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March 24, 2010

Understanding value through cost modeling and data-driven analysis

Business growthIt's been a busy winter in the IT Financial Management world, and the spring is shaping up to be even busier. Companies are starting to awaken from the hibernation induced by the financial crisis, and are beginning to ramp up their IT spending -- rather than solely focusing on slashing costs, which has been the motto for the better part of the last two years.

During this forced hibernation period, many IT organizations lost considerable fat, and have emerged both leaner and hungrier. The "slash costs" mandate which has dominated the ITFM conversation for the last couple of years is changing to a new motto: "deliver measurable value."

This new perspective, which is becoming more and more prevalent, is a natural outgrowth of the lean years from which IT is emerging:

  • Many IT organizations slashed costs blindly across the board, only to find that key projects suffered, and the effectiveness of IT declined drastically. They want to avoid repeating these mistakes.
  • Many others were able to slash costs more successfully by doing it both at the project and operations level, and these organizations want to distill the positive lessons they learned into a more robust ITFM framework, and evaluate any new spending with those lessons in mind.

In either case, the ability to determine how much value each IT service or project is delivering, and to maximize that value, have become a primary focus. IT organizations are hungry for ways to show their business customers, in a tangible way, exactly how much value they deliver to the business.

So how do they accomplish this?

I am currently working on a project with a Fortune 500 multinational that finds itself in just this kind of situation. A recent Gartner benchmark showed that this firm's IT organization is quite lean, with most services delivered at costs that are below industry benchmarks. However:

  • their IT chargeback methodology does not reflect consumption, and some business segments end up subsidizing others;
  • there is no cost model tying service costs to a financial source, so the true unit cost of each service delivered by IT is not known;
  • the data sources are many, but they are scattered -- and there is no ITFM framework that unifies all this data from a cost management perspective.

What all this boils down to is -- there is no way to determine how value flows from IT to its customers.

We are in the process of organizing all of these existing data sources, developing a service-based cost model, and using this cost model to develop a meaningful consumption-based IT cost recovery methodology. This will result in an IT organization whose unit costs are well understood and transparent to the customer, which will in turn enable intelligent demand management and well-informed business decisions.

In going through this process there are three key insights to remember:Data-driven IT  

  1. To understand value, you must first understand cost. A brand new washing machine might be a great value at $200. It's not such a good value at $2000. Similarly, understanding how much it costs IT to deliver various services to the business is key to determining the value of IT to the enterprise. To be effective, any such cost model must be:
    • service-based, because IT is at its core a service organization;
    • consumption-driven, so that it reflects how customers actually use IT services;
    • and tied to a financial source like the GL or budget, to make sure it reflects reality.
  2. Be data-driven, not data-obsessed.Usage metrics and measurements, financial benchmarks, demand forecasts -- all these things are crucial to determining IT value. Reliable consumption-based metrics are key for developing a robust cost model, benchmarks are essential for understanding where improvement is needed, and demand forecasts are indispensable for effective planning. A data-driven IT organization is an effective one. That said, avoid taking this data obsession too far -- too much data, or the wrong kind of data, can lead your quest for IT value off track and cause more confusion than good. Be sure to keep the number of metrics in use relatively small, and focus on business-oriented metrics over technical metrics. The key here is to strike that delicate balance between simplicity and accuracy.
  3. Ultimately, an IT service is only as valuable as what its consumer does with it.When it's all said and done, IT is not an end in itself. It is a means toward enabling the company's core competency -- the widgets it sells or the services it provides. And this is exactly why cost transparency is so important. Once customers understand what exactly they are getting from IT and how much it is costing, they can evaluate their IT investments, and make informed business decisions on where to decrease their IT spend and where to increase it. In other words, they can manage their costs and maximize business value through intelligent demand management.

So if you want to gain some insight into the value that IT delivers to the business, make sure to build a service cost model, streamline your data sources, and work with your customers to develop demand management capabilities. This will put you well on your way toward a better relationship with the business, where customers view IT as a valued partner that enables the business.

Posted on March 24, 2010 | Permalink


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