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 all the products and services that IT delivers, and many IT departments don’t clearly define the specific products and services they deliver for a given level of funding.
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.
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 a comprehensive product and service catalog, at a level of granularity that portrays specific client purchase decisions. 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.
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.
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. There are two problems with this approach. First, it cannot distinguish an inefficient IT department from a highly efficient one 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.
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? In technical terms, the optimal amount 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.
There are two things IT can do.
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 “check book” (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 check book 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.
N. Dean Meyer is founder of business strategy consultancy NDMA.