by Robert D. Kugel CFA |
2/22/2008 | Article ID: V08-09 | Article Type: VentanaView
Summary
A common complaint of IT departments is that they struggle to maintain their relevance in the face of budgets that allow them to do little more than fund daily operations and basic maintenance – what often is referred to as “keep the lights on.” Our research finds an important but overlooked connection between this issue and the charge-back process that most companies use to assign the cost of operating their IT departments. This process fails in two respects. It does a poor job of connecting line-of-business actions to IT department costs, and it assigns expenses in ways that provide little or no incentive for line-of-business executives to eliminate wasteful IT spending. To remedy this situation, IT organizations must be able to track and manage their expenses more intelligently, in ways that connect the dots between business-unit requirements and their expenses. They also must develop charge-back methods that use these more precise systems. This is an issue that Ventana Research believes is best handled by a joint effort of IT and Finance.
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What it costs to run an IT department is easy to determine. For most companies, though, why it costs that amount is not. In our judgment, the inability to connect IT costs to business units’ activities is an important factor limiting the effectiveness of IT departments. The disconnect focuses their efforts more on maintenance and less on using information technology for more productive or innovative uses. Not enough of the IT budget connects the true costs to the cost drivers in ways that allow and incent the consumers of IT to decrease their use of software and services they no longer find cost-effective.
When it comes to allocating IT expenses, there are three basic cost buckets. One consists of expenses that a business unit clearly incurs, such as named user software licenses and related maintenance charges. These can (and should) be charged directly. A second bucket includes expenses that clearly are part of corporate overhead (the CEO’s laptop) or those rare exceptions that are so widely and generally used that it is not worth treating them as anything but general overhead. Allocation in the first case is straightforward: the charge goes to the specific business unit. In the second case, the charge is like all other general corporate overhead: it is a “tax” allocated by some method.
The third – in some cases the largest – bucket consists of IT costs that can be traced to specific users through factors that are both identifiable with and controllable by those users. There are a couple of complications, though, that stand in the way of doing this. One is the inability of the company’s information systems to track the connection between specific costs and the cost drivers. This may be either because the IT organization has not created the means to track costs or because it has not identified the specific cost drivers. As a consequence, these IT costs wind up in a general pool and are charged back to business units using some agreed-upon formula.
While this practice may not appear arbitrary, any such formula is a barrier to maximizing value from IT spending. The reason is that it effectively eliminates any “vote” that business managers have on that element of IT spending because the only control they have is indirect. If the allocation is based, for example, on occupied space, managers would have to reduce this amount to reduce IT costs – a difficult proposition because the space may be under a long-term lease. If it is determined by a headcount formula, in order to lower their IT costs, managers have to let people go. Or it may just be a negotiated percentage of revenues – in effect, an excise tax. None of these formulas is likely to encourage managers to make IT spending more effective.
Allocating what ought to be identifiable and directly assessable IT costs create a dysfunctional spiral. Managers lobby to keep IT spending as low as possible to be able to show greater profitability or to have more resources that they control directly. They lobby to keep their specific IT “tax” as low as possible. Yet since this part of IT is a common cookie jar, they have little incentive to refrain from asking for services or to use them as wisely as possible.
To address this problem, companies must create systems that do a better job of tracking IT expenses and tying them back to business units based on factors that drive the actual costs. Ideally, IT departments should be using portfolio management systems to enable this process. Companies also must have internal processes that give managers greater understanding of what drives IT costs and how to manage them better.
Assessment
Addressing the common complaint that IT is consigned to a maintenance role is partly a bookkeeping issue, but keeping those books better is at the heart of the problem. One reason Ventana Research believes it is difficult for IT executives to address their strategic problem is that they do not recognize the connection between shortcomings in their charge-back systems and the reluctance of many executives to spend more on IT. The solution is to give line-of-business people better information on what is spent and why, and also give them – where appropriate – a say in how IT spends their part of the budget. Such a solution requires having an ongoing process in both IT and Finance that accurately identifies the cost drivers and also having software and systems in place to measure them. CIOs who want to contribute more value to the business must work in partnership with finance organizations to ensure that IT dollars are spent most effectively.
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