CIO Leadership, Technology, Applications

Financial Management and the Business of IT

A profit center?

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Like the cobbler’s children. who lack shoes, most IT departments lack the expertise for managing the business of IT itself. IT departments can boast of long experience automating business processes, in this function or that, but when it comes to automating the governance and business management of IT there is no ERP in place. Those chickens seem to be coming home to roost. IT is asked more frequently to explain the business value it provides to the organization as a whole and a very clear demonstration of the financial value of IT is expected in the answer. Cost reduction, cost avoidance, or, at the very least, cost optimization, continue to be a big concern in corporate boardrooms.   

Cost control is not the only reason the business side of IT is more in focus. Since the collapse of Enron and the accounting crisis of the last 10 to 15 years, corporate governance has gained a high profile. In some jurisdictions, it is the law, such as the Sarbanes-Oxley act of 2,002. IT governance is part of corporate governance.

An IT services perspective has also taken hold in the last decade. The value of IT is calculated as a function of utility plus warranty. There isn’t much value in a product that matches all the required features. but isn’t stable or secure, doesn’t scale and is impossible to maintain. Services are also easier to map to business processes and IT governance is definitely about insuring that limited IT assets are allocated to the business processes that define an organization’s competitive advantage, in the market spaces it competes in.

Last time out I discussed how mature IT financial management was a winning pattern in those organizations that are well governed, the ones with higher profits and a greater return on their IT asset investments. In those organizations, IT is a profit center or a business partner, rather than a cost center, which is the most common view of IT departments. In some organizations, IT hasn’t even matured to the level of a cost center. IT is viewed as an unpredictable cost and there is very little visibility into, or accountability for, IT costs. In other words, there is essentially no accounting, charging or budgeting for most IT expenditures.

Cost centers regard IT as an expense only. There is no serious effort put into service valuation or IT investment optimization. The IT department is a cost recovery organization, where the budget is designed to match revenue with costs. IT is not driven by a profit motive. If IT services are charged out at all, through a tax or perhaps a crude, charge back mechanism, it is simply to recover costs.

The change currently taking place in the business of IT is the demand for an IT that can be described as a profit center or a business partner. As a profit center, organizations are looking to IT for a positive return on investment. IT budgets are evaluated much like other capital expenditures, with respect to business impact. Financial management is aligned with customers and services and IT develops transparent charging methodologies based on the actual consumption of IT resources, rather than equally shared usuage estimates.

The most mature organizations see IT as a business partner, from a financial management perspective. IT is a key contributor to corporate strategy. These organizations deploy value added financial management activities, like service investment analysis, to evaluate the best way to provision services, internal, shared or external. They setup mature IT charging systems, internal and external, and deploy automated tools to gather and charge actual resource usage. They also engage in extensive service valuation, to determine if IT services are adding to the bottom line and by how much.

The business of IT is changing, just as the technology is. In essence, it is becoming more like a business itself.

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Discussion
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jdisuja
James Disuja 0 Points | Wed, 09/25/2013 - 10:38

Yeah, I agree with your view guys that, the most important issue comes in IT sector is insufficient budget. So this sector strongly needs finance support.



pcalento
Paul Calento 256 Points | Mon, 10/22/2012 - 17:36

Could a simple move to consumption based costing be a catalyst for a move from service/cost-center to profit-center-like perspective?

--Paul Calento

(note: I work on projects sponsored by EnterpriseCIOForum.com and HP)

Goddardd
Doug Goddard 122 Points | Tue, 10/23/2012 - 13:44

I suppose one could move to a utility like consumption model, simply to recover costs, rather than relying on estimates, or distributing costs equally, no matter the actual usuage patterns. However, when one defines services as "a means of delivering value to Customers by facilitating Outcomes Customers want to achieve without the ownership of specific Costs and Risks" the profit motive is likely to win the day. One seldom makes investments, without a gauareentee of return, or takes on risk, if not motivated by profit. It is difficult for people to wrap their head around the idea of an internal organization charging for profit, unless it is a shared service perhaps. It certainly makes sense for external provisioning entities, such as an outsourcer or a public Cloud. The wider purpose is simply to make better IT investment decisions, that have a direct, measurable impact on the bottom-line and financial management is key to that objective. It is all part and parcel of transforming IT assets into strategic assets and opening up a competitive environment.

ReneHermes
Rene Hermes 0 Points | Mon, 10/15/2012 - 09:13

IT finance is indeed immature and broken at many companies. Two recent research studies from Nucleus are addressing this immaturity. 

In the first study it is interesting to read that IT decision making has to rely on information that is on average 14 months old while only half of it is correct (http://www.alfabet.com/en/resources/nucleus-research-the-risks-of-inaccurate-data-on-it-applications.aspx). The result is that companies can’t predict the effect of budget changes, and the relationship between IT and the business suffers.

The  second study reveals that barely 4 % determine their IT budget in accordance with the company’s actual business strategy or an IT portfolio analysis. As a consequence, more than 90 % of the participants admit that they base their IT budget on industry benchmarks - as an arbitrary percentage of revenue - or simply tweak the previous year’s budget. The delivery of IT is a function of the budget; the budget should be a function of the required innovation. 

You can access the second study: http://www.alfabet.com/en/resources/nucleus-research-it-budgeting-perception-and-reality/

 

Goddardd
Doug Goddard 122 Points | Mon, 10/15/2012 - 11:23

Thanks for the links Rene. Asset visibility is a huge problem, which causes and adds to the problems of budgeting and forecasting. Budget forecasting weaknesses also ripple directly into capacity planning, which can cause service warranty issues. I believe IT charging, based on actual consumption, and cost modeling will alleviate many of these problems, once it becomes more widespread. The best governed organizations are the only ones benefitting from it now. In fact, most of them consider it to be part of the their competitive advantage formula.

 

pearl
Pearl Zhu 89 Points | Wed, 10/10/2012 - 17:26

Hi, doug, thanks for sharing, true, the mantra of IT: running IT as business, doing more via innovation, just well reflect such transformation: From a cost center to  a profit center, organizations are looking to IT for a positive return on investment. IT budgets are evaluated much like other capital expenditures, I think that's why IT also should develop a new set of business value-driven KPIs, to communicate with stakeholder on IT's value propositioin, besides charge back mechanism. thanks. 

Goddardd
Doug Goddard 122 Points | Wed, 10/10/2012 - 17:52

Hi Pearl

Thanks for the feedback. Carge back systems can also be used to measure IT value, in addition to their normal role in demand management. When executed across business heirachies, in enough detail, they are a great way of aligning costs with revenue and performing other types of performance measurement.

 

Doug