Five IT Service Costing Best Practices for Complex IT Organizations

Five IT Service Costing Best Practices for Complex IT Organizations

The concept of allocating the cost of IT services (commonly called “IT service costing”) is not new. Organizations since the 1980s have been doing zero-based budgeting, activity-based budgeting since the 1990s, and portfolio management since the 2000s.

Today’s on-demand and pay per unit consumption business mentality present significant challenges to traditional IT organizations. This new on-demand pay per unit consumption mentality is forcing business leaders to probe deeper into the use and value of IT expenditures by asking questions such as:

  • What services do I use and how much of that service do I use?
  • Are my IT expenditures market competitive?
  • What is the value and business relevance of my IT expenditures?
  • Why aren’t there more bottom-line improvements and/or innovations stemming from my IT expenditures?
  • Are IT resources and the workload they manage complementing my business objectives?

Addressing these questions using traditional budget planning and forecasting methods is an insurmountable task, until now. Implementing automated IT service cost modeling software, though necessary, is not the final answer. It also requires some paradigm shifts in the thinking of CIOs in how to transform IT into a value-laden organization.

Here are some examples of how CIO’s must think and work differently:

All IT direct and indirect expenditures should be attributed to business units based on their consumption of IT services.

Business unit leaders should priorities of IT expenditures (i.e., the budget) based on the services they consume.

Map all IT expenditures to services, rather than to tasks and projects.

IT cost allocation rates are derived through a consistent and repeatable analytical budgeting process. As opposed to being developed outside of the budgeting process.

IT views itself as running a business within a business.

The following are five IT service costing best practices specifically for complex IT organizations.

  1. Map Costs to the BudgetThis best practice is the assignment of all direct and indirect costs to the delivery of the organization’s technology-based services. To accomplish this, you must allocate the service costs to each organizational entity based on their measured usage of services – not high-level drivers and formulas that loosely relate to usage. Doing this eliminates the controversy that business units do not have control of their IT expenditures. Adopting this best practice results in many benefits, such as improvements in:
    • governance processes,
    • customer relationships,
    • IT and aligned business strategies,
    • staff job satisfaction, and
    • organizational performance.
  2. Make Costs TransparentThis best practice maps costs and allocations to high-level services, rather than detailed physical assets. Also, it defines services in terms of units of service. This is the first step toward achieving full-cost budgeting and allocations. This requires that the IT organization begin thinking like business people that are running a business within a business. They create services that represent specific sets of related resources that may include personal computers, network devices and services, applications, staff support activities, and more. For example, some of the bottom line results are:
    • services are well documented and based on a consistent set of principles and metrics,
    • budget details are simplified, because costs are illustrated in terms of relevant services, and
    • service delivery processes and actions are improved, because IT service providers must think in terms of business services delivered rather than tasks – a paradigm shift.
  3. Measured Accuracy in Cost AllocationsThis best practice allocates costs based on each business unit’s planned use of services, and allocates showback/chargebacks based on their actual use of services. Accomplishing this requires that each business unit agrees to their assigned set of services that are available for their use. Adopting this practice results in fewer business complaints about unfair allocations. Why? Because the business unit leaders begin to clearly understand the relationship between their allocation and their set of consumable services. This frequently induces a culture of improved stewardship and frugality for both the IT and business organizations.
  4. Rates Are Derived from the Budget This best practice bases allocation rates on the total cost (direct and indirect expenditures) related to the delivery of the organization’s services established through the budgeting process. Traditional cost allocation methods determine rates outside of the budgeting process by aggregating expenditures based on cost centers or codes. Unfortunately, this approach does not facilitate service stewardship and frugality, nor does it support market cost competitiveness analysis, or improved strategic sourcing decision making that is required today. Given that you actively adopt the “Make Costs Transparent” best practice you achieve this practice by simply calculating the rate(s) and services unit costs that total their consumption — for both budget planning and forecasting purposes. Adopting this practice results in budgets that you carefully consider for their value to business units and their achievement of business objectives.
  5. Manage Business Unit ExpectationsThis best practice documents services and cost allocations to clearly identify what the budget does and does not pay for. This ensures that business unit IT service consumers don’t expect the unreasonable. Adopting this practice results in budgets that can be interrupted in terms of consumption/purchases of service. This practice allows you to properly prioritize and quickly resolve unfunded mandates either through budget increases or service availability and support trade-offs.

    KEDAR Information Technologies leveraged years of research, knowledge, and experience spanning large and medium sized public, private, and not-for-profit organizations in the development of a prescriptive, repeatable, SaaS IT service cost modeling solution called the Cost Optimization Service (COp-S™). The COp-S™ solution incorporates the above best practices and more, for complex IT organizations.

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