[Leila Dige and Max Meyer co-authored this article]
In order to compete with the speed and agility of startups, organizations need efficient, disciplined financial management practices that detail how their money is spent and how each investment ties to specific business outcomes. This requires decision-making frameworks and management systems that use credible, timely information to empower leaders to quickly evaluate a situation and determine a course of action. Often, the fastest-moving organizations either are those with the most streamlined financial management practices, or the most careless. Developing these sound financial practices can give leaders critical information they need to act with confidence during uncertain times.
IT financial management is a journey. CIOs can mature throughout this process by managing costs, increasing cost transparency and partnering with the business to communicate the true value of transformation initiatives.
Establish a framework for service-based cost models
Many organizations still manage their budget based on traditional general ledger categories such as hardware, software, labor, and the like. The difficulty with this approach is that it provides a financial view that is not particularly helpful for IT. Business functions might track revenue by the accounts served or services provided. To improve cost transparency and promote accountability, IT leaders should do the same, tracking and managing costs based on the services provided, whether end-user, business or technology services.
Technology Business Management (TBM) is one of the most common service-based cost models we have encountered with our clients. The TBM framework allows organizations to track how costs and initiatives align to different cost pools, IT towers (e.g. compute, network etc.), services and business units. This helps drive cost accountability among IT teams by establishing baseline and ongoing costs for the services provided to the organization while providing business owners with the true cost of IT services.
With the help of Metis Strategy, an international financial services organization implemented a similar framework to gain more clarity about how it’s nearly $500 million budget aligned with business goals and created value for the company. We first analyzed the labor and managed service spend on key IT services such as application support, IT service desk, network and telecom, and other business functions. With this breakdown, the client was able to identify cost per employee based on location, job type, and which application or service the employee supported. This increased transparency ultimately allowed the organization to save or reallocate $15 million in costs.
Increase transparency through showback or chargeback models
While service-based models provide greater cost transparency, they come with their own set of challenges. A common one is tracing shared infrastructure costs back to the business unit that consumed them. Often things like laptops or storage budgets are listed as run items that aren’t tied to specific business units. This often results in a large bucket of “run items” that no one outside of IT quite understands. Without the ability to see how these costs directly support business units, CIOs often face pressure to undertake arbitrary budget cuts.
To provide more clarity on how costs are allocated, adopt an allocation model across the entire financial portfolio. Based on their maturity, organizations typically use the following two allocation models:
- Percentage-Based Allocation: Allocate shared costs evenly across all stakeholders or based on the size of the organization. This can be controversial but is often a good place to start.
- Usage-Based Allocation: Fully define each service offering, implement the service in order to track usage by stakeholder groups, and allocate costs to each group based on usage. This is a common model with the advent of services like AWS, in which you “pay for what you use,” but organizations sometimes have difficulty segmenting internal user groups with legacy applications.
After defining an allocation model, IT organizations should aim to influence business demand and accountability for IT services by educating them on the cost impact of their decisions. We recommend that IT start with a “showback” model that illustrates the cost allocation through a dashboard or report. This will give IT the data it needs to shape the demand for additional requests and have more productive conversations with colleagues: “What is the return on this investment? We can show the cost, but are you able to articulate the value?”
In many cases, a showback approach can create a sense of shared ownership for how a business decision may impact an IT budget (i.e., if I hire 10 more people, the IT costs will go up by $100*10). In other cases, where a single stakeholder is consuming a large volume of a service, or has a justifiable business need to control spending, a direct “chargeback” may be more appropriate. For example, if a business unit is driving a major sales campaign, they may need a burst of capacity on a website for a finite period of time. There is a clear return on the investment, but very little value in IT governing whether it is the right way to spend the money. The business unit should simply be charged directly for its consumption and be empowered to control its own destiny.
Shift the conversation away from costs and toward value
Once a well-defined financial management framework is established, IT can begin to shift conversations with business partners away from IT costs and toward IT-driven value. A showback or chargeback model will provide transparency on the total dollar spent and can also help illustrate the benefits and trade-offs of different initiatives.
Metis Strategy worked with a manufacturing company that went on this journey. The IT organization was responsible for running and maintaining the Manufacturing Execution Systems (MES) in the factories. Over time, the systems had become disjointed and expensive to maintain. However, upgrading them would be a multi-million-dollar project that would span two to three years. The CIO tried to make the case for an upgrade, but his proposal fell on deaf ears until he was able to articulate the hard and soft benefits of the upgrade to the business. Implementing a showback model allowed his team to build a robust business case that highlighted the potential for future savings by reducing data storage, maintenance and labor support costs. That financial information also allowed the CIO to show how the upgrade would create a more harmonious manufacturing environment and better access to data.
Integrate with your project portfolio management process
Financial management cannot happen in isolation from project and portfolio management processes (PPM). Organizations need to align their portfolio to the company’s strategy, manage demand, and prioritize investments. This becomes easier to achieve when these key activities are supplemented with the right financial data. Instead of prioritizing a project portfolio based on arbitrary soft benefits, improved financial management practices can help organizations understand and quantify costs and negotiate a seat at the table by demonstrating value for the company.
Process first, technology second
There are many financial management solutions in the marketplace, but they will be of little use if they are codifying and scaling a broken process. Before adopting a solution to kickstart your financial management practices, it is important to start with the problem you are trying to solve and define the financial metrics that will help improve decision making. It is also critical to ensure your company can produce credible data. If the data collection, manipulation, publishing, and consumption processes are not ironed out first, organizations are likely to run into data quality issues, which can ultimately lead to a lack of trust, branding challenges, and a less successful implementation.
Dynamic companies need well informed leaders who can quickly decide how to respond to a competitive threat, where to invest more money or where to make tradeoffs. With IT budgets often among the top five cost centers in companies, a clearly defined IT financial management framework can provide greater cost transparency and help influence those decisions. An elevated financial management discipline will also strengthen relationships throughout the business by streamlining investment decisions and more clearly quantifying IT’s value.