The New Star of IT Cost Allocation

A holy grail for many companies is to reduce the 70% or so of their information-technology spend that is devoted to operating existing systems, thereby freeing up more resources for adding new capabilities. But the way costs are allocated across business lines and corporate functions can keep the goal out of reach.

Most companies use a “lump-sum” allocation method, distributing operating costs based on the revenue or head count of the various units. Despite its prevalence — in place at 72% of 183 organizations surveyed recently by the CIO Executive Board — the method typically provides little connection between the costs and the volume of services actually consumed. Departments are not motivated to use less IT because they know it wouldn’t lower their charge, notes Andrew Horne, senior research director for the networking and research group, which is part of the Corporate Executive Board.

The opposite approach, used by 16% of those surveyed, is similarly unproductive. The “granular-chargeback” model provides for usage-based charge backs, which sounds like a better way to stimulate effective cost management, but generally entails detailed cost accounting with perhaps hundreds of line items. “Every year [the IT department] swamps their business partners with data about how every cent is spent,” says Horne. “In theory all the information is there for them to make decisions and change behavior, but there’s so much of it, people don’t understand how to use it.”

Almost all other companies use a combination of the lump-sum and granular-chargeback models. But a comparative handful is taking a different tack that the CIO Executive Board is recommending as a best practice. The method involves aggregating IT costs into a relatively small number of service categories, such as network connectivity, desktop computers, laptops, mobile devices, e-mail and collaboration tools, financial systems, customer management systems, databases, and reporting tools. Most companies can allocate all costs into fewer than 25 categories, but even for very large companies with hundreds of specific IT services, grouping costs into 40 or 50 categories would be a big improvement, says Horne.

Divisions and departments pay based on usage volume, as under the granular-chargeback model. But they are able to more easily identify cost-reduction opportunities, not only because of the manageable number of service categories, but also because the categories conform to the way the units experience IT.

Traditionally, when IT explains what it does and puts a price on it, it uses terms such as network, data center, processing, and mainframe — a department pays for x amount of network bandwidth, or for so many hours on the mainframe. “That’s pretty meaningless to someone trying to run a business,” Horne points out. “It’s better to bundle up the costs and present them in terms of things people recognize doing. The more understandable it is, the more controllable it is.”

An extra benefit comes from a blurring of the lines between the IT teams that manage infrastructure and applications. Often those groups don’t work closely together and present charges separately. But reallocating expenses into business-facing categories forces them to merge their costs, which in turn can open the door to productive reorganizations of IT staff.

From a bigger-picture standpoint, allocating costs to business services offers a mechanism for aligning the objectives of IT and its business partners; adapting the supply of technology services to shifts in demand; and maintaining an IT-business relationship founded on transparency and trust, the CIO Executive Board wrote in its report on the research.