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General Information
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August 28, 2009
• Vol.31 Issue 22
Page(s) 30 in print issue
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Quantifying The Cost Of IT Services
Accurately & Transparently Reporting IT Costs
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| Key Points
• As IT has become a strategic part of the business, it is increasingly important to identify, quantify, and report IT costs to business managers with the authority to incur the cost and responsibility for controlling it.
• The most accurate accounting methodology, as described by the ITIL (IT Infrastructure Library), requires developing an IT service catalog and mapping various cost drivers, such as hardware and personnel, to specific services.
• Greater cost reporting rigor and transparency can be used with a chargeback billing model that identifies major IT services, associates some usage dependent measures and rates to each, and bills individual business units based on monthly consumption of the service. | | The digitized online information economy has moved IT from the organizational backwoods to the corporate boardroom, as a strategic player involved in most new business endeavors. “As IT has become more pervasive in most organizations, it has migrated from a supporting role to an enabling role for products and services,” says Craig Symons, vice president and principal analyst at Forrester Research.
Although IT has matured into a critical business unit, it often doesn't act that way regarding financial discipline. As Karen Berman and Joe Knight note in their book, "Financial Intelligence for IT Professionals” (reviewed in the May 22 issue of Processor), corporate finance departments and IT have historically had a rocky relationship. “IT departments have a reputation for spending lots of money (and always asking for more), yet they often have difficulty demonstrating their impact on the bottom line,” note Berman and Knight in the book. According to Symons, “IT costs represent a growing and sometimes significant part of products’ and services’ total cost—yet many firms lack the IT financial transparency to understand the implications.” This situation can distort executive decisions and even a firm’s financial reports.
In light of IT’s elevated importance, Berman and Knight stress that managers need to start speaking the language of business, namely numbers—and they don’t mean bits, bytes, and megahertz. Yet it’s impossible for IT to provide meaningful financial figures and so-called transparency, without being able to link specific costs to IT services, and in turn, map service usage to actual business activities.
 Develop IT Cost Transparency
Like all other forms of financial reporting, the benefit of IT cost transparency is that it facilitates better business decisions by providing accurate information on the various components of IT’s budget, the services provided, the users of services, and their total consumption. The ability to map IT charges to business usage also allows IT managers to more effectively and credibly communicate IT’s value to the overall business and to proactively manage service demand and resource consumption. While typically used as a charging, cost allocation, or control mechanism, Terence Quinlan, director of the IT Financial Management Association, says accurate IT cost reporting is also useful when planning and evaluating IT investments.
The operative phrase in this litany of virtues is ‘IT service.’ To enable cost transparency, IT must move beyond being simply an infrastructure operator or technician dispatcher but must develop what is known in ITIL (IT Infrastructure Library)-speak as a service catalog. “You need to think of the services you provide instead of the technology assets you operate,” says Symons. This requires developing a list of major IT services, for example, email, PC support, and ERP; identifying the assets and personnel used for each; and allocating their costs to each service.
The practice of mapping assets and resources to services and apportioning costs according to some measure of service consumption is known as chargeback. “IT chargeback remains the best tool for influencing end-user behavior, but only if it delivers enough information about the actual cost of IT services that are consumed and enables end-user management to link its IT consumption to value,” says Symons.
IT Cost Drivers
Once a service catalog is in place, the ITIL provides a convenient model for understanding how to categorize and allocate costs. As per Cost Accounting 101, there are two major cost groupings: capital and operational. The former includes the obvious items such as major pieces of hardware, but also application software with a significant life span, such as ERP or CRM systems. Operational costs include everything from personnel and facilities, such as rent and utilities, to telecom charges and external services, such as SaaS (Software as a Service) and consultants.
Having identified the major cost drivers, ITIL’s methodology breaks them down further into three classes: direct, indirect, or overhead. The first can be directly tied to a specific service, while the other two must be allocated to users in some equitable manner.
Cost Metrics & Standard Reports
When analyzing IT spending, a common measure is to examine the total budget as a percentage of company revenue, yet Quinlan finds this metric largely meaningless because it varies widely across industries. He says that with a chargeback mechanism in place, allowing IT expenses to be tied to a company’s products or services, a better metric is to analyze IT’s share of the total product cost. For IT investments, Quinlan recommends using the standard ROI measures such as payback period, IRR (internal rate of return), or NPV (net present value). He also suggests doing a postmortem audit of each major IT project, say, the top five as a percentage of IT’s budget.
When initiating a chargeback scheme, Quinlan advises focusing on the 10 or 20% of IT services that consume 80 to 90% of the typical budget. Each chargeable service should have some unit of measure with a causal linkage to cost (for instance, an email account or GB of storage), have rates tied to this usage measure, be a controllable activity, and require minimal data acquisition to get a reasonable assessment of usage. Although developing IT financial discipline does require up-front effort, Symons says the ongoing operational overhead of chargeback accounting is small, typically only 0.3 to 0.7%, of IT’s total budget.
Laura DiDio, principal at research and consulting firm ITIC, also stresses the importance of quantifying the business value of various IT services, such as their ability to generate revenue; improve efficiency; or lower non-IT production, support, and operational costs. This value analysis can identify areas where IT may be over-spending or need additional investment. “You need to ask ‘How much can you afford not to spend,’” she adds.
Accurate and transparent IT cost reporting, when coupled with a service catalog and chargeback model, can be a powerful tool in controlling IT costs, but Quinlan adds such reports can also improve IT’s credibility within the business and assist managers in making better decisions. Symons agrees, adding, “Understanding your IT cost of goods sold can lead to a more agile and competitive organization.” 
by Kurt Marko
Recommendations To Improve IT Transparency
Being able to allocate IT costs to the appropriate activities requires the ability to link IT costs to IT services that, in turn, link to business services and business capabilities. This implies that IT must first transition from a technology management culture to a service management culture.
• Define services and implement a service catalog. The first step is to understand the services that IT is providing rather than the technology. You can then define these services and incorporate them into a service catalog.
• Develop cost models for each service. For each service in the catalog, develop ”a cost model that maps the technology, labor, and other costs required to support the service. Once the cost model has been developed, use it to set the service price. This is the cost that the business will be charged.
• Define allocation methodologies. Charging customers for IT services requires a method for allocating the costs. Common allocation methods include direct consumption, per transaction, or headcount. A document archival service might be consumption-based and linked to page counts, while an email service might be allocated based on headcount.
• Integrate with financials. The final step is to embed IT customer invoices into the enterprise financial accounting system, so that IT charges are accurately reflected in the business units’ profit and loss statements arriving at complete IT financial transparency.
SOURCE: “DO YOU KNOW YOUR IT COST OF GOODS SOLD?”; FORRESTER RESEARCH REPORT BY CRAIG SYMONS; APRIL 28, 2009. |
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