By N. Dean Meyer\u201cWe\u2019ve got to manage clients\u2019 expectations.\u201d I hear that phrase from CIOs all the time, and I hate it. It evokes the image of manipulating others\u2019 feelings. But the problem is real. Clients generally expect more of an internal service provider like IT than the organization can deliver with its limited resources. Will, the CIO in a not-for-profit health-care provider, got through the budget planning process, and as usual, the watchword was \u201ccut!\u201d He ended up with fewer resources and even more \u201ckeep the lights on\u201d operational work (thanks to last year\u2019s projects). That left less than ever for new projects. But, of course this reality didn\u2019t stop clients from wanting new things. And lots of them! Thus, the gap between clients\u2019 demands and available resources was larger than ever. Will figured this was a good time to think about managing clients\u2019 expectations. \n\nSource of Unrealistic ExpectationsWhere do unrealistic expectations come from? It\u2019s simple: Like the proverbial kid in a candy story, clients want everything because they don\u2019t have to pay for anything. When price is zero, demand approaches infinity. So the kids clamor for everything. Daddy says no because he knows the limit of his checkbook and is aware of other competing demands. And of course when Daddy says no, Daddy is the villain. Similarly, Will knew the limit of his IT organization\u2019s resources. And whenever he said no, IT was the villain. Realizing this, Will set up a governance process, foisting the villain role off on a committee of executives. What did this accomplish? Clients still wanted more than IT could deliver, and all the executive committee could say was, \u201cHere\u2019s our sense of priorities. Now do all the high-priority items.\u201d Thanks to the committee, IT was now looking bureaucratic and unresponsive, and Will still found himself grumbling about managing expectations. \n\nThe Simple SolutionThe key to solving the \u201cmanaging expectations\u201d problem is found in market economics. Essentially, give the kid in the candy store an allowance and let them buy whatever they want. In corporate terms, clients need a sense of how much is in their checkbooks and what everything costs. I\u2019m not talking about chargebacks. A fee-for-service internal economy is the most advanced and most challenging form. But chargebacks aren\u2019t necessary to make market economics work within corporations. Two ingredients are necessary: a defined checkbook which clients own and manage; and prices for everything IT sells. With these two ingredients, IT can establish a non-bureaucratic, client-driven portfolio-management process. Then, clients will never expect more than they can afford to buy. Sure, they\u2019ll want more. We all want more than we can afford. But we don\u2019t blame the store when we can\u2019t afford everything in it. Clients will come to understand that the limit is the corporation\u2019s spending power, not in the IT organization. \n\nClient CheckbooksThe first ingredient in this systematic solution is a well-defined checkbook, handed over to clients to manage. By \u201ccheckbook,\u201d I don\u2019t mean cash. Clients only get real money if IT has implemented chargebacks. If you don\u2019t charge fees for services, the checkbook represents a claim on IT resources. Think of the IT budget as a \u201cpre-paid account\u201d\u2014money put on deposit by the corporation in order to buy things from IT all year long. Some of that budget should be managed by IT. The rest goes in the clients\u2019 checkbook. Specifically, there are two subsets of the budget which should be managed by IT rather than clients. One subset is funding for \u201ccorporate good\u201d activities, which pays for services that IT does for the corporation as a whole, which competitors (like outsourcing vendors and decentralized IT groups) don\u2019t have to do. It includes things like policy coordination, architectural standards, \u201cconsumers report\u201d style research like on PC configurations, and participating in non-IT tasks like corporate committees and community-action programs. (It does not include mass-market commodities like desktops, interconnectivity and e-mail, which are services to clients.) \n\nThe other subset of the budget that IT should manage is one-time funding for improvements in the IT organization. This includes both capital and operating expense to fund infrastructure (anything that\u2019s capitalized and depreciated), start-ups of new lines of business, and other major organizational improvements. Think of it like a loan from the bank, paid back (in some cases) through depreciation. The rest of the IT budget belongs to clients. It covers all their ongoing operational services (the \u201ckeeps the lights on\u201d activities) plus new projects. This portion of the IT budget must be isolated, and then turned over to clients to manage. There are various types of client checkbook management processes. Clients may manage their checkbook with a corporatewide committee, or it may be divided among the business units and managed locally. \n\nPricesOnce clients own a checkbook, they need to know what everything costs\u2014the second ingredient in systematically managing expectations. Clients need to know the cost of ongoing services, so they understand where much of their checkbook is going and have an incentive to shut down less-valuable services to free up resources for new things. And they need to know the cost of all the new projects and services they might want. It\u2019s critically important that prices represent the true, full cost to shareholders of each purchase decision. Anything less will cause clients to buy more than is economic. Worse, with marginal-cost pricing, internal support functions won\u2019t be able to grow as the IT business grows, and the \u201cmanaging expectations\u201d problem will crop up again in a different spot in the IT organization. (The pitfalls of marginal-cost pricing are described in detail in my book, The Internal Economy.) Every product and service should be priced at a rate that includes all direct costs plus a fair share of indirect costs. Indirect costs include: \n\nThe cost of staff\u2019s \u201cunbillable\u201d time for sustenance activities like their own training, new-product research and client relations. External-indirect expenses to train and equip staff and to support the infrastructure. Internal-indirect expenses when one IT group \u201csells\u201d its services to another IT group; for example, infrastructure engineers sell upgrades to the operations group, a cost which is spread over all the services sold by the operations group. Overhead that\u2019s spread across the entire IT organization. The proper name for this is activity-based costing. There are many challenges in making ABC practical. Two key challenges are: First, to define each IT group\u2019s products and services, both those sold to clients and those sold internally. Second, to get all the indirect costs spread in the right places, without circularity (A sells to B, who sells to C, who in turn sells to A). \n\n\n\nSingle SolutionThe challenge of managing expectations comes down to two fundamental financial processes: budgeting and pricing. The budget must sort out how much goes in the clients\u2019 checkbook(s) versus resources to be managed by IT. And prices must represent the true, full cost of everything clients might buy. These are not really two separate things. You wouldn\u2019t want to quote a cost in the budget and then charge a rate during the year that adds up to a different number! Both budgets and prices should be developed by a single, integrated operational planning process. The planning process begins by identifying the lines of business within the IT organization. \n\nThen, each manager lists all the deliverables (products and services) he\/she might sell (internally and to clients) in the year ahead. This becomes the basis for a service catalog designed around clients\u2019 purchase decisions. These deliverables are prioritized, leading to a \u201ckeep the lights on\u201d pessimistic forecast and an optimistic growth forecast. Analysis includes the types of staff (employees and contractors) to be utilized, the billable-time ratios for each, the costs of each and of course direct and indirect expenses. In this process, managers agree on what they\u2019ll sell to one another and what overhead services they\u2019ll build into their prices. All indirect costs are carefully scrutinized by IT senior management. Then a budget is presented for deliverables instead of for cost-factors like compensation, travel and training. This leads to a rational discussion of what the corporation will and won\u2019t buy from IT in the year ahead. Already, clients know what to expect of IT. Furthermore, knowing what the budget is meant to pay for allows IT to sort funds into the various checkbooks, which is the basis for an ongoing, dynamic portfolio-management process. Finally, prices are extracted from this data-cube. This integrated operational planning, budgeting, and pricing process is the first step in a systematic approach to managing expectations. This process can be done either to prepare for the next budget cycle, or mid-year to reverse-engineer the current budget and set up the process ahead of the next cycle. In either case, expectations and resources will snap into alignment once results are communicated to clients. \n\nThe Systematic ApproachThe \u201cmanaging expectations\u201d problem can\u2019t be solved by lectures on IT\u2019s limits, nor by bureaucratic committees and approval processes. Only a systematic approach solves the problem in the right way, once and for all. The systematic solution is found in market economics and an integrated operational planning, activity-based budgeting and pricing process. \n\n Dean Meyer helps IT leadership teams design high-performance organizations. Author of six books, numerous monographs, columns and articles, he brings innovative systematic approaches to what others consider the \u201csoft\u201d side of leadership. Contact him at firstname.lastname@example.org or visit his website for information that can help you implement these ideas, or with suggestions for other buzzwords to analyze in future columns.