By Jeff Relkin

This article is also available as a PDF download.

Building a better bottom line is just as important for an IT
department as it is for the whole organization at the enterprise level. Implementing
sound financial management within an IT framework is broader than simply being
more efficient. Many factors are involved: an understanding of the main drivers
of IT costs, aligning IT spending plans with overall business strategy, using
financial resources efficiently, viewing IT expenditures as investments and
having procedures to track their performance, and implementing sound processes
for making IT investment decisions.

Estimating what a project will
cost is only half the battle; controlling those costs during the project and
after delivery is equally critical. In this article, we examine some methods to
predict and manage costs, part of a sound basis for overall IT financial
management.

#1: Control
baseline costs

Nondiscretionary money spent
maintaining established IT systems is referred to as baseline costs. These are the “grin and bear it” costs, those required
just to keep things going. Baseline costs constitute around 70 percent of all
IT spending for the average organization, so this is a good place to start. These
costs tend to creep over time due to the addition of new systems, meaning there’s
less money available for discretionary project work. Worse yet, this creep
gives the appearance that IT costs are rising while the value derived from IT
investments stays the same or actually goes down.

Fortunately, baseline costs
can be easily controlled. Renegotiate vendor contracts, reexamine service
levels, manage assets effectively, consolidate servers, sunset older
applications, maintain a solid enterprise architecture, and practice good
project and resource management. By so doing you can lower the percentage of
the IT budget allocated to baseline costs and keep them in line, avoiding
problems with opportunity costs. Think of IT projects as an investment
portfolio; the idea is to maximize value and appreciation. Baseline costs are
food, clothing, and shelter; we have to spend the money but it doesn’t have to
overwhelm the budget.

#2: Acknowledge
hidden IT spending impacts

Gartner estimates more than 10
percent of corporate technology spending occurs in business units, beyond the
control of IT. Several factors contribute to increasing hidden IT spending:

  • Flat organizational models more difficult to
    rein in and control
  • Virtual enterprise structures ostensibly set up
    as nimble, agile organizational constructs but without regard for policy and
    procedure
  • Changing organizational authority where business
    unit managers are given (or take) responsibility for decentralized technology
    spending
  • Selective IT outsourcing, in which a business
    unit will independently decide it doesn’t need to participate in overall enterprise
    architecture to fulfill its departmental mission

The impact of all this hidden
technology spending can be profound and prevents IT from being able to control
project costs. Architectural pollution from rogue projects can delay change,
resulting in cost overruns and lost opportunities. Business unit-sponsored
systems eventually become the responsibility of IT, increasing the cost of
support and maintenance (there are those baseline costs again). Cultural biases
in business units may conflict with overall strategic goals, increasing costs and
resulting in the destabilization of information and knowledge. This is just as
important for small companies as well as large; fundamental business decision-making
is driven by solid information, and if we don’t have it we can’t do it.

#3: Understand
long-term application costs

As a
general rule, ongoing application costs are about 40 percent to 60 percent of
the original development cost for each year in an application’s life cycle. Sound
like a lot? These are the costs associated with application support,
maintenance, operations, software licenses, infrastructure, and allocated help
desk and operational staff. Controlling these ongoing costs is critical; as a
component of baseline costs, they’re necessary evils. Collect and maintain
information about all new development work underway throughout the entire
enterprise and actively participate in all projects as a value-added business
partner. Communicate effectively and relentlessly; report to senior management
anticipated costs both at the start of projects and at appropriate intervals
thereafter. Don’t forget to maintain a historical record of all costs.

#4: Understand
IT cost estimation truths

How
good an estimator of project costs are you? I’m sorry to disappoint you, but no
matter how good you think you are, you’re not that good. None of us is; your
crystal ball is just as cloudy as anyone else’s. This is the single biggest
reason IT projects have such a high failure rate. Remember: The cost of IT initiatives will typically
exceed original estimates by an average of 100 percent
.

Institutional
knowledge is lacking as to the result of major intitiatives, the advice and
counsel of IT is routinely omitted or ignored, and business process change
relies too heavily on IT ownership of those business processes. How often have
you been called upon to estimate, if not virtually guarantee, a project cost
before the scope has been fully defined?

As
an IT professional, whatever your role on a project, you must provide business
managers with parameters for setting funding expectations and force those
business managers to explain why their assumptions are valid. If you’re an IT
manager, track all major development efforts throughout the enterprise and
regardless of your role, participate in the creation of a knowledge base of
maintenance and support costs to drive future verifiable and credible
estimation. Don’t underestimate the future costs of maintenance and support and
whatever you do, don’t make the classic cardinal error: Do not, under any circumstances, pad budgets
in anticipation of an underestimation. Keep track of project costs as the
project unfolds and communicate, immediately and vociferously, the instant you
detect even the potential for an overrun.

#5: Leverage
current system investments

Applications,
purchased software, networks, infrastructure, and any IT investment should all be
regularly reviewed, at least on an annual basis, to ensure maximum value is
being extracted and that original ROI goals are being met. Start with the
original requirements and review them to ensure return on investment goals were
delivered. Examine changes in the business and review new requests to determine
whether they fit with the existing systems. Consider business reengineering. Review
embedded processes to determine whether they’re consistent with new
organizational models and make changes where necessary. Review vendor and
product features, making sure they still fit within the organization. Enterprise architecture
is organic; it’s not once and done. It changes over time. Keeping up with those
changes allows for adjustments either at the periphery or by making
modifications to existing components. This is an effective way to control
overall costs.

#6: Implement
short-term cost cutting measures

Often we can control costs by
putting in place tactical solutions. Short-term thinking can also be an
effective tool in project cost estimation, in that it focuses us on the details.
Getting from New York to Tokyo involves a fairly long flight, but we can’t
forget that we still have to figure out how we’re going to get to the airport
to begin with.

Try to postpone capital purchases
as long as possible. This may not only provide time to negotiate better costs,
but an idea for a less expensive solution may present itself after the project
has begun. Always control project scope. Come to agreement as quickly as
possible with business unit customers and sponsors as to the overall project
scope and put that in writing. Have an effective change management process for
the inevitable “just one more thing” discussions, which will limit or postpone
until after project delivery the single biggest reason for cost overruns.

Try to control human resource
spending. There are only two reasons to use external consultants–to fill a
knowledge gap (we don’t know how to do something) and to fill a resource gap
(we have too few to complete the project on time). Negotiate the best possible
rates and where possible, use fixed-price agreements rather than T&M (time
and materials).

#7: Implement
long-term cost cutting measures

Be tactical, but don’t forget to be
strategic at the same time. Make sure there’s an enterprise architecture; it’s
hard to put the puzzle together when you have no picture on the front of the
box to go by. Eliminate duplicate processes and systems, eliminating
unnecessary costs in the process. Reprioritize and rejustify
all IT projects on a regular basis. Just because something made sense in
January doesn’t mean it still does in August, so why waste the budget? And
outsource selectively. These are the costs that typically are the most
controllable yet too often lead to the highest cost overruns.

#8: Implement
pricing and chargeback mechanisms

I
once worked for a CIO at a Fortune 500 company who decided an internal
chargeback process was needed to make business units more accountable for
technology costs. He successfully implemented the new approach and was credited
with saving the corporation many millions of dollars. He was also fired,
because this approach is the one most fraught with political peril.

Absent
a chargeback mechanism, business units tend to look upon IT as a giant free
toystore. Put one in place and those same business units feel free to go to the
outside to get more competitive technology pricing, and IT loses control and
becomes marginalized.

If
your company is going to consider this, there are ways to achieve both goals:
making the business units accountable and maintaining central technology
architectural control. Internal IT must be competitlve with external service
providers. Periodic benchmarking exercises are key. Don’t underestimate the
substantial resources needed to effectively administer chargeback mechanisms to
ensure that business units have all the information they need and no one feels
at a disadvantage. IT must have a clear understanding of all costs and manage
the demand appropriately. Use client satisfaction surveys and service level
agreements (a good idea no matter what the circumstances) and always show a
balance between costs and benefits.

#9: Use
governance to drive IT investment decisions

Too
many organizations fly blind, with little synergy between IT and the business. In
most organizations, IT is a discretionary expense center; there’s a fundamental
framework (baseline costs again) but most, if not all, of what’s required
beyond that isn’t necessarily mission critical.

Enlightened
organizations understand that IT is a value-added strategic business partner,
and a successful collaboration between IT and the business drives significantly
increased stakeholder value. Establish, or if one exists become a participant
of, a strategy council to examine enterprise-level issues of strategy,
politics, priorities, and funding. Set up a business council to define
priorities, oversee projects, and measure (and communicate) project success
across business units. This group must, of course, have the courage to cancel
projects when that becomes necessary; not everything that starts must finish. Put
together a technical council to develop guidelines and principles for
technology standards and practices. These are three very different
organizational constructs, and while there may be some overlap in terms of
participation, the mission of each is mutually exclusive.

#10: Quantify
the value/benefit proposition for IT investments

Why
do we do what we do? That’s not an existential or rhetorical question. IT exists
to provide value, to participate in the achievement of organizational strategic
goals. How can we prove we’ve done so? Just because we’ve built a thing, that
doesn’t mean much. Does the thing work? Does the thing provide value? Is that
value measurable and consistent with the corporate mission?

Some
quantifiable benefits of IT work can be improved operating efficiencies,
enhanced personal productivity, enhanced decision quality, and/or enabling or
supporting organizational strategic initiatives. What’s most critical is to ensure
the credibility of any measurements used to justify IT investments and provide
after-the-fact valuations. You may be working on a project that will reduce a
process from five person-days’ worth of work to two. Does that mean three
people are going to be fired, with the resulting compensation cost saving
attributable to your project? Probably
not. Those folks will most likely be reassigned, so don’t take credit for
expense reductions that aren’t going to happen.

Jeff Relkin has 30+ years of technology-based
experience at several Fortune 500 corporations as a developer, consultant, and
manager. He has also been an adjunct professor in the master’s program at Manhattanville College. At present, he’s the CIO of the
Millennium Challenge Corporation (MCC), a federal government agency located in
Washington, DC. The views expressed in this article do not necessarily
represent the views of MCC or the United States of America.