Creating value by optimising IT
Organisations have increasingly become reliant on techology to create and maintain a competitive edge due to the emergence of digital transformation, smart phones and the cloud. As a result, many organisations are actively seeking out new ways to better leverage their finite IT resources to generate the most value for their business. The increasing demand for techology services has created an environment where business units and internal stakeholders are constantly competing for a limited supply of IT resources, while struggling to align allocated IT infrastructure with business strategy.
The challenge of balancing supply and demand while creating business value has lead to the formation of IT Financial Management (ITFM), a framework consisting of best practices and processes that enable organisations to optimise IT services and related expenses. In recent years, the proliferation of ITFM principles has driven the need for better systems and analytics designed to help organisations manage technology resources and spend.
The Power of Business Value
Before the introduction of ITFM, many IT departments were viewed as a roadblock to necessary strategic initiatives such as digital transformation due to budget and resource constraints caused by limited insight into how IT infrastructure impacts and aligns with business services. In the past, the IT function was structured as a siloed cost center that operated in a vacuum completely disconnected from the rest of the organisation.
Organisations have recently recognised the correlation between IT infrastructure and the business services that drive customer outcomes and profitability. This new perspective has placed IT leadership at the forefront of strategy and innovation, while cultivating a partnership between IT and the business because technology platforms and services are directly tied to the quality/cost/timeliness of business products and services.
The power of ITFM lies in an organisation’s ability to gain financial transparency, understand the factors driving resource usage, and align demand for IT infrastructure with strategic initiatives. The true value of IT is unlocked when it provides your organisation with enhanced scalability, operational flexibility and financial agility.
Getting the foundations right
Aligning IT services to business capability and business process
The ability to shape resource demand and optimise spend is tied to your organisation’s understanding of how IT services are related to business capabilities. In order to create this correlation you will need a well-defined taxonomy that shows the relationship between costs, infrastructure, applications and business services that provides enough transparency to allow IT to accurately calculate unit costs at the following 5 layers:
Leverage and refine the data stored in your existing IT Service Management systems, Application Portfolio and Business Service Catalogue to establish the relationships between infrastructure devices, applications, internal services, business capabilities and initiatives. ClearCost connects to your existing systems and organises your data to create the necessary relationships and automate unit costing.
Understanding business demand and needs
Initiating the business conversation between IT, business units and stakeholders early in your ITFM journey is essential to fully understand the needs, concerns and potential roadblocks. This will also help establish transparency, consensus and buy-in across your organisation. Engaging with business stakeholders early will allow your ITFM function to understand current demand, establish a baseline, identify priorities, create governance and develop metrics that align with business strategy. All parties involved should have the same vision for IT strategy to ensure that IT delivers value to the business. All business unit feedback should be collected on a regular basis to ensure that alignment exists throughout every step of your journey.
“ITFM is greenfield practice for AGL, which required a partner who could bring the tools, processes and managed services to help us grow and mature this capability. ClearCost demonstrated professionalism and experience dealing with a changing set of requirements from AGL and complicated financial structures. We are already seeing great results, not only commercially, but with improvements in service and business partnerships.”
Technology Relationship Manager,
Supplier Management – Technology AGL
5 Steps to Optimising Technology Spend
IT Leaders have been faced with increasing pressure to improve spend transparency, reduce wasted resources, and locate funding for ongoing digital transformation efforts. In recent years IT Departments have shifted from being viewed as an Expense Centre to being recognised as a vital business partner offering a broad portfolio of technology services that the entire organisation consumes. This new vision of IT has required leadership to better understand how resources are being used and identify which business functions are driving consumption.
We have formulated a five-step approach to cost optimisation by leveraging our first-hand experience gained from guiding our clients through their ITFM journey. Each step should be utilised sequentially as your organisation matures its ITFM capabilities.
In this eGuide, we highlight Step 4 on the path to optimising technology spend: Shaping Business Demand
Shaping consumption with supply & demand
Traditionally technology resource consumption has been shaped by using headcount, percentage of revenue and other indirect inputs to allocate IT spend to departments and business units. This approach often creates an adversarial environment between IT and the business due to budget constraints within the IT department. Implementing a showback/chargeback process transforms the conversation from “no, we can’t do it because we don’t have the money” to “yes, we can do it, but it will cost $x.”
An oversimplified allocation model for shared technology costs can initiate a better conversation between IT and the business but it will not provide enough insight to understand which departments are responsible for driving overspend due to increased demand. The charge will be visible on the department’s P&L as a line item, but it won’t provide enough transparency to determine how the department’s resource consumption is contributing to overall IT spend.
To show the value IT is delivering to your business and increase transparency into what is driving IT spend, your organisation will need an accurate cost recovery process that shows the cost components of IT services and the related department/business unit level consumption. This level of granularity will fortify your Bill of IT with the transparency necessary to drive spend accountability within business units and create an understanding of how business unit resource consumption impacts the bottom line.
Popular methods for sharing IT spend
Showback and chargeback methods are used by world-class corporations to boost financial agility, enhance cost transparency and build a better balance between supply and demand for technology resources.
Let’s explore each method.
Allocation - Simple Method
The initial step for sharing IT costs within most companies is to allocate using a simple method that involves spreading costs based on a metric such as headcount, amount of revenue or server count. The organisation spreads costs based on the agreed upon metric and uses the result to create business unit budgets and calculate the actual IT spend.
This approach can cause spend to be under/overallocated to business units since the metric used to spread costs most likely won’t be aligned with actual IT resource consumption. Simple allocation isn’t designed to provide the level of granularity needed to align spend with resource demand and can impact business units unfairly while creating the perception that IT costs are uncontrollable.
Too “High-level” for shaping demand
The most basic allocation strategy utilised by companies is an even spread approach that charges each business unit an equal amount. This method allows for full recovery of shared IT costs, but it doesn’t consider the varying levels of demand for IT resources within each business unit. Using the even spread approach can leave some business units struggling to manage their technology consumption since actual usage isn’t factored into their portion of the shared IT expense.
Many companies spread their IT spend using the percentage of headcount or revenue that business units contribute to the organisation. This methodology is slightly better than the even spread approach since it uses these inputs to account for the varying sizes of departments. Spreading costs using revenue or headcount helps allocate spend more proportionally but it doesn’t consider the disparate IT resource needs of each business unit which can vary based on their intended purpose. For example, a large sales business unit may have a higher headcount but lower technology demand since sales personnel are more focused using soft skills to generate revenue in the field as opposed to leveraging applications and platforms to perform their role effectively.
A more advanced allocation method would be to use the server count attributed to each business unit to spread costs. This method helps align shared costs with the IT infrastructure that each function uses but it still doesn’t provide the level of granularity needed to optimise spend since it leaves out the amount of computing power (CPUs) and capacity that each server provides.
% of headcount / revenue
% of total servers
“The ClearCost solution exceeded all of my expectations. We were looking for a simple method to collect IT-related costs for application, infrastructure, and program support for our clients. Within the first year of implementing ClearCost, we could demonstrate the true expense of providing each service, and we could invoice each cost appropriately.”
Director of Information Technology, Department of Public Safety (US State)
Cost Optimisation Rating
The rating table provides a quick glance at the effectiveness of each method for sharing IT costs. The simple allocation method requires minimal effort and allows IT spend to be fully recovered.
This approach provides limited cost transparency and most likely will not drive spend accountability or enhance business conversations between IT, Finance and business units. Business units will have little to no control over their IT budgets and may view IT as a roadblock instead of a business partner.
Showback (Unit Cost* Consumption)
The showback method is a preliminary step to creating a defensible Bill of IT. This approach provides additional transparency by incorporating two elements used to shape demand, the fully-burdened unit cost of IT services and the amount of each service that business units consume. Showing business units the cost and current consumption of the services they use will make them aware of their individual impact on IT spend and create accountability for their portion of technology expenses.
Showback is frequently used to generate organisational awareness of how business unit technology consumption drives overall IT spend. Implementing showback before chargeback will eliminate future roadblocks since it will allow IT budget owners to clearly understand their costs and dispute any discrepancies prior to being billed for IT services.
Once business units are aware of how much IT services cost and their related consumption, they will have more of an incentive to help the organisation optimise spend and reshape usage to align with higher priority initiatives. Showback also helps to shift the business conversation from a focus on the components that comprise a service to overall service demand since the unit costs are fully burdened.
The showback method fosters better communication between IT and the business by presenting technical and financial data in a format that is more palatable to business units (example: cost per gigabyte of RAM, application cost per user, IT onboarding cost per new hire).
Setting up your showback process
Organising for showback:
Cost Optimisation Rating
The Showback method is more complex than the simple allocation approach since it requires a well-defined service catalog that is associated with cost drivers such as labor, infrastructure and data center expenses. Costs are more accurately allocated to business units by leveraging consumption as an input to calculate IT spend which brings awareness to the relationship between usage and financial impact. Cost recovery can vary based on whether showback is used as a basis for IT billing.
Chargeback (Unit Cost* Consumption)
The chargeback method utilises all the features of showback and enhances the functionality by adding a recovery method, service tiers, and a recurring bill that is distributed to business units. Cost recovery creates an incentive for business units to manage the consumption more efficiently since they are held accountable and invoiced for the IT services they consume. The service tiers allow business units to select the level of service that is the best fit for their needs and provides them with a lever to pull in order to manage their IT bill.
In order to successfully implement chargeback, it is essential for the business units to clearly understand the components that drive their Bill of IT, service cost and consumption. Creating a consensus on the chargeback methodology will eliminate push back from business units once the Bill of IT goes live.
The Bill of IT needs to be easy to comprehend and should be accompanied by analytics that will provide the business units with enough granularity to identify the cost components responsible for driving their charges. This will empower budget owners to modify their consumption to reduce unnecessary spend and accurately forecast the financial impact of future demand.
Chargebacks should be distributed to business units via the Bill of IT on a recurring basis, e.g., quarterly, monthly, and need to be logged on the company’s G/L system as an actual charge. The financial consequences of inefficient resource consumption will help promote optimisation and accountability at the business unit level.
Before charging business units for consumption, organisations should broadcast the Bill of IT publicly or provide showback to bolster buy-in, allow for discourse, and ensure that the charges are clearly communicated.
Shape demand using service tiers
Segmenting IT services into tiers gives business units the opportunity to choose the correct level of consumption for their needs. Implementing a well-defined set of service offerings will improve the clarity of the Bill of IT and reduce the need to create customised solutions which can waste valuable technology resources.
Service tiers provide business units with options that can be used to optimiSe spend and pay for the level of consumption that is the best fit. Tiered services also enable IT organisations to reduce unused capacity caused by over-allocating IT infrastructure to business units that have a lower demand.
As your organisation defines service tiers it’s important to avoid confusing business unit stakeholders by offering too many options. On the other hand, you should offer enough choices to avoid requests for customised configurations. This same approach should be used when transitioning to a SaaS, PaaS or IaaS provider since they offer a multitude of service offerings. Having the appropriate amount of service options will allow your organisation to forecast and control demand for resources more effectively and enable other functionality such as benchmarking consumption internally or against industry peers.
Organising for chargeback (Cost * Consumption):
Cost Optimisation Rating
The chargeback approach has a higher level of complexity than showback since it requires clearly defined service levels and has a tangible financial impact on business unit budgets. The benefits of chargeback vs showback is enhanced accountability, transparency and the ability to influence resource demand.
“ClearCost is obviously a mature product with a large feature set. The transparency that it is providing is allowing us to have fact-based conversations with our business units about the real cost of service.”
Chief Information Officer, Fujitsu Australia
Chargeback (Fixed Rate)
The fixed rate chargeback approach is a great option for organisations that want to shape demand to achieve a desired consumption pattern instead of letting business units determine demand and consumption. Your IT department would be able to drive the adoption of a new service by offering a more favourable rate than the other available options. This would incentivise business units to migrate current consumption to the services and platforms that are aligned with your company’s technology strategy.
The power of rate setting lies in your organisation’s ability to price services intentionally to encourage an intended market behavior. A lower price for a comparable service or service level will always be more attractive than paying a higher cost for the same outcome. Conversely, paying a higher rate for a similar service won’t be appealing to business units and will direct their consumption towards other options that are more cost effective.
Be sure to consider the potential backlash from setting rates exorbitantly high or unfairly pricing your services in a way that will negatively impact specific business units. These business units may seek to supply their demand using shadow IT and impair cost transparency. It is always best practice to proactively discuss rate changes with the business to avoid dissent due to unfair pricing.
Once you agree upon the set rates you should keep them in place for a full fiscal year to allow for discussion prior to changing your cost structure and eliminate any surprise charges on business unit P&Ls. Since fixed rates can differ from actual unit costs you may not be able to fully recover IT spend through chargeback. It is recommended that your IT budget includes additional funding to account for overspend/underspend that can result from setting rates artificially. This additional funding can be used to reconcile any business unit overages or shortfalls caused by fixed rates.
Fixed rate setting strategies
There are different techniques you can leverage to set service rates. Each approach is tied to the maturity of your organisation’s ITFM function. In addition to ITFM maturity, IT should have good knowledge of how much third-party vendors charge for comparable services and service tiers. Your pricing will need to be competitive to deter the business unit end users from seeking the same services outside of your IT department.
It is also essential to understand internal market forces in order to set prices to levels that will change consumption behavior. There should be enough of a price difference to motivate business units to use the desired service over the alternatives. This is especially important when you are attempting to eliminate redundant systems and shepherd business units to adopt the tool of choice. Another technique is to provide a service at no charge to business units if it is necessary for compliance or security reasons.
This is a good place to start if you don’t have accurate unit costs in place. This rate can be based on industry benchmarks or managed service pricing (Ex. $3.50/GB of Storage)
Leverage your calculated unit costs to set fixed rates (Ex. $5/GB of Storage)
Cost with incentive/deterrent
Unit cost plus projected maintenance (Ex. $5.75/GB of Storage)
Enhancing Accountability and Transparency
The fixed rate chargeback method leverages the features of cost/consumption-based chargebacks and adds the ability to set fixed rates to encourage a behavioural change in the way business units consume services. Rates for services are structured to strategically promote or deter the use of specific services and service tiers.
Fixed rate setting strategies
Refining your showback & chargeback process can be time consuming if you are managing your data in spreadsheets or trying to customise your financial ERP system to deliver Bill of IT. Many companies struggle with repeating the same allocation and service pricing process every month and dedicate an overwhelming amount of resources to manage this function.
Our ClearCost Bill of IT software delivers a transparent and defensible bill to your business partners, translating costs and consumption in simple terms that everyone understands. Our Bill of IT platform has been used to handle the most complex IT billing issues within world-class organisations globally.
Shaping Business Demand
We deliver great outcomes for our clients.
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Shaping Business Demand