The Virtuous CIO  

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August 01, 2010 — Managing Costs

No successful manager in the IT arena (or any area of business for that matter) can be ignorant of cost issues. The challenge is to change it from a ball and chain around one leg to a tool for fulfilling the mission of the organization.

Placing cost in its proper place in the IT world

Cost is one leg of the business plan. Once a business grows beyond its entrepreneurial roots, the technology spend draws notice from the corporate financial management. Technology is an area where it is easy to lose control of spending, so IT is often tasked with building a reasonable budget. As part of the IT management team, your responsibilities may include controlling spending. One aspect of IT governance is providing accountability to corporate management for IT spending. The budget is part of this, as are the financial reporting instruments used in the business.

Types of cost

Part of the budget mechanism is taking the time to identify the types of cost accumulated by IT. Some of these are obvious. Others are not so.

Hardware costs -- this is the easy one. The expenditures for the various kinds of hardware will fall into just a few general ledger account numbers, and the reporting is easy. The accuracy of this information is dependent upon how strictly the business enforces rules against ad hoc spending.

Software costs -- software purchases may be more difficult to track. Records of purchases of boxed software generally are recorded properly. Without an aggressive asset management team in place, it's very difficult to track software that is downloaded and paid for with a credit card.

Vendor maintenance costs -- most significant software is purchased with a support and upgrade agreement which costs between 18% and 25% of list price of the software. Because invoices for this maintenance arrive regularly, they are usually recorded in the proper accounts and can be tracked. What is less easy is it identifying shelf ware since it tends to be out of sight and out of mind.

Communications costs -- as businesses grow, so do the number and variety of communication links to the outside world. Most businesses will have a collection of local lines, Internet links, voice grade T1’s, as well as a multitude of cellular plans for employees. This is one of the more complex areas to track and manage.

Infrastructure costs -- these are the costs associated with the network switches and cabling. These are often lumped in with general hardware expenses. As IT shops become more sophisticated in their budgeting, this category should be broken out for separate management.

Administrative costs -- a software license administrator, a budget administrator, or an IT personnel coordinator are part of what would be called administrative expense. In many IT shops this function has grown over the past 10 years from nothing to what is now often a separate department within IT. In public companies, Sarbanes-Oxley has made this area critically important.

Operations costs -- in the vernacular, this is often called keeping the lights on. This is where a majority of the IT budget now resides. It costs big money to keep a competitive IT operation running.

Internal support costs -- if you have end users, you recognize by now you are obligated to take care of them. If we surveyed corporations around the country we would see end user support characterized as anything from simple break fix to elaborate handholding and training. If the service personnel are ITIL certified, they should have a basic knowledge of how to track costs, and know what the costs mean.

Software development costs -- it is expensive to develop software. Having had experience of paying large integrators $150 to $200 per hour I can testify to that. What is less obvious is the substantial cost of an in-house development team. It is something that is right to bring under control.

Next week we will talk about measuring cost and controlling cost. There are some unique challenges as well as opportunities as we look deeper into this topic.

Measuring cost

Last week we discussed the various aspects of IT related costs, and how they might be categorized. Less obvious is that there are multiple ways of measuring these costs. How this is done largely depends on the corporate culture as well as the preferences of the CFO.

From the macro level down

If the corporate cost model is relatively uncomplicated, the CEO or the CFO may decide to simply place all of the corporate technology costs in one bucket. This can be done by fiat, and has the advantage of being the easiest to achieve. It may be as simple as directing the procurement people to park all technology purchases within a selected group of general ledger account numbers.

This methodology becomes interesting when the CEO therefore parks all technology spend authority with the CIO or IT director. This gives IT a great deal of power and it must be used carefully. It also has the least risk of creating bureaucratic overhead.

The downside is that this method does not provide a very granular reporting capability, and does not easily display which parts of the organization are doing the spending.

From the micro level up

Some businesses with sophisticated budgeting systems have developed ways to charge back individual departments for their technology purchases. The individual departments manage their own budgets as well as technology spend, and IT is less powerful. In many cases like this one, there is no true centralized IT.

While this provides a detailed understanding of how a business is spending its money, it's almost inevitable for a bureaucracy to grow up around it. The danger is that corporate spend management becomes a zero sum game. A growing group of employees spends 100% of its time managing the budget and chargeback process. This does not create value for the business, and becomes a dead weight upon the balance sheet area

Horizontally, as part of a matrix

As businesses become more process oriented, they have begun to develop ways to track costs based upon business function. As a process is tracked through organizational entities, the process itself including technology resources is tracked. This is perhaps the most difficult way to measure cost, but it is also the most rewarding. This method clearly shows the processes that create value for the corporation.

Controlling costs

Costs must be controlled. There are numerous accounts of businesses which cratered because the management was not paying attention to cost. When the employees begin raiding the candy dish, the business is in trouble. The low-level employees will take advantage of this because they see the managers and the senior management also behave in this fashion.

If you are a CIO, you're obligated to manage IT costs, whether or not anyone else in the company is doing so. In fact, if you come across this kind of situation, and you are unable to convince the CEO or the CFO of the problem, then you would be very wise to get you resume up to date and bail out. Because somebody will eventually be going to jail.

Tactical, short-term control

During periods of crisis, senior management is often obsessed by the short-term financial health of the business. Of course, if there is danger of cash flow issues driving the business into bankruptcy, this is wise.

This way of looking at expenses is often characterized by strict budgeting. The budget numbers also tend to be arbitrary. This is influenced by the short-term health of the balance sheet or stock price, with little thought for long-term value creation.

Strategic, long-term control

Under this type of oversight IT costs are viewed as investments. The metrics are designed to evaluate the systems in terms of the contribution of value to the enterprise. This is where a strategic IT management wants to be. By implication the CIO in this kind of an organization has a seat at the table. IT is contributions are viewed in light of how they contribute to sales, or to the growth of the business.

Functioning of these environments

Coming to the point of this discussion, how does the CIO function in these environments? First of all it's important to begin gaining a thorough understanding of the business. If you are in a leadership position, you already know how IT is supposed to run. Delegate that to your subordinates and hold them accountable. Begin spending time in the various critical operations of the business and make it your goal to know the business as well as those managers do.

Take the time to implement whatever elements of IT governance that can be done quickly. This is where you look for the low hanging fruit. Get your budgeting under control. Quickly fix the badly broken things. Strive to provide some basic accountability to the CFO so that he can begin developing confidence in you and your operation.

Along with implementing governance elements, begin educating senior executives on the necessity of holding IT accountable. This will likely be a new experience for most of them and will take some time to sink in. It is rare for the head of a business unit to accept responsibility for the actions of his employees when it is not necessary to do so.

Begin aligning IT with the business. This requires a good understanding of the corporate strategic goals and objectives. Begin to fashion initiatives which support the corporate goals. Develop a business case for each initiative to as well as a project charter. Work hard to communicate to the other business unit heads that you are developing projects to enable them and make them successful.

Conclusion

IT professionals will vary from cost gurus to relative neophytes. In each case plan on continual education as you learn more and the business changes. Work to develop expertise within the IT organization so that IT sets the standard for professionalism in internal cost accounting.