating model of an organization also plays a crucial role in the performance lag effect. An operating model is a representation of how an organization delivers value to its internal and external customers. When an organization invests in IT, it may need to adapt its operating model to accommodate the new technology. This adaptation process can take time and resources, further contributing to the performance lag effect.

Business processes also need to be adjusted when an organization invests in IT. Optimizing business processes can increase consistency, quality, and compliance, reduce risks, and provide greater visibility for customers. However, the process of improving and optimizing business processes can be time-consuming and complex, leading to a delay in the realization of returns on IT investments.

Unpacking Contributing Factors

Up-front costs, implementation problems, and system enhancements are other issues that can contribute to the performance lag effect. IT investments often require significant up-front costs, which can strain an organization’s finances and delay the realization of returns. Implementation problems can also arise, causing delays and increasing costs. Furthermore, system enhancements may be necessary to fully realize the benefits of the investment, adding to the time and cost required.

Then the need for complementary investments can also contribute to the performance lag effect. In essence, the degree to which a particular company gains from changes in IT depends on its ability to exploit investments in complementary assets, including not just physical capital but also human and organizational processes. Therefore, while the adoption of new technologies can make a company more adaptable and able to change rapidly, it’s the strategic investment in complementary assets that ultimately determines the success of this transformation. Again, a delay in taking those complementary investments will lead to a performance lag.

Another cause is the need to address security and compliance issues. Organizations are often exposed to potential legal penalties, financial forfeiture, and material loss due to non-compliance with industry laws and regulations, internal policies, or prescribed best practices. This risk, also known as integrity risk, can significantly delay the realization of returns on IT investments.

The Shakedown Effect

Then there is the concept of a shakedown effect, as proposed by Markus & Tanis that also plays a role in the performance lag effect. This refers to the period after the implementation of an IT system during which the system is fine-tuned and users become accustomed to it. During this period, productivity may decrease before it starts to improve.

The dangers of the shakedown phase must not be underestimated.The time it takes to iron out defects in new systems, the adaption of processes both in software and in business processes and the delays in delivery of working systems, are known to have caused enterprises to fail (also ) and public entities to effectively go bankrupt.

Untapped Potentials of IT Investments

And one last thought to consider is this: When a firm makes an IT investment, it acquires a set of real options – opportunities for future actions that can enhance the value of the investment. However, these options do not exercise themselves. The firm must make conscious decisions about when and how to exercise each option, based on its assessment of the current situation and its projections of future conditions. In essence, the real options framework emphasizes that IT investments are not just about buying technology, but about acquiring strategic flexibility. This flexibility can be a source of competitive advantage, but only if the firm is able to effectively manage and execute its options. This requires a combination of strategic foresight, operational agility, and the ability to learn and adapt over time.


Revisiting Innovation vs Efficiency in Cloud Adoption

Let’s circle back to the study by to examine how various types of initiatives compare. At one end, we have initiatives driven by innovation, which seek quantum leaps in performance and overall business transformation. At the opposite end lies adoption of cloud to improve efficiency, aimed at subtle, incremental gains — what we may term as sustaining innovation. However, the research underscores that in both approaches, organizational performance tends to suffer initially. Notably, this decline is more acute when the focus is on groundbreaking innovation rather than modest efficiency improvements. This outcome aligns intuitively with the contributing factors for performance lag discussed earlier.

Weighing the Risks and Rewards of Innovation in Cloud Adoption

Opting for the path of innovation is inherently fraught with risks—it demands substantial organizational change, calls for additional investments, and requires a longer runway for benefits to materialize. It’s no wonder then that many organizations hesitate to undergo such transformative change, opting instead to maintain their existing operational cadence.

However, this cautious approach leaves the transformative potential of cloud computing untapped. For a deeper dive into the myriad benefits and supporting strategies, you can refer to my series on cloud value fundamentals. In essence, cloud technology can revolutionize how an organization delivers value to its clients and stakeholders, while also serving as the linchpin for digital business model transformation.

The Imperative of Agility in Today’s Competitive Landscape

In our current Red Queen competitive environment (see , the capacity for ongoing innovation and adaptability isn’t just advantageous—it’s essential for survival. As noted by “the ability to learn faster than your competitors may be the only sustainable competitive advantage.” Employing cloud technology at a strategic level can be instrumental in evolving into a more resilient, agile, and adaptive organization. To clarify, a single isolated initiative won’t suffice; what’s needed is a fundamental shift in your organizational strategy and approach.

The Opportunity Cost of Not Innovating

To put it succinctly, as argued by , any digital transformation strategy should aim for radical improvements via disruptive innovation. By choosing not to venture down the path of innovation in your cloud adoption journey, you forgo an invaluable opportunity to fortify and future-proof your organization.

In today’s fiercely competitive landscape, where standing still is tantamount to moving backward, audacious digital transformation steps are not just recommended; they are imperative for carving out even a fleeting competitive edge.

Thus, the stakes are high, but so are the potential rewards. The decision to innovate or not in the realm of cloud adoption is not just a technological choice; it’s a strategic one that could well determine your organization’s future standing in the marketplace.


Final Thoughts and Strategic Takeaways for Your Cloud Journey

As we conclude this deep dive into the long-term economics of cloud adoption, several key takeaways emerge that ought to inform your strategic approach to cloud transformation.

Firstly, abandon any illusions of immediate financial windfalls from your cloud initiatives, particularly if your goal is to fundamentally reshape your organization. While vendors might dazzle you with projections of immediate savings and efficiency gains, a prudent approach would be to plan for a return on investment over a more realistic timeframe exceeding five years.

Secondly, be mindful of the performance trough that often accompanies cloud adoption. Before you start reaping the cloud’s benefits, there may well be an initial dip in organizational efficiency and profitability. This is a critical phase where processes are adjusted, teams are trained, and workflows are transitioned. Factor this into your long-term planning by setting aside resources and contingencies for this valley of turbulence in your cloud journey.

Third, if you’re already in the process of adopting cloud technologies, seize this moment to truly elevate your organization’s competitive edge. Don’t get sidetracked by low-hanging fruit like simple “lift and shift” migrations of virtual machines. While these might offer incremental benefits, they can also divert focus and resources from more transformative opportunities that the cloud presents.

Lastly, at a strategic level, use the cloud as a catalyst for disruptive innovation rather than just an IT upgrade. Don’t just dip your toes in the water; dive in head-first with innovation as your guiding star. Take chances, be ambitious, and let the potential for paradigm-shifting changes in how you conduct business guide your cloud adoption strategy.


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