By Raja Pabba and Rakesh Singh
The difficulty in managing IT costs for large enterprises has increased in the past 15 to 20 years because of the complexity inherent in managing IT Systems, which includes proliferation of sourcing IT services from multiple vendors, and delivering IT solutions. Typically, IT projects are the largest capital expenditures in most organizations – almost 50 percent – and operational IT expenditures have increased in most industries every year. Today’s chief executive officers are unable to manage IT costs effectively because they do not fully understand the costs and value of IT.
Since the 2008 recession, many CEOs have decreased expenditures while trying to find ways to drive efficiencies and reduce the bottom line. The increased scrutiny of expenditures has placed immense pressure on the IT organization; many IT managers have difficulty communicating the value of IT and explaining why IT expenses keep increasing. In addition, the absence of accountability concerning IT expenditures is due to organizations’ lack of financial management skills, processes and tools. Without clear and transparent understanding of IT value and IT expenses, CEOs are unable to make optimal investing decisions.
Thankfully, a new capability – IT Financial Management – is emerging. It encompasses a set of processes, tools and skills to manage, communicate, and evaluate IT expenditures.
Rules for Effectively Managing IT Costs
It seems straightforward for a CEO to manage IT costs similar to marketing costs. However, the complicated nature of IT functions doesn’t fit this approach. There are three main reasons: 1) IT is a new management function and it has impact on the entire company; 2) there is a lack of general management skills within the IT function, although this is changing; and 3) there is a lack of management processes.
In this context, we recommend CEOs take a fresh approach to managing IT costs. Our research and combined experience has led us to suggest four rules to help CEOs implement effective IT cost management solutions.
Rule 1: Know thy costs. Before one embarks on the journey of managing costs, it is imperative for one to know the costs. This seemingly simple rule is difficult to implement because not all IT costs are tracked completely by IT management and many times the costs are buried in other departmental expenditures. For example, an increase in power consumption or space could be driven by IT consuming more power and space for its servers; these costs, however, typically are borne by the facilities department. IT expense information oftentimes is distributed to different departments, making it a challenge to consolidate the data. For example, a leading state university had one accounting system, but it was configured to manage IT into disparate accounts that weren’t linked. More than 50 departments used this system and executives never had an idea of any of the IT costs. With this example in mind, managing IT includes evaluating the different types of costs that affect the department.
Rule 2: Know thy activities. After you have solved Rule No. 1, it is imperative to learn why these costs are incurred. In our experience, this can be quite challenging because of a lack of segregation of duties, roles, and responsibilities. In addition, a detailed discussion about getting this right is simply not in anyone’s agenda. Correlating IT costs to different activities performed provides critical and powerful insights into how IT costs are distributed so that they can be analyzed for optimization. Our analysis of one leading Fortune 500 client revealed that the IT staff was spending almost 90 percent on operational-related work and the rest on new projects. This was quite opposite to what management had been thinking. Many decisions and plans resulted as part of this analysis, which not only led to better utilization of resources, but also enabled the company to look at outsourcing some of the non-value added activities.
Rule 3: Know why. Knowing why IT costs are occurring only provides the consumption side of the equation. The more important question(s) to ask is “why” the IT costs and the resulting activities are the way they are? What is the demand that is getting fulfilled by IT? An organization is about an internal balance between supply and demand for resources, so it is critical to understand “what” is driving the demand for IT services. This could lead to identifying inefficiencies that are not contributing to creating value. As an example, a large chemical manufacturer was spending the majority of its IT resources on reworking the system. We found that there was no prioritization of demand for IT services by different business units, leading to inefficient allocation of IT resources.
Rule 4: Know thy value. The responsibility of creating value in the organization must be on everyone’s agenda, including IT. Based on Rule No. 3, knowing why someone is doing something in an IT organization is one thing, but tagging a specific value to the activity is completely different. This knowledge enables executives responsible for managing IT costs to move the conversation from cost to value. Migrating to value-based evaluation of IT expenses could become one of the key changes a CEO can bring to a company.
Benefits of Managing IT Costs
By implementing these simple rules, an organization can derive many lasting benefits, which may include reducing the operational costs that impact SG&A and improving profitability. Specifically, the following represents the major benefits inherent in managing IT costs.
In the current economic climate, managing IT costs is critical. A CEO needs to work closely with the technology executive to set the agenda for managing IT costs. Executives need to invest in sustaining their financial management capability when implementing processes to drive fiscally responsible decisions that deliver shareholder value effectively.
Raja Pabba is the Founder & CEO, and Rakesh Singh is the co-founder & COO, of Fort Worth-based Claritia. Claritia is an IT financial management solutions company focused on helping CEOs, CFOs, and CIOs maximize the value of their IT investments. http://www.claritia.com/
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