IT Value: What It Really Means

Here in December, some of you are sighing with relief that your budget process is over. Others are down to the wire and still haggling.

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Value and the CIO Role

But all who remember how painful the budget process was understand that a CIO’s negotiating power is, to a great extent, determined by how well clients understand the value they get for the money. There are three components to the concept of value: understanding exactly what IT delivers, believing that the cost is fair and evaluating the contribution of those deliverables to the bottom line.

Let’s look at what we can do to build clients’ understanding of the value of IT.

What Do We Get for the Money?

In many cases, clients’ poor perception of IT value is as basic as not understanding the full bundle of products and services that IT delivers.

Sure, everybody knows that IT delivers essential services like desktop computers, network services, applications engineering and applications hosting. But that sounds simple. Many clients don’t understand why IT has to cost so much just for that.

The problem is, many IT departments don’t clearly define the specific products and services they deliver for a given level of funding. Typically, there’s a lot more in that bundle than clients know. When the specifics are defined, clients come to understand why IT needs the budget that it does.

Explicitly defining IT’s products and services also counters the less-honest outsourcing vendors who glibly offer to do 50 percent of what internal staff do for 80 percent of the cost, implying a 20 percent cost savings. One can see the fallacy in that claim only if IT can clearly define all the products and services that it delivers.

There are two steps required to understand the exact list of products and services that the IT budget pays for.

First, IT must publish its product and service catalog. The catalog must be comprehensive, and at a level of granularity that portrays specific client purchase decisions. It’s not sufficient to define high-level categories, which don’t portray all the many things IT does within each category. For example, “e-mail” is too broad. A fully defined catalog would distinguish a basic e-mail account, extended storage and BlackBerry forwarding as three distinct services.

Second, IT must define exactly what subset of that catalog the budget pays for, and in what quantities. For example, it might forecast the cost of basic e-mail for everybody, extended storage for only the customer service department, and BlackBerry forwarding only for executives. And it might forecast the cost by application for each major project, for necessary repairs and patches, and for discretionary enhancements. Breaking out the budget in such a way makes it clear exactly what IT delivers (and, by implication, what it doesn’t).

Said another way, the budget must forecast more than spending by expense code (such as travel, training or licenses) for each manager. It must include the full cost of all clients’ purchase decisions. I call this a “budget by deliverables.”

Is the Price Fair?

The next question related to value is, “Am I getting a good deal? Is the IT department delivering its products and services at a cost that’s competitive?” Answering this question requires benchmarking against the market.

It’s not enough to compare the internal IT budget to other companies using high-level statistics like percent of revenues or total cost per desktop computer. This doesn’t take into account the unique configuration of technologies within the company, or the unique needs of the business. For example, your company may be spending more on IT because it’s using technology to gain strategic advantage, not because the IT department is more expensive.

The only way to demonstrate that internal IT is a good value is to compare the cost of products and services, like to like. IT must be able to answer the question, “What would this exact bundle cost if bought from vendors rather than staff?”

The easiest, but least accurate way to assess this is to benchmark the entire bundle all at once. This involves adjusting industry average IT expenditures based on the attributes of your bundle that make you unique, such as the number of servers, users and transactions.

There are two problems with this approach. First, it cannot distinguish an inefficient IT department from a highly efficient IT department in an overly complex business. Second, the data is not actionable; it does not tell you which IT product lines need cost reductions. A far more accurate and useful way to benchmark IT is product by product, based on unit costs. To ensure fair comparisons with the market, IT should calculate rates for each item in its product and service catalog (“service costing,” as ITIL puts it).

All costs (including all indirect costs) must be amortized into those rates. It’s misleading to allocate fixed costs, and then claim that rates based on only direct (or marginal) costs are competitive.

But be careful not to amortize into rates any costs that are, in fact, entirely separate from the delivery of those products and services. One example is corporate-good services like policy, standards, oversight and technology advice (like the consumer report for PCs). These are services that have their own price, and should not be amortized into the cost of client products and services. Another is capital for IT-owned infrastructure. These costs should be depreciated, and only the depreciation expense goes into rates.

Value and the Bottom Line

The final question of value is at the higher level: Does IT contribute to business value? To optimize its contribution to the bottom line, IT must install processes that ensure two things: that the enterprise is spending the right amount on IT, and that the IT budget is spent on the right things.

What is the right amount to spend on IT? The answer is certainly not found in industry averages of what others are spending (following the lemmings), nor in what was spent in prior years (which may be wrong).

In technical terms, the optimal amount to spend on IT is determined by funding investments (from best to worst) until the marginal internal rate of return drops down to the weighted-average, risk-adjusted cost of capital. In simple terms, the enterprise should fund all the good investments, and no more.

Obviously, “keeping the lights on” is a very good investment. Without it, the enterprise would grind to a halt. Beyond that, services and projects alike should be scrutinized to be sure they pay off.

IT, in isolation, cannot calculate the ROI of its products and services. Only clients can vouch for the value they receive from their IT purchases.

What can IT do? There are two things.

First, IT can ensure that clients are in control of what they buy and are accountable for spending the IT budget wisely. This means implementing a client-driven portfolio-management process.

Note that portfolio management is far more than rank ordering projects on an unrealistically long wish list. Clients must understand how much is in their “checkbook” (a subset of the IT budget), and what IT’s products and services cost, in order to know where to draw the line. That is, they must work within the finite checkbook created by the IT budget as well as understand the deliverables that they will (and won’t) get. Thus, true portfolio management is predicated on the above steps of defining IT’s catalog, costing it, and presenting a budget in terms of the cost of its deliverables. Once all that is done, an effective portfolio-management process can be implemented.

Second, even if clients know the costs of their purchases and are working within the limits of their checkbook, they’ll make better purchase decisions if they understand the returns on technology investments. IT can help clients estimate ROI of their proposed purchases. The cost side of the ROI equation was handled by calculating a budget by deliverables and rates. The remaining challenge is to quantify the benefits. Cost-displacement benefits (which include both cost savings and cost avoidance) are easy to measure. The real challenge is measuring the so-called “intangible” strategic benefits.

One Step at a Time

In summary, the question of IT value is fully addressed when:

1. IT has defined its product and service catalog in detail, associated all its costs with its products and services, and calculated rates that can be compared with the market.
2. Clients understand exactly what they’re getting for the money spent on IT, and indeed can control it by deciding what they will and won’t buy from IT.
3. IT can help clients assess the value of their IT purchases by measuring the benefits.

These three things are presented in order. The catalog must come first, and the costing must come closely on its tail (ideally through an integrated business planning process). This first step alone may settle questions of value in many organizations.

Next, a client-driven portfolio management process can be implemented, one predicated on knowing the costs of all of IT’s products and services, and how much of IT’s budget is available for clients’ purchases (the checkbook).

Finally, as clients grow in their ability to manage the IT checkbook and begin looking for ROI calculations to fine-tune their judgments, IT can offer help with strategic benefits measurement.

You can read another version of this article on consultant N. Dean Meyer’s website with links to other Beneath the Buzz columns, relevant white papers, books and other resources. Contact him at dean@ndma.com.