Learn to Trim IT Costs Strategically

Two years ago, when Richard Toole became CIO at pharmacy service provider PharMerica, he faced two very tough challenges: Reduce IT costs and earn the trust of the business. At the time, IT organizations all over the country were facing similar pressures. The U.S. economy was still stumbling after the double blow of 2001’s terrorist attacks and the turn-of-the-century financial scandals. At PharMerica, the pressure was even greater. The IT organization that Toole inherited had little credibility within the organization, and had even less when it came to driving cost savings itself.

"We used to be called the ’helpless desk’ when I joined," recalls Toole.

Toole knew that unless he changed his department’s relationship with the business, IT would always be viewed as a cost center, facing an endless stream of declining budgets dictated by others. So he was determined to demonstrate financial discipline by managing IT strategically, correcting inefficiencies to cut costs before he was asked to.

That strategy paid off, and the trust Toole earned not only allowed him to determine the cuts and their nature but also permitted him newfound say in where the savings he reaped could be redirected.

"I wanted to not just cut costs but also build capacity for the future," he recalls.

First, Toole invested in building a help desk system so he could bring the poorly performing outsourced desk back inside the company. That addressed IT’s most visible failure. He diverted some resources to creating an architectural team so IT would no longer be managed in silos, reducing redundancy while increasing agility. And he invested in increasing business, leadership and developer skills so his staff could deliver better service and applications with an eye toward adopting modern approaches such as service-oriented architecture and Web services.

Toole’s experience is hardly unique. A CIO Executive Council survey in April found that 12 percent of the 51 CIOs interviewed faced what they called "very high" pressure to cut costs, while another 28 percent had "significant" pressure. "In a lot of cases, all the business expects of IT are tactical decisions. It’s viewed as an order-taker, a big cost, just data processing," says Dennis Gaughan, research director for IT governance at AMR Research.

CIOs have already done a great deal of work cutting costs. But all too often the money they’ve saved has disappeared into the maw of the business, never to be seen again—at least not by IT. That’s why CIOs can’t just cut costs; they have to have a strategic plan to cut costs. And they have to leverage that plan to gain or maintain a seat at the organization’s strategic table. In that way, the cuts they make can be transformed from a way of slowly bleeding IT to death to a way of adding value to the company.

Cut, But Cut Smart

"A lot of the [IT] cost savings in the last three to four years have been accomplished by shrinking budgets," says Greg Bell, a partner in the information risk management practice at audit, tax and advisory firm KPMG. In most cases, IT cut costs without determining whether those efficiencies increased costs elsewhere, increased business risk or short-circuited a potential strategic initiative for the business. For example, the management team of residential real estate company Crye Leike Group asked CIO Gurtej Sodhi to consider outsourcing the company’s call center. Sodhi declined.

"My call center is one of the biggest advantages we have over our competition. The potential savings did not justify [outsourcing] it," he says. Sodhi saw the call center as the customer’s touchstone to the company, and he wanted to invest in it by taking better advantage of customer intelligence for cross-selling and targeted services. That’s hard or impossible to do with an external, outsourced call center, he says.

"CIOs may find themselves in a hole by not managing [cost cutting]," says James Kaplan, a partner at the consultancy McKinsey & Co. "Fortunately, we’re seeing in the last 18 months more strategic direction from the CIOs on cost cutting." That’s because optimism about future growth has turned the businesses’ priority from cutting costs across the board to building long-term efficiencies that will permit IT to focus on helping the business grow. "In 2002–2003, there was a need to reduce costs quickly," he says. That period, according to Kaplan, is over.

While CIOs will arrive at different conclusions about what costs to cut and how to make those cuts, there are several universally applicable strategies that Toole and other CIOs have found successful. They include making the IT costs of business technology demands clear to senior management so you’re not stuck with supporting unfunded mandates long-term, separating IT operations from innovation initiatives, and making the infrastructure—which Forrester Research says typically consumes 76 percent of IT budgets—both more efficient and less complex.

The implementation elements of a successful long-term infrastructure reduction strategy are deceptively simple: standardize as much as possible to reduce complexity; get rid of hardware, data and applications you no longer need; and understand the cost and value of delivering each IT service so you can determine what to outsource, automate or manage at the appropriate level of staff.

But while these elements are straightforward, translating them into action can be hard. That’s where your department heads and technology experts come in. With a clear strategy in place, they can choose the right solutions. And IT can then focus on delivering what the business really wants and needs, says Alex Cullen, principal analyst for IT management at Forrester Research, "not just be some general corporate overhead target."

Know the Value Before You Cut

To cut costs strategically, you need to understand your actual costs and the value of your various technologies, services and business deliverables. Otherwise, the cuts you make may degrade important business processes and reduce their value. A good way to clarify these issues is to seek expertise.

"Add a finance person to your staff to help you understand your costs and cost drivers," suggests Forrester’s Cullen. And be sure to make the costs associated with specific business initiatives clear to the business process owners so that they understand how much you’re spending to support them. That can help the CIO team up with other business managers to reevaluate the service levels they demand or the value of the IT they’re using and demanding. Essentially, this approach treats IT as a portfolio of services and resources. "This improves demand management, so the enterprise picks the right things to spend money on," says AMR’s Gaughan. "Portfolio management is a good approach for long-term savings," he adds.

PharMerica’s Toole used this approach, following the accumulated costs of each business application through the accounting ledgers, to figure out what his largest application support costs were and how they were accounted for in both business and IT budgets. (Hardware leases and purchases were his biggest expense, followed by software support and maintenance, then long-distance, local and data communications.) "We then made some attempt to calculate the value these expenses returned to the business," he says. This exercise uncovered significant waste in equipment leasing costs (mostly for old, unused or underused equipment). Not only was Toole able to reduce his leasing costs, he also got some rebates for unused equipment. But he also went further, citing the discovered inefficiencies as reasons to launch a more sweeping IT consolidation effort, getting rid of unnecessary servers, consolidating data and applications onto fewer servers where possible, and reducing special-purpose servers, applications and operating systems. That resulted in both equipment savings and lower labor costs, as less management overhead was needed.

Toole’s cost and value analysis also led him to stop outsourcing his "helpless desk." He applied the labor savings from the infrastructure consolidation to manage the help desk internally. Although his dollar cost didn’t go down, the quality of service went up dramatically. And that showed his company he could both drive fiscal restraint and improve service. Over time, that approach won Toole a separate IT innovation budget—a recognition that IT was not merely a service organization. And that in turn let Toole focus on building the right IT infrastructure (as well as applications and integrations) instead of just squeezing the one he inherited.

Other CIOs have benefited from similar cost and value analyses. For example, Crye Leike CIO Sodhi analyzes every IT infrastructure project through three lenses: project cost, the impact on productivity and competitiveness. Like Toole, he found many inefficiencies in the organization he inherited, including 28 percent in excessive costs for telecom circuits and PBXs, 25 percent wastage in server utilization, 30 percent wastage in storage and inefficient distribution of IT staff to regional offices. "My CEO still says that I’m the biggest spend in the company, but he knows it could be a lot worse if we weren’t as efficient as possible," Sodhi says.

To ensure that his company’s cost and value analyses are on target, John Von Stein has created an IT service catalog to benchmark unit costs against peers and research firms’ recommendations. The CIO at the financial transaction processor The Options Clearing Corp. works closely with the finance department on this effort. The result: "We have a good handle on the costs," Von Stein says. "And our business partners understand that if you put several straws in the milk shake, it’s coming out of the same pool."

Separate Operations from Innovation

With the costs and values understood, CIOs can separate their operations from their new initiatives. This not only lets the business understand the balance between the services it has come to count on and the services it may want to add, but also the long-term implications of making new demands on the infrastructure. "Remember that every project you did the year before goes into maintenance," says Forrester’s Cullen. Truly appreciating that cold calculation helps the business team comprehend the long-term implications of technology initiatives, and also helps ensure that the CIO is always on the lookout for efficiencies to make room for those new operational requirements, he says. The average company spends about 76 percent of its IT budget on maintenance, operations and support, Cullen notes, while efficient companies fall between 50 percent and 60 percent. (See "Flex Time," www.cio.com/020105, for more on the budget strategies that can make such separation successful.)

But the separation should not be just about budget lines. The separation also helps CIOs identify which staff and technologies are core to the business and which ones aren’t. By definition, innovation is core to the business, but that doesn’t mean everything else is not. Within the operations part of IT, the CIO needs to understand which aspects require special skills or focus, and which are routine. This analysis helps determine both where to target efficiencies and where to invest.

For example, manufacturer ThyssenKrupp Elevator discovered that it could safely outsource mainframe and AS/400 operations to reduce costs, but it could not outsource network management. That’s because the mainframe and AS/400 systems management is "fully stable, fairly repetitive and low-volatility," says CIO Jim Miller. But it made more sense to invest in internal network management skills since ThyssenKrupp’s 180 or so locations required intimate knowledge of the network connections and relationships among the locations, a level of ongoing focus that Miller concluded an outside vendor could not deliver.

Similarly, document-processing equipment manufacturer B¿we Bell & Howell concluded it could outsource desktop support but needed to reallocate some of the IT staff budget to work on its SAP ERP deployment. "We were heavily invested in resources for the infrastructure, which were not lined up to our strategic areas," recalls CIO Ron Ridge. Properly providing desktop support for the company’s 2,000 employees, 1,400 of whom are in the field, would have required a significant investment in help desk management systems, he says, yet what the company really needed was to build on its ERP deployment to help the business team improve productivity and increase revenue. Understanding the operational/innovation separation made the need to change the IT strategy clear.

By understanding which functions are strategic, ADP Employer Services CIO Bob Bongiorno has been able to increase the budget for IT staff working on new development efforts by 17 percent from 2005 to 2006, permitting growth from 575 to about 690 people, while keeping his overall budget nearly flat, rising just $1 million this year to $116 million. The extra money for new development efforts came from a variety of sources, including streamlining data center operations and reducing maintenance costs.

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