By Bob Denis, Maureen
Vavra, and John Dick, in conjunction with The
Enterprise Computing Institute

The authors bring more than 50 years of collective
experience to this article on budgeting—one of the most important aspects of
any CIO’s career. They discuss:

  • Budget philosophy.
  • How to approach budgeting for success.
  • How to simply break down the elements of a solid
    budget.
  • The role of relationships in budgeting.
  • Useful budgeting metrics.
  • The budget toolbox.
  • A simple budget process flow.

It is important for a CIO to have a philosophy around
budgeting. More important is that the philosophy be aligned with other members
of the senior management team. Some philosophies that you may see include:

Budgeting is a
necessary evil.
This philosophy reduces the overall impact IT can have on
improving the health of a company. This approach can lead to companies that
feel IT is not a major component of their competitive front, a conservative
approach that might result in very tight spending, few to no projects, and a
largely a sustaining-only environment. If this philosophy inhabits the entire
enterprise, the CIO may need to boldly but carefully evangelize the value of
change, persuading the executive team of the value of IT as a competitive
weapon and a change stimulus. This can be a difficult situation, but rewarding
if a turnaround is achieved.

The budget is the
bible.
This means very tight monitoring of all major spending categories
and little to no flexibility in adjusting for changes in major influencing
factors. Although the budget components might be very well planned, forcing a
budget to survive for a full period of 12 months with little flexibility can
lead to mediocre results in energizing the enterprise. If this is the way of
the enterprise, you must work on relaxing this boundary so you gain the
flexibility you need to react appropriately. Keeping executives abreast of
trends in external influencing factors is one way to address this; another is
to take advantage of opportunities created by significant changes in the
enterprise (acquisition, divesting, reorganization, a new product line launch,
a new line of business) to revisit your budget and propose necessary
adjustments to make the change a success.

The budget is a
guide.
This looser definition implies flexibility, but too much of it over
the course of 12 months can lead to overreacting to changes that do not
necessarily critically affect the success of your enterprise. This philosophy
can result in major overspending in one or several areas of IT. If managed well,
this approach is a good one; allow corrections based only on major changes in
influencing factors.

The budget is an
opportunity to influence change and support overall corporate direction.
This
means the IT budget is considered an investment, not a cost. A budget stemming
from this philosophy is usually balanced and filled with corporate and line of
business (LOB) strengthening projects, a very healthy approach. Adjustments are
made for significant changes in influencing factors and in harmony with the rest
of the senior management team. This is the most effective in our opinion.

Overall, the budget is a significant aspect of managing for
success, but it is only one of many. Be serious in defining and using it in
balance with the other aspects of successful IT management, such as people,
internal and external relationships, organization, and technology.

Building blocks for a strong budget

The following are some important elements in building an
effective budget process.

  • Having a
    budgeting philosophy:
    It is important to know the rationale behind the
    budget: Control? Change? Conservation?
  • Investment
    justification (the ROI thing) and planning:
    A solid planning phase with
    clear budget impact statements, using a solid justification for the investments
    and attracted yearly expenses, is a necessity.
  • Building
    support for investments:
    The CIO can recommend investments within the IT
    “plumbing” domain. For all other investments, build the necessary support
    between the LOB and corporate function primaries.
  • An enterprisewide architecture: It is difficult to build
    a structure without a blueprint. This is your reference point for all adds and changes in the infrastructure, and it is simply a
    must.
  • Simplified
    view of the budget:
    Typically, people need to know about large expenses and
    major changes year over year. They also need to know the rationale behind the
    investments and their impact on the budget. Avoid getting lost elsewhere. Avoid
    getting too deep in details.
  • Review,
    acceptance, and signoff of initial budget and of all significant interim course
    corrections:
    Any major change affecting budgets (plus or minus) should be
    reviewed and ratified by the executive team at least.
  • Review of
    previous years’ actual spending (two years worth is enough):
    History has
    good value for adjusting ongoing expenses and for normalizing ratios. Make good
    use of it.

Relationships and budgets

The long and short of it is that a strong relationship with
the executive team and the rest of the executive management members is critical
to successful IT management, budgeting being just one aspect of that success.
Solid budgeting relies on enlisting the team to support critical investments
(strategic or sustaining) and getting their endorsement when significant budget
adjustments (up or down) are required.

One way of accomplishing this is to link projects that
represent major budget initiatives to specific enterprise or LOB goals and
objectives, and then demonstrate how those links benefit and can be tracked
back to the business goals.

The strength of the relationship is usually based on the
CIO’s credibility in managing budgets and projects during his or her tenure as
an executive. Managing bad news is critical to credibility; waiting until the
last minute to inform the executive team of cost overruns and/or major
deliverable delays can be career-limiting and certainly tarnishes your
credibility. This is all just common sense. The best advice we have is to leave
your ego outside the office when it comes to managing IT investments and
expenses; it is a humbling yet very rewarding experience to perform well in
this area.

In some companies, there exists an IT leadership group,
usually composed of representatives from the LOB and the corporate function
groups. This group is tasked with issuing IT investment recommendations to the
executive team, who are more than likely to endorse them. IT often co-chairs
these groups, but the leverage comes from
getting consensus among the group on investment priorities
. This approach
is often slower to produce decisions but does help in gaining acceptance, thus
easing implementations. Although this can be a test of patience for CIOs, maintaining composure and good relationships with all
members of such a team is highly advised.

The process of determining buy-in on a budget requires
support from senior staff and your IT users. You can accomplish this through
the empowerment of users via an operational planning layer that includes them
in the prioritization process and the strategic participation of the senior
staff, which reinforces LOB participation and gives them “ownership” of the
results.

Budget feeds: Significant influencing factors to consider

Significant influencing factors are clustered in two major
categories: corporate factors and IT environment factors.

Corporate factors

  • Geographical
    coverage (local, domestic, international on some or all continents):

    Infrastructure complexity and costs go up substantially in a multilocation setup, even more so if multicontinental,
    especially in locations in which infrastructure and support services are much
    less developed.
  • Size
    (small, medium, large, mammoth):
    The more users, the more complexity and
    costs. The logical breaks differ between companies, but you can always tell
    when a barrier has been broken. Anticipating the growth steps just before they
    happen is an art to develop.
  • Trajectory
    (growth, as in investing or mergers and acquisitions, versus decline, as in
    cost reduction or divestment, versus holding, as in cost containment, flat
    revenues, or majority market share):
    The budget philosophy adopted is
    almost directly related to this factor. Be wary of overbuilding your
    infrastructure when targeting meteoric growth; it is easier to adjust IT
    expenses up as revenues are coming in than it is to reduce IT expenses if
    revenues fail to match expectations.
  • Business
    type (tangibles, services, e-commerce, traditional):
    Most companies within
    a particular industry group have similar cost structures. The smart CIO keeps
    abreast of the trends and the major shifts affecting his or her business sector.
  • Enterprise
    business organization architecture:
    The organization of the enterprise can
    have a significant impact on the budget and on project investments: single
    versus multiple lines of business, centralized versus decentralized corporate
    services (such as finance, manufacturing, planning, information services, human
    resources, research and development). Each permutation comes with its pros and
    cons from IT management and budget impact perspectives.

IT environment factors

  • Systems
    availability expectations:
    Must be 24/7—but there are shades of 24/7. The
    closer to full 24/7, the more expensive, with the last four hours of the 24
    logarithmically more expensive.
  • User
    support expectations
    : Online 24/7; what are the repair time expectations?
    Again, shades of 24/7 with increased expense in the last four hours.
  • Systems
    response time expectations:
    Subsecond response on
    transaction and R&D systems? Any subsecond
    expectation costs dearly—weigh the value before jumping to such tight
    expectations.
  • Security:
    Spam, virus, intrusion detection systems, encryption—at what levels? Overinvesting in this area can be expensive and complex to
    manage. Consider a balance of investments in protection and service
    restoration.
  • Access:
    From anywhere in the world at all times? Connectivity and access redundancy to
    ensure no single points of failure and access at all times is expensive.
    High-availability technologies (such as ATM and Frame) are also expensive.
    Research the amount of time you can afford to be out of access before it negatively
    affects the business.
  • Makeup:
    Is your IT shop “buy” or “make”? Do you need more developers or more business
    analysts? Consider the need to fund and maintain development environments and
    whether to increase engineering change controls, rollouts, and documentation.
  • Are your application users advanced or
    traditional? An engineering environment requires more
    skilled IT personnel.

Are your IT organization and budget management centralized
or decentralized? Since some cost is typically incurred in a decentralized
model, ensure that the IT organization is
in synch with the enterprise business organization architecture
. If the
enterprise is decentralized (including major decision making), centralizing IT
is probably going against the fabric of the company.

How are data and voice responsibility allocated (or not)?

Significant outsourcing versus insourcing? Outsourcing entails management overhead
and may be more expensive, but the pros (such as a more flexible staffing model
or specialized skills) may be worth it.

Do you have an enterprisewide
technical architecture? You are flying blind without it. You need a reference
blueprint to build something solid.

What kind of network architecture are you using? More
advanced technologies (VPN, VoIP, and so on) are
expense savers overall but require technical skills to configure and maintain
the environment.

  • Legacies
    from prior commitments and budgets:
    Are multiyear projects in progress? Are
    multiyear equipment and services leases in force? Are outsourcing contracts
    active?

These lists of influencing factors are partial, and you
should amend any factor deemed a major influence in your business context.
Writing down your list of influencing factors is what is important. You may
consider weighting these factors for complexity of the environment involved;
this can be useful during the justification portion of the budget process.

Partitioning your budget

IT budgets are stated in two types of dollars: capital
expenditures and expenses. Capital expenditure is cash that is treated differently,
in financial terms, from operating expenses. Simply put, capital expenditures
create assets that are consumed over periods of time. Examples include
implementing a new ERP system or expanding the capacity of a storage area
network. From a financial reporting standpoint, cash is reduced during the
build/acquire phase, with a resulting commensurate increase in the capital
asset; for example, pay $1,000 for a component, and the value of your assets
goes up by $1,000. When the asset is put into production, a “useful life” and
“residual value” are estimated based on financial reporting rules. The
difference between the cost of the asset and the residual value is divided by
the useful life in months, and that amount, called depreciation, is charged to expenses
every month that the asset is in service. The theory is to align the expense of
the asset with its useful life.

Expenses represent cash outlays for goods and services that
are consumed in the period in which they are acquired. Examples include employee
salaries, electricity, and copier paper. Consult with your CFO for a deeper
understanding of the differences in financial reporting treatment in your
organization.

Capital expenditures

The capital expenditure budget is probably your most
important tool in enabling change. CIOs are evaluated
on their accuracy in estimating capital expenditure dollars in projects; a
deviation of plus or minus 10 percent is usually an acceptable performance,
with 5 percent approaching heroism. Capital expenditures usually include
purchases of the hardware and software (including licenses) required for
implementation projects and the related professional services implementation
fees (for consultants, offshore development, and so on).

Capital expenditure dollars are allocated to a depreciation
schedule (between three and seven years, with the bulk in the three-to-five
year range), and a depreciation line is entered on your expense budget as soon
as a portion or the entirety of the new capital project is officially in
service. The impact on the expense budget is important to recognize, as it can
be significant. Capital expenditure typically does not include “maintenance and
updates” annual fees, nor does it cover end-user training fees; it does,
however, cover training for the implementation team.

A final note on capital expenditure money: some or all of it may be eligible for
R&D tax credits depending on the custom nature of the project. Review with
your tax primary to ensure you take advantage of this corporate tax feature.

It is important to track capital spending (quarterly at a
minimum) if only as a good project management practice, but also for sound
business reasons. Remember that capital expenditure is “cash,” and the company
may have bank covenants limiting its cash outlays quarter-over-quarter until
its cash position improves. Work closely with the CFO to understand this impact
and adjust project spending accordingly. One way to help bring relief to a cash
crunch from an IT perspective is to consider leasing as much as makes sense of
a new project’s equipment, perhaps even selling existing in-service equipment
to financial companies willing to lease it back to you over a decent period for
a favorable rate. Application packages are also included in assets that should
be considered for leasing.

Capital expenditures for large projects

Dealing with mega
projects spanning multiple budget years can be a challenge but one that
really boils down to good project management, specifically tying deliverables
to capital expenditures in each budget period. Realizing that some deliverables
can run over into the next budget year, you need to make the necessary
adjustments to compensate in the new budget year.

Here’s a tip: the
smaller your time intervals for meaningful deliverables, the easier the
challenge of managing multiyear projects. We recommend logically slicing
deliverables to no more than three months elapsed time, ideally a single month.
Deliverables of less than one month for mega projects can, however, become a
management burden. Be careful about getting too granular; thrashing details
that bring little value to the project or enterprise can give you a false sense
of control.

Strategic versus sustaining capital expenditures

The difference between strategic and sustaining capital expenditures
can be simply explained as follows: Sustaining
investments
are those that keep the infrastructure operating at your
advertised availability and performance targets. We are talking about the “two
9” to “six 9” targets and the 5/8 to 7/24 coverage periods. The closer to 24/7
at 99.9999 you want to be, the higher your yearly investments in this area.
Potential investments include:

  • Redundancy galore
  • End-of-life replacement
  • Expansive disaster recovery and business
    continuity plans
  • Complex network analysis and security tools
  • Sophisticated backup equipment
  • Technology conversion projects
  • Asset management

You may find it useful to further divide sustaining
expenditures into “survival” and “maintenance” for normal operations. This will
ensure at least the network security and connectivity investments typically
found in the survival category are retained.

LOB, corporate functions, or both can initiate strategic
investments
. They are usually based on increased revenues, increased
efficiency and productivity, business process reengineering initiatives,
increased customer loyalty, and integration of mergers and acquisitions. From a
pure IT perspective, this area also includes research into technologies and
applications for potential future sponsoring by the LOB and corporate
functions, as they would best determine the value. Items in the strategic list
include:

  • Typical core systems implementations: ERP, CRM,
    PDM, APM, OSS, billing, and so on.
  • E-business: B2B, B2C, partner sites, and so on.
  • Online employee self-services: expenses,
    timesheets, stationary orders, and so on.
  • Data: knowledge, intelligence, and intuition
    projects.
  • Network: voice over IP, wireless, and
    productivity user devices such as PDAs and handhelds.

There might be value in further splitting strategic
investments into “growth” and “breakout.” This helps in securing breakout
investments, since they are usually mega projects that typically require
investments across multiple years.

Prioritizing capital expenditures

Another approach to deciding on capital expenditure
investments is to assign a priority
to each investment proposed. The priority is a combined representation of the
ROI and the risk of not doing (which is sometimes difficult to assess in ROI
terms). We tend to limit the priority scale to values, as follows

  1. Absolute
    Must.
    Includes security, legal, regulatory, end-of-life equipment;
    typically externally mandated, that is, you really have little or no choice.
    Simply stated, if you are under very tight capital expenditure and/or expense
    budget constraints, the cutoff is drawn here.
  2. Highly
    Desired/Business-Critical.
    Includes short-term “break even” (less than six
    months), significant short-term “return to top or bottom line” less than
    months), and mega projects already in progress. Most priority-2 items are
    approved for budget year funding under normal revenue growth projection
    conditions. Typically, the cutoff for funded projects gets drawn here.
  3. Wanted.
    Valuable, with a longer return term (more than 12 months). Typically, these
    projects get funded only if there is capital money remaining, if resources are
    available, and if revenue projections are fairly secured. They may find their
    way to priority 2 or even priority 1 in subsequent budget years.
  4. Nice
    to Have.
    Given available bandwidth in people and money, there is a good
    return on these projects, but typically the ROI has more intangibles. Unlikely
    to be funded in this budget year; might go up the priority list in subsequent
    budget years. It is important to have some projects in this priority, as it
    helps to better calibrate the higher priorities.

One possibility in prioritization is to continue on the
theme discussed above and track the projects back to the business goals and
associated resources. Another, more tactical approach that can be effective,
particularly in small to mid-size organizations, is using a budgeting
philosophy that is conservative in its focus on business benefit,
justification, and ROI.

Expenses

The following items constitute what is most typically
referred to as “the budget.” The major categories of budget expenses are:

Personnel

  • Salaries and benefits (including hiring fees and
    bonuses)
  • Training and education
  • Travel
  • Morale
  • Staff-related depreciation
  • Temporary help/consultants
  • Miscellaneous (space, telecom, and so on)

Hardware

  • Depreciation
  • Maintenance
  • Repairs
  • Leases

Software

  • Depreciation Maintenance
  • Customer support
  • Updates
  • Repairs
  • Leases

Services

  • Leased lines
  • Outsourced network services
  • Security services
  • Applications service providers (ASPs)
  • Miscellaneous (transport, courier, periodicals,
    and so on)

The following sections provide rationales for each of the
items in the list:

Personnel

Salaries and benefitsare obvious. You know where to get the actual salaries for regular
full-time employees, and the controller can help you determine what ratio to
use to capture the benefits (usually 30 percent of the base salary). For new
hires, any public domain salary report contains the high-low for a given job
description, and you can simply add the benefits; added expenses are usually a
one-time fee for the hiring agency (up to 30 percent of the hiring salary) and
a hiring bonus payable to the new employee at specific anniversary date(s).

Training and
education
is probably the
most important people investment. We use the rule of $500/day including
expenses and plan for a minimum of five days of development per year per
person. Think of it as five out of 220 days, or a 2 percent time investment in
keeping skills current. This number needs adjustment if the IT infrastructure
is using more new technologies. It is good practice to track training, seminar,
and conference days for each of your employees as well as any personal
education time spent on business -relevant subjects. We do this, review the
information monthly, take action where appropriate, and report on it at the end
of the year.

Travel
should be considered separately. Since many companies are geographically
distributed, IT staff are often asked to travel for
new installations or repairs. This can amount to a significant expense and may
justify a local permanent hire at a break-even point, which makes the expense
more visible. This category could be roped into the miscellaneous line if
direct visibility is of no value.

Morale
is a contentious item used to single out in some companies. However, we believe
it essential to the proper functioning of the IT group. It certainly should be
placed into the miscellaneous line. The important message is to plan a certain
amount of group-bonding (team-building) activities to keep the energy level and
overall participation at their highest. For budget planning purposes, we
suggest an average of some $500 per head for the year. In more progressive
companies, the activities tend to be more elaborate; try to keep a per-head
view of this investment in your people.

IT Staff related
depreciation
includes
furniture, personal computers, workstations, desk servers, test equipment, and
so on. Again, we recommended that you develop and apply a ratio based on the
typical cubicle configuration for your IT folks.

Temporary help
and consultants
, as a talent alternative, charge between two and
four times what you pay a permanent employee. However, there are clear
instances in which this approach makes for a wise investment:

  • For large implementations (such as ERP, CRM, and
    so on) involving a “bubble” of work.
  • For highly technical initial implementations
    such as security packages, new network technologies, and the like.
  • For reengineering initiatives in which the
    internal bias is removed and best practice is preached by specialists.
  • For assessments of the technical or operational
    health of the infrastructure, the organization, or the environment in general.
  • For feasibility studies for which subject-matter
    experts’ knowledge is required.

Although the instant value is high, without a transfer of
knowledge into the IT organization, much or most is lost in sustaining the
change or implementation past the initial effort. Make sure that the IT
organization can support the results of these efforts. Some organizations, with
an avid thirst for change and leading-edge technology, may want to consider an
ongoing entry in the operations budget for some percentage of their workforce
count to come from outsiders (hopefully under 15 percent unless outsourced
managed services are used).

Another increasingly popular form of external resources is
offshore development. If you are a “make” shop, this can be a very attractive
approach to many somewhat generic projects, by which we mean integration and
reports type of work and operations automation as opposed to product related
work. For the latter, you need control and assurance of confidentiality with
regard to the goods produced (code). Again, there is overhead in managing these
arrangements, but the value to the IT shop and the enterprise makes it worthwhile.

Miscellaneousexpenses should be managed by
establishing a ratio over your headcount base and applying it across the budget
period covered. Guard against putting too much in here; a fat miscellaneous
line will negatively affect your credibility as a business manager.

Hardware

These categories are fairly standard:

Maintenance
in hardware runs typically 15 to 20 percent.

Depreciationoccurs over two to seven years,
depending on the item. Use a budget tool that allows the insertion of new
hardware in a specific month and calculates the monthly depreciation based on
the entered depreciation period.

Repairs
should include relatively little if you cover all your hardware with original
vendor maintenance. (This practice is highly recommended, at least for the
critical servers and all network elements.) Establishing a solid third-party
service contract covering repairs and upgrades is a viable alternative but can
lead to trouble if vendor personnel are not certified for all the equipment
providers you use.

Warning: Saving a few dollars on
maintenance is a dangerous game to play unless the company is willing to live
with the possible consequences of business downtime due to system
unavailability.


Tip

For critical equipment (such as network switches and routers
and servers used for business transactions or customer interactions), it is
generally more advantageous to replace the equipment at the end of its
depreciation period than to keep on paying maintenance on it and “stretching”
its useful life.

For critical equipment, you might want to invest in “hot”
redundancy. If under budgetary constraints, standardize on a family of servers
and maintain “cold” standbys that you can quickly insert in the event of a
crash or can pick for parts on a needs basis.


Leases
of hardware are an attractive alternative that you should carefully consider.
Pros include:

  • Preserves cash for more business growth-oriented
    investments.
  • Predictable monthly expense hit on the budget.
  • Forces the discipline of turning over
    end-of-life equipment.
  • Usually includes full maintenance and support
    built into the deal.

Cons include:

  • A bit more expensive over the life of the lease
    than the original purchase price; nowadays, the leasing premium is around 10 to
    12 percent, with good deals still existing in single-digit percentages for some
    equipment.
  • Requires action at the end of the lease (extend
    lease; new lease/new equipment; buy for $1, at fair market value, or at
    predetermined value).
  • Can get complicated in the case of vendor or
    leaser bankruptcies; cover yourself in the Terms and Conditions (T&Cs) of the leasing contract.

Negotiating a lease can be complicated. Using reputable IT
infrastructure equipment vendors who offer leasing options is generally safer
and easier to deal with.


Tip

Perform a detailed review of the terms and conditions,
particularly the fine print. Work closely with the corporate counselor for best
coverage. In the absence of a corporate counselor, we recommend the use of an
attorney specializing in contract ratification or an experienced broker.


Software

Budgeting for software can be very complex, since it is
highly dependent on the contract terms negotiated and the nature of some of the
projects on which the software will be used.

Depreciation
is simple enough in that you determine the useful life of the software
purchased (three to seven years, usually four years for enterprise software,
three years for others). If the software is part of an overall implementation
project for which consultants are engaged, their fees are normally included in
the depreciation over the same period as the software. All other
project-related nontangible expenses (training,
travel, and so on) are entered directly in the budget for the year incurred.

Maintenance
is at the heart of the software budgeting complexity. Vendors vary on how they
approach this, and at the moment there are no set definitions of types of
licenses, which largely drive maintenance. The bottom line is that this is all
negotiable at the time of contract, which can have a major impact on the budget
if rushed or overlooked.

Aspects to consider in negotiating software maintenance
include the following:

  • In many cases, the maintenance percentage goes
    into the customer service bucket, so the P&L is under a different managing
    executive; the sales representative has little or no power over this part. You
    may need to deal directly with the service organization to receive more
    favorable terms.
  • Maintenance is often broken into two types:
    software upgrades and technical support; each type has its own percentage
    setting. We recommend software upgrades as a must. Technical support can be
    avoided if you have enough experience and expertise on staff and the vendor
    offers a fee-per-support call service feature. You are exposed, but the savings
    may justify it depending on your comfort with the inside knowledge or if the
    software is not on the list of critical applications.
  • If using the fee-per-support call option,
    attempt to include a clause in the contract providing a credit back for
    expenses incurred by calls resulting from bugs in the vendor software. It might
    also be worth negotiating a partial inclusion, like coverage for a preset
    amount for a predetermined period, usually equal to the implementation plus
    three months live.
  • Some vendors are covering their increased costs
    in customer service by building in an annual increase, typically in
    percentages, and applying a cap over a predetermined period. Ensure clear
    understanding of these terms, or negotiate this out altogether, as it can have
    a significant incremental impact on your budget for years to come; maintenance
    fees can run over 30 percent over time if this is overlooked.
  • Some vendors’ maintenance fees are based on the
    number of users; typically, they use a sliding scale approach under which the
    fee per users diminishes with the number of licenses in use. This scheme makes
    for a lot of ambiguity and unpredictability in your budget. We recommend
    negotiating this out in favor of a flat rate-based approach.
  • Repairs, as an expense category, is used mainly
    in cases in which IT has opted away from technical support maintenance and is
    using the fee-per-support call option, usually set at a predetermined rate per
    hour with a minimum number of hours charged per call. Also consider using this
    category for consulting fees for the purpose of repairing software that is not
    on maintenance. It is prudent to count on two four-hour calls a year for
    assistance where the applications are stable and under predictable usage.

Leases
of software are becoming more popular for the same reasons provided for the
hardware paragraph. Monthly distribution for leases should be managed
separately in this category.

Services

Leased lines
are the telco and Internet service provider (ISP)
connectivity lines to the Internet or private networks. Although this is a
single account in the budget, we strongly recommended that you keep a detailed
accounting of the monthly charges by facility, by circuit, and by provider, as
this can get complex over a large number of locations and more so if
international circuits are involved. One alternative is to turn this management
task over to a brokerage firm responsible for provisioning and providing you
with unified, detailed billing; they are often very much worth their management
fee.

Outsourced network
services
include network management fees (onshore or offshore) that
typically represent a flat rate for an entire network or a monthly rate per
network node under monitor contract. The flat rate is simplest; divide your
contract by 12 to give you the expense line result. This type of contract has
thresholds for the number of nodes changed over a defined period, with
consequent rate adjustment. The per-node monthly charge method is a bit more
complex to keep track of but ultimately gives you more granular control over
the costs. In either case, aim to get a detailed monthly bill for all charges
from your provider(s).

Also use this
budget bucket to collect your equipment collocation fees (such as for Web
servers), fees for value-added networks (VANs) such
as Electronic Data Interfacing (EDI) transparency nets, and any other
network-type services subscriptions.

Security
services
are a collection area for virus
protection and spam filter subscriptions, private key
infrastructure (PKI) key management services, network security audits, network
intrusion audits, security equipment servicing (card readers, fingerprint
readers, retina scanners, and so on), and other related expenses. We prefer to
differentiate these from standard network services for better visibility of
security costs; arguably this category could be rolled into outsourced network
services.

Applications
service providers
covers the monthly fees for total ASP services
(ERP, CRM, and so on), Web (e-commerce) storefront services, mail and collaborative, and other metered or flat-rate user
applications services provided by entities outside the corporation. Again, the
contract is of crucial importance, as it sets the distributed monthly fees for
a determined period of time.

Miscellaneous
is a collection bucket for the rest of your expenses. This should be less than
1 percent of a well-constructed budget.

Headcount budget

Much has been written on proper project planning. There also
exists plenty of literature on establishing functional staffing based on
ratios. This section focuses on the operating and functional staffing aspect
rather than on project staffing.

The best approach we have found is to use ratios for most
functions and plot your target staffing based on an aggressiveness scale. For
example, the normal helpdesk technician to user count could be 1:100, whereas a
very aggressive ratio to squeeze expenses would be 1:200, which you could
choose to manage at 1:150 to remain at an aggressive ratio. The potential
consequences of this decision should be captured and presented to the executive
team for endorsement.

For business analysts, you may elect to have solid coverage
on critical applications and minimal coverage on noncritical
applications, compensating as needed by making more effective use of vendor
support. In any case, document the rationale in the executive team
presentation. The same goes for your DBAs, network
people, server team, voice team, and so on. The key is to establish ratios and
explain the coverage and exposures.

Useful ratios and metrics to consider

This section covers some measurements you can use to make
sure your budget is well constructed and aligned with your business. The
following items are aimed at getting a handle on IT personnel expense drivers
to help normalize the operations budget or detect early signs of a major shift
in influencing factors.

  • Dollars
    per megabyte of equivalent bandwidth.
    Consider overall, by region, by
    service provider.
  • Dollars
    spent per long distance call.
    It might be worth regionalizing, at least per
    continent. Compare with other companies with similar demographics.
  • Dollars
    spent per cell phone.
    Going to flat rate with maximum minutes free
    simplifies this.
  • Number of
    helpdesk user requests per week/per month.
    Annotate this chart with
    significant changes in user population served.
  • Number of
    desktops/laptops, per population group or overall.
    There will be different
    ratios for engineering (2.3), manufacturing (.75), corporate office (1), and
    sales (1.25). Important in predicting workload and technology turnover
    investments.
  • Cost-based
    metrics.
    TCO per user on desktops and laptops (consider depreciation,
    maintenance, helpdesk, and so on); TCO per ERP transaction user (consider
    maintenance, DBA, business analysts, helpdesk portion, and so on).
  • Benefit-based
    metrics.
    These are ROI metrics, typically stemming from projects, but how
    often do we go back to the original justification to assure ourselves of the
    return? Many payload or cost metrics have a companion benefits metric. For
    example, increased bandwidth at the same or lower expense can be translated
    into engineering time returned to the enterprise, while increased server
    performance throughput can translate into increased revenues if it is used in
    the partner or customer service realm. Creating benefits-based metrics is well
    worth your time—just another avenue for better communication with the rest of
    the executive team.

A simplified budget generation process

Now that we have defined a working philosophy for the
budget, explained capital expenditure and expense budgeting, and reviewed the
various budget buckets, let’s put this together in Figure A.

Figure A: Simplified process flow diagram

The timing of the budget process is of some importance. For
the capital expenditure portion, if the company has an annual strategic meeting
involving LOB and corporate function primaries, the IT investment plan and
profile should fall out of that session within, say, two to four weeks. If not,
we recommend creating an IT investment review in which the CIO proposes
investments based on their business sense for the audience (executive team
minus the CEO) to debate and eventually ratify. Based on a January to December
budget timeline, this should take place in an August to September timeframe.

The normal operating budget process can operate independently
of, but in parallel with, the capital expenditure process during the same
August to September period. During October and November, merge the expenses
impact of the new investment profile, targeting the final release of the IT
budget for no later than the end of November.

Managing the budget

Managing your budget typically means tracking spending,
comparing it to monthly, quarterly, and yearly targets, reporting on
significant deviations, and issuing corrections when a significant change is
encountered. Simple enough, and a major component of
the CIO’s credibility. Here are some guidelines to help you avoid becoming a
CIO casualty:

  • If managing within 5 percent of budget targets
    either way, simply and quietly go on about your business.
  • If managing under budget by more than 5 percent
    but within 10 percent, work with the LOB and corporate function primaries to
    find areas in which this budget excess can potentially help them.
  • If managing at 20 percent or better under budget
    by midyear, you will be called a “sandbagger” (or worse) unless you explain
    thoroughly and return the excess over 10 percent to the IT controller or CFO.
    Headcount fluctuations or late project implementations are the usual causes of
    such significant deviations. Beware: you
    will most probably be under scrutiny when creating the next year’s budget.
  • If overspending by more than 5 percent but
    under15 percent, be well prepared to explain the causes and generate remedial
    action immediately.
  • If spending more than 15 percent over budget,
    you are exposed to the CIO terminal virus. Serious attention is required; this
    can be a critical test of the strength of your relationships with the rest of
    the executive team unless they were
    preconditioned for this possibility.

These guidelines apply to project spending as well as to the
operations budget, but scrutiny of the latter is usually much closer.

Managing project budgets involves different complications.
Conditions affecting company revenues and earnings can drive the executive team
to revisit the project list and make cut decisions—the “you’ve got to know when
to hold, know when to fold” axiom.

Postponing or eliminating projects yet to begin is
relatively straightforward. Before interrupting or stopping projects in full
flight, consider the cost of shutting down a project as well as the cost of
reactivating it if there is expressed intention to complete it at some point in
time; these costs typically amount to 10 to 30 percent of the original
estimate. Consider a project as a jet
engine: when you turn the engine
off, it needs to wind down over a period of time to get to a complete stop, and
when you turn it on again, it winds up to full power over a period of time.

If a project has passed two-thirds of spending or deliverables,
stop or cancel it only under severe financial downturn conditions; the chances
of ever completing that project are slim, as the people involved may not be
around anymore or may have been reassigned to other full-time jobs. If forced
to interrupt a project with intentions to restart later, make sure enough time
and effort is spent in securing the environment (specs, software, hardware
configurations, status of deliverables and financials, and so on) in a “vault”
before reassigning the resources.

The budgeting toolkit

Anybody involved in budgeting must be literate in
spreadsheet, presentation, and word-processing technologies—in that order. No
rocket science here. Intermediate to advanced spreadsheet knowledge is
particularly useful. If the enterprise uses a more advanced budgeting tool, you
can work directly in that environment or use the spreadsheet package and upload
the results.

Spreadsheets to maintain

  • Investment
    portfolio
    (multiple sheets):
    Proposed for the year (see the discussion of strategic investments in the
    section “Capital Expenditures for Large Projects”); ratified by the executive
    team; actual spending versus proposed for the ratified list.
  • Purchase
    order tracking:
    Tracking different worksheets for software, hardware,
    consulting services, data telecom, voice telecom, subscriptions, and a summary.
  • Personnel
    training tracking:
    One sheet with specific classes, seminars, and events
    attended by each employee; another summarizing technical, professional, and
    personal time in days spent on education per employee.

From an operations perspective, we use a workbook containing
all major expenses that generate a purchase order or receive an invoice for IT
services. The IT expenses planning workbook is copied to create the tracking
workbook for the budget year, in which actual expenses and related details are
entered per purchase order required or generated. The IT expenses planning
workbook is a copy of the tracking workbook from the previous year, edited with
new information as required.

Reports healthy to generate (from a budget perspective)

  • Project-related financials should be reported as
    a function of project progress reporting.
  • From a pure budgeting perspective, report on
    major category deviations of greater than 5 percent and keep a running log for the
    year. Any deviation at or over 10 percent will probably need some deeper
    explanation, so be prepared.
  • The selected operating metrics (some discussed
    earlier) should be presented monthly to the IT people and at least quarterly to
    the executive team—more frequently if they are under some amount of heat.
  • The year-end report should contain a section for
    the investment progress summary (including finances) plus a section
    highlighting budget deviations and significant changes in influencing factors.

IT expense distribution

This is a controversial topic in many companies, and yet, if
the budget has the blessing of the executive team, there is support for the
overall spending level. This largely stems from the fact that the CEO/CFO team
wants to see the businesses pay fairly for the services they receive from
corporate. In companies where there is only one LOB, this is very simple, of
course. For companies with multiple LOBs
(full profit and loss responsibility), it can become an issue. There is
no simple answer to this dilemma, but it is essential that the CIO take an
active role in determining a fair repartition of the expenses to each business.
The days are over when we took total IT expenses and charged back based on LOB
revenues. A blend of metrics is required to help work this challenge at the LOB
general manager level as opposed to the CEO/CFO level.

In the case in which LOBs are
granted dispensation or reductions of their fair calculated value of
allocations (corporate sponsoring for good business reasons), this must be
discussed and agreed upon at the executive team level to eliminate bickering
behind the scenes. Avoid cutting special allocation deals one on one with
executive members; get it all ratified by the entire executive team.

It is good practice for IT-related invoices to be routed
directly to the consuming LOB as long as the accounting code (reflecting IT
spending) is correct; this maintains the visibility of IT while payment
initiates directly from the LOB. Some metrics to consider with shared resources
include

  • Applications:
    Volume based (transaction, lines, overall cost), per named user.
  • Network:
    Cost per named user per site.
  • Voice: Get
    detailed billing, direct charge, and subscribe to a communications brokerage
    firm.

Granularity of allocations flowing to the lines of business
can become complex. However, if it is required to get an accurate reading of
their profitability, establish the necessary calculation tables and have
dedicated staff responsible for producing the correct charge backs at the end
of fiscal periods.

Using this approach, you might want to allocate certain costs
back to the business using a rational algorithm such as business analyst time
spent, specific project benefit for departmental or LOB projects, or
applications usage. Such mechanical schemes as square footage are useless;
avoid these. In the case of projects that can be identified to specific lines
of business, it is almost always advantageous to identify them specifically.

Conclusions

Budgeting is an exercise in common sense. Adjusting IT
expenses to revenues, buying off-the-shelf if product provides the required
functionality, keeping an eye on the critical influencing factors, keeping the
executive team involved and informed, and treating the budget as a change agent
all help you successfully manage the IT shop to be viewed as a solid piece of
the foundation from which the company pursues its goals.

Remember, relationships with the IT controller and the CFO
are two career-enabling relationships within which you should work to build
credibility.

The Enterprise Computing
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