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Understanding and Managing IT Costs (Article)
Date: Nov-2008 Sector: News
“Most IT metrics efforts lack relevance to the business and are not well linked to business outcomes. They tend to be IT-centric and operationally focused on the underlying technologies, such as WAN availability or server downtime. It’s difficult for the business to understand how these measures relate to its objectives, and they provide little insight into the value that IT delivers. As a result, the business typically focuses on the one metric that they understand — the cost of IT and how to reduce it — and this lead s to a continuous cycle of cost reductions.” Five Essential Metrics For Managing IT”, Forrester Research, April 2008.
IT systems and applications are an integral part of almost every business and, as such, ensuring that they operate effectively and efficiently is a matter that is of interest to all Boards and investors. However, the technical nature of these systems means that it can be difficult for non-specialists to assess whether a company is spending too much, too little or the right amount on its information systems. Simply cutting costs is easy but it is important to understand where this represents good management and where it may be false economy, risking either business disruption or the creation or perpetuation of inefficiency in the business. If the business does not have good information systems it will be harder to understand how the business is performing or to see developing trends that may represent either opportunity or risk.
There are a number of elements to IT costs and they can be analysed in different ways. On one hand, these costs can be divided along simple cost categories such as staff costs, support and maintenance charges, hardware and software costs, personnel costs, third party support etc. In each of these categories it is possible to assess whether costs are appropriate for the nature and scale of the business, whether they are in line with market rates, what alternatives are available that may be more cost effective, etc. However, it is often the case in small to medium sized businesses that, even if there are IT staff in-house, they have limited experience outside the company and therefore may have little basis for comparison. There are no hard and fast rules for how much should be spent and on what but there are industry norms that can give an indication of what would be expected typically in any particular sector. This may range from as low as 1-1.5% of turnover to 20% or more, depending on the nature of the business.
Another useful way in which to think about IT costs is to consider what proportion of expenditure is going into maintenance activities, as opposed to investment, that can improve either top line or bottom line performance. Maintenance activities are, of course, important but by their very nature are rarely going to represent anything other than a cost and/or a means or risk mitigation; in general the approach should therefore be to achieve the necessary levels of service at the minimum cost. In this area, knowledge of what alternatives exist, how to specify service levels and good negotiation skills are important. However, true investment into IT generates improvement in business performance and should be expected to show a return just like any other investment. For any given level of overall IT spend, the higher the proportion that can go into investment, as opposed to maintenance activities, the better. The first step is to analyse the IT spend as either maintenance or investment and to track this over time. Very often maintenance activities consume an increasing proportion of spend, leaving less and less for investments that will improve business performance. When money is tight it is better to make savings on maintenance activities and preserve true investment spend rather than the other way round; the latter is an easier but much less beneficial approach.
Of course, for IT-related investments to be assessed it is essential to make a realistic and credible assessment of the benefits and this is an area in which IT projects have very often been poor, with rather nebulous benefits being claimed that cannot be measured after the investment has been made. Business ownership of the benefits being claimed is essential and no investment project other than those relating purely to IT cost reduction should have an IT manager as the sponsor. IT Managers must be responsible for performance in delivering the technical elements of an IT investment and business managers must be accountable for the realisation of benefits.
The whole area of IT project delivery performance has been and remains a concern for almost all businesses. Much research has been done in this area and over a period of 15 years there has been very limited change in what are very disappointing outcomes of IT projects. The seminal work done by the Standish Group in 1994 showed that less than 20% of software projects were completed on time and within budget; even those that were did not always deliver the full scope that was anticipated. A follow-up study in 2001 did not make for much happier reading. Given this poor record, it is essential that IT investments are well specified, that the benefits are clearly defined and measurable and that the staff responsible for delivering them have the right experience and expertise. Again, in small to medium sized businesses it is common that in-house staff have limited experience and may never have undertaken such a project before. Getting the right skills and experience on the project team can improve the chances of success and reduce the risk of time and/or cost overruns or even outright project failure.
In summary, every case is different but there are a number of guiding principles that Boards and investors should use to ensure that they understand and can make informed decisions about IT spend in their businesses: