Understanding IT Costs

by Bob Benson, Tom Bugnitz, and Bill Walton, Senior Consultants, Cutter Consortium

We are constantly amazed at the number of our clients who are strongly focused on cutting IT costs. Just this week, a large financial services organization asked us for assistance in cutting its IT budget. Yet this same organization continues to grow and to demand more IT services.

Why This Interest in Cutting IT Costs?

We asked this of a CEO who runs a more-than US $1-billion service business that is highly reliant on IT. He spends about $125 million directly, and his business units spend even more. His business could not be done without IT. In fact, most of his clients use his IT capabilities directly to use his services and buy his products.

The answers are pretty simple. First, the CEO doesn't understand what's inside the black box -- and 125 million is a big black box. Therefore, he's certain that costs can be cut without damaging what IT does, or damaging his business. Second, his business unit heads do not understand how exactly they are paying for IT, and therefore complain to the CEO about high costs that go to their bottom line. In other words, IT's billing methods confuse rather than clarify what each business unit gets from IT and the costs of providing what they get. The management climate, therefore, is one of discussing IT's costs as a problem. Third, there's little leadership from either the business or IT in providing significant business innovation. IT is a factory, not a source of new business ideas. Fourth, IT speaks to the business in IT-speak emphasizing the neat new technologies. This communicates the fun "toy" aspect of IT rather than business bottom-line impact.

It isn't surprising, then, that IT is a focus for cost reduction or, at best, flat costs from year to year. Almost every client we speak to faces this challenge.

What Is to Be Done?

The challenge is exacerbated by IT's belief that they've been cutting costs for years, and at the same time they've faced continuing and increasing growth in demand for services. It seems cruel to ask for more cost cuts -- and yet complain about problems in meeting increased demands.

IT organizations that successfully address the combined cost-cutting and increased-demand challenge do three critical things:

1. They understand their costs and assess their performance.

2. They bill their users based on business services actually delivered.

3. They focus on business, not technical innovations that improve how business processes are done.

These three things make up an effective cost-cutting, service growth IT organization. How is this done? We'll describe the first two here.

Understand IT Cost and Assess IT Cost Performance

Very few IT organizations understand the full cost of each service they provide their users. Ask yourself: exactly what does it cost us to provide the financial systems portfolio service to our company? This is the full cost of operating, maintaining, and supporting the financial systems application portfolio, including all people and infrastructures. And if you don't know this, your business users can't know it either. Oh, you exclaim, we do bill our financial systems out to our users! Our experience is, typically, IT organizations that do bill, don't include the full cost -- such as operations, space, energy, benefits, share of IT management, etc. If you don't know full cost, you don't know anything. (See the August 2006 Cutter Benchmark Review for our article describing how companies fail to understand the full cost of IT in their methods for allocating or billing IT costs.)

The understanding of cost is linked to assessing the performance of IT's costs -- the strategic alignment, service level, quality, risk factors, and effectiveness of what IT provides its users. Ask yourself: exactly what is the performance of our financial systems portfolios -- the costs to provide the portfolio -- in terms of alignment, service level, quality, effectiveness, and so forth. Only by linking performance to cost can IT -- and, more importantly, the CEO and the business unit leadership -- determine the need for, impact of, and opportunity for cost reduction.

Bill the Users for (Business) Services Delivered

This takes the assessed costs (per above) and connects them to the users who receive the services. Without this connection, the discussion of IT costs occurs in a vacuum without fact-based assessment linked to each business unit's consumption of IT.

Too often, business units see IT costs solely as aggregations of technical things: storage, disaster recovery, servers, networks, workstations. This prevents them from understanding those costs as something connected to what they do in their business activities. For the financial services portfolio, for example, it is not helpful to convey IT costs in terms of servers, storage, etc. This is simply part of the black box and the users don't understand it. Rather, it is important they see their financial services portfolio costs by the actual services rendered: payroll, general ledger, etc. (Note that many IT organizations cannot distinguish IT costs even at the high portfolio level, distinguishing the costs of providing applications to financial services from, say, marketing and sales.) These costs, then, can be connected to assessments of performance -- how well the financial services portfolio satisfies the users requirements.

Responding to the Challenge

Now, by following the first two practices outlined above, the CEO and business unit heads are in a position to understand IT costs and to effectively participate in discussion of cost reductions and growth demands. To accomplish this requires a simple set of programs to define costs and performance, and establish appropriate cost recovery methods.

-- Bob Benson, Tom Bugnitz, and Bill Walton, Senior Consultants, Cutter Consortium