Lesson 2- Managing IT Costs

Lesson 2 is about the importance of managing IT costs. The article "How to Manage IT Spend" on the website cio.com, does provide the perfect introduction about the dilemma of managing IT costs.

"IT departments have traditionally been weak at controlling IT spend, let alone be able to explain the cost in the first instance to the business. So why is it so difficult to manage IT spend? Typically this is due to:

• The fragmented nature of IT. Spend is often incurred in many departments and business units with a varying degree of central control. This is often further exacerbated by spurious IT recharges. 

• An ever expanding IT environment. Demands on IT grow continuously. This results in increased cost. However, businesses often fail to distinguish what is a real cost increase (unit price), versus expansion of the IT environment (volume).

• Lack of financial skills. Typically, IT staff lack finance understanding and they are unable to talk the language of the accountants. 

As a result many businesses feel that IT is not properly managed. Businesses respond by cutting or "freezing" IT spend. This leads to frustration in the IT department and with an equal annoyance on the business side as the business feels that they need to "watch" the IT function as the "techies" cannot be trusted to make managerial and cost effective decisions."

McKeen and Smith (2012) list,  two types of IT budgets: fiscal and  functional IT budgets. These are the two main corporate processes IT budgeting .

Fiscal budget is the one prepared for the CFO--it breaks spending into capital expenditures & operating expenses. Things that can be claimed as a capital expenditure are controlled by the CFO & generally accepted accounting principles. Fiscal budget often does not correspond with the categories that IT leaders 

The important factors of overall IT spending levels:

• How much other firms spend: firms may use how much other org's spend to determine a percentage of revenue to spend on IT.
• Regulatory environment: legislation, st&ards, & professional practice determine what IT may & may not do &, therefore, place limits on IT spending.
• Number of competitors: a high concentration in an industry generally reduces the amount spent.
• Uncertainty: more uncertainty in an environment tends to lead to larger IT budgets.
• Diversification of products & services: firms competing in multiple markets will generally spend more on IT.
• Affordability: the better the org.’s financial performance & cash flow, the more it has to spend on IT.
• Growth: growing firms tend to invest more in IT.
• Previous year’s spending: IT spending does not generally deviate significantly from year to year.

The most common problems occur by basing corporate IT spending on what other similar firms spend. It could inhibit competitive advantage & increase similarity with other firms. It also does not provide any indication of how well IT is using its funds and does not address IT’s ability to use IT strategically.

The are two different IT budgets, centralized and decentralized. Boths offer benefits and disadvantages, depending on the individual firm and their resources.

Benefits - A centralized IT budget

• provides the most control over the IT budget so it can be streamlined through st&ardizing the IT infrastructure & sharing services.

• provides a better funding model for enterprise-wide investment.

Disadvantages - A centralized IT budget

• becomes a larger target at budget time & attracts increased scrutiny.

Benefits - A decentralized IT budget

• allows IT costs to be allocated to the greatest users of IT.

Disadvantages - A centralized IT budget

• leads to “gaming” between biz units.

• creates less incentive to participate in & fund enterprise-wide initiatives.

• allows duplication of IT services across biz units.

• creates biz unit resentment of allocations that they may feel they have little control over.

Finally, in order to ensure and implement effective budgeting practice, IT leaders and CIO should follow the following steps:

1. Appoint an IT finance specialist
   Having an IT finance specialist also helps the IT group better underst& their costs & drivers. This also helps to ensure that IT speaks the same language as the CFO & finance group--this gives the IT group a better footing for justifying IT costs & value. 
    
2. Use budgeting tools & methodologies
   Ensuring the appropriate tools are in place supports & enables good IT budgeting. These tools should help tie budgets to overall corporate financial reporting, connecting IT budgets to corporate strategy, resource strategies, & performance metrics.  
   
   
3. Separate operations from innovation
   ensures that each one has appropriate visibility. This allows IT leaders to better control their operations budget, have a more accurate accounting of each, & ensure appropriate levels of funding continue to get put into strategic initiatives.  
   
   
4. Adopt enterprise funding models
   Enterprise funding models ensure that funding is available for enterprise-wide IT initiatives. Otherwise, various biz units must agree to fund these initiatives, & this can be very difficult to achieve. Decentralized IT budgets can stifle innovation  
   
   
5. Adopt rolling budget cycles
   IT budgets & plans should be reviewed more than once a year. Adopting a rolling budget cycle with more frequent reviews will ensure that these plans more adequately incorporate changing information.

References

Austin. R.D., Nolan, R.L. & O'Donnell, S. (2009). The Adventures of an IT Leader. Boston: Harvard Business School Publishing Corporation. 

How to Manage IT Spend. (2011). Retrieved April 23, 2016, from http://www.cio.com/article/2407252/financial-software/how-to-manage-it-spend.html

McKeen, J.D. & Smith, H.A. (2012). IT Strategy: Issues and Practices (2nd ed.). New Jersey: Pearson Education, Inc.