by Craig Symons, Vice President, Forrester Research

Know your IT cost of goods sold

Jun 29, 20094 mins
IT Leadership

As IT has become more pervasive in most organisations, it has migrated from a supporting role to an enabling role for products and services. As a result, IT costs represent a growing and sometimes significant part of the products and services your organisation offers total cost – yet many firms lack the IT financial transparency to understand the implications. At one level, this limits executives’ ability to optimise or manage their gross margins, while at another level it may even distort the firm’s financial accounting reports. Understanding your IT cost of goods sold can lead to a more agile and competitive organisation.

IT costsmanifest themselves in diverse ways across the enterprise, and because few organisations chargeback for IT in a consistent and detailed way, accurate financial accounting is unattainable. IT costs may be incurred for:

• General enterprise wide administrative purposes-email and global ERP systems. • Business unit administrative purposes-inventory management and point of sale systems. • Sales and marketing purposes-CRM and territory management systems. • Direct product or service purposes-applications enabling employees to produce or sell products.

Although these IT costs are associated with a number of different activities, many organisations account for all IT costs the same way-lumping them all into general and administrative costs. This is true whether or not these costs are charged back to the business units. This treatment distorts financial statements and hampers executives’ decision-making.

IT financial transparency enables smarter business decisions With complete financial transparency, IT not only splits out IT costs by activity, but charges back all IT expense at the service level based on consumption by the customer. This provides business executives with information that they can use to make key decisions.

Take an insurance claims process for example: a claim may require a claim form, an accident report, photographs of damages, estimates, etc., and by implementing a web-based document management system, an insurance company can significantly reduce the cost and time to process a claim by enabling documents to be scanned at their source and transmitted electronically. The cost of the system is a direct cost of providing the “process claim” service and should therefore be accounted for as a cost of goods sold expense, not a general and administrative expense.

This kind of information enables IT and the business to have a fact-based discussion. In this example, the insurance company reduces claim cost and processing time by implementing the document management system, which then passes lower prices to customers and draws new customers with faster claim times. IT financial transparency is only an incremental process 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. Do this by:

• Defining services and implementing a service catalogue. 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 catalogue. • Developing cost models for each service. Cost models should map the technology, labour, and other costs required to support the service. Cost models then set the service price, i.e., the cost that the business will be charged. • Defining allocation methodologies. Common allocation methods include direct consumption, per transaction, or headcount. • Integrating 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’ P&L statements arriving at complete IT financial transparency.

About the author:

At Forrester ( Craig Symons serves CIO professionals. He is a leading expert on deriving business value from IT investments. Craig helps Forrester clients implement improved IT governance to drive strategic alignment and maximise the value of IT enabled business change investments.