Businesses are demanding greater accountability from IT directors about who pays what for IT - and why. Helen Beckett evaluates differing approaches.
As the regulatory grip tightens on businesses to exact greater accountability, there is mounting pressure on IT directors to make the charges their departments levy more transparent. The IT department used to enjoy the status of a protected species, able to spend freely and pass the cost on to other business units. But the collapse of dotcom businesses curbed boards' willingness to spend excessively on IT and the profligate IT director has disappeared. Without a clear model for how IT should be priced and its goods delivered to an internal market, IT is still susceptible to accusations of irresponsible spending.
Financial institutions and multinational corporations are having to comply with new Basel 2 and Sarbanes-Oxley regulations and demonstrate that transactions are justified.
"As a result of recession and regulatory concern, there is a desire for greater cost transparency across the board," says Will Cappelli, vice-president with analyst firm Meta Group. He expects the result of these compliance efforts to be more transparent pricing for IT and, consequently, improved relations with the business units.
At present, charges levied by IT departments tend to be permutations of two pricing models: the allocated charge, which recovers costs by dividing the outlay among end-users; and the usage-based charge, which uses metering to assess consumption of applications and services. Other options such as charging out IT services to make a profit, or operating IT within a budget independent of costs, do exist but are rare. The profit-motive method usually leads to the division being spun off and sold on the open market, as Cadbury Schweppes did with ITNet in 1995.
Most IT departments today use a combination of both fixed-fee and usage models but neither is wholly satisfactory. "Most business leaders are working hard to get their direct costs under control," recalls a former marketing chief for an insurance firm. "There is this extra line on the bottom of the profit and loss account for IT and you are promised it is going to be £750,000. The next minute it is £1.1m."
The increased IT charge may be an enhanced information security routine or a desperately needed storage upgrade that benefits the entire company. But to the embattled business manager the extra expense is likely to appear arbitrary.
"The concern of the IT department is to get rid of a cost, whether it is staff or purchases," says the ex-marketer.
This tale of conflict will be familiar to any manager who has done the budget rounds. The weakness of the allocated fee approach is that it relies on the political power of unit managers to fight their corner. It is not unknown for a spending surplus to be pushed on to an unwitting business manager.
The formulae that many companies use for cost allocation are ad hoc and pseudo-scientific. Cappelli recently examined the cost-allocation models of 10 companies on the Global 2000 list and was startled by what he found. "It was completely arbitrary," he says.
In its favour, David Rippon, director of the University of London Computing Centre and previously IT director at Land Securities, says the allocation charge is part of the fabric of most organisations. "Some organisations recognise and accept this method of charging ITbecause they also allocate other functions, such as finance and personnel," he says.
The key to reducing the pain of charging for IT is to allow business departments to review budgets and see the actual costs. "Be open - otherwise you are going to poison the relationship," he says.
The usage method of allocating IT costs is not without its shortcomings. The process of measuring, pricing and billing for IT services can become an industry in itself. "The last time I charged departments for usage was for a mainframe system," says Rippon. "We had to use a sophisticated billing system that itself used mainframe processors. And explaining how applications consume processing power is very difficult."
Similarly, the physics of IT systems is such that incremental usage does not necessarily incur costs in a consistent way. For example, a quick glance at the profit sheets of the telecoms providers reveals how suppliers can amass vast profits from this kind of pricing model.
Despite the difficulties of metering usage and building a price list, Jos Creese, head of IT services at Hampshire County Council, advocates operating an internal market and charging end-users for what they consume. "If you expose what people are spending on IT and what they get for it by putting visibility into the departments, you encourage intelligent IT buyers within the organisation," he says.
Creese dismisses the argument that pricing and monitoring IT is too big a burden: if IT departments do not monitor what resources are being consumed or provide performance indicators, they should not be doing the job anyway, he says. "It is not easy, but it is not that difficult either. The difficulty is if you go for perfection. You need to do a cost analysis that demonstrates transparently what services cost," Creese says.
Chris Potts, director of Dominic Barrows, a consultancy specialising in value-driven IT, agrees with this pragmatism. "There is a simple method of cost recovery. Identify the people and groups who are spending on IT and how much and work out who is creating value by using IT," he says.
Businesses must focus on making the connection between what individuals - or departments - spend on IT and how much value they create as a result, he recommends.
Potts encourages IT directors to provide services in terms that are meaningful to the business, such as numbers of seats or hours of access. "Measuring usage of an application in Mips means nothing to the business person," he says.
However, the method of recovery - allocation, usage or even taxation (the higher the profits, the greater the contribution to the corporate IT budget) - is less important than this underlying principle of ensuring that the users of IT create value from the spend.
This concern to charge business units according to how much value they create reflects a wider feeling within the business community that end-users be held accountable for their IT consumption. Alongside compliance, this is part of the drive towards usage-based charges. "It is beginning to dawn on businesses that even if IT is responsible for the actual spend and excessive costs, the end-users bear some responsibility," says Cappelli.
But, he adds, the internal IT department, or insourcer, is at a disadvantage when it comes to influencing user economic behaviour.
"The IT department is perennially castigated for not behaving in a business-like manner. Unlike an external provider, IT does not have the corporate legitimacy to discipline the end-user community when it is excessive in its demands," says Cappelli.
The move towards greater transparency means more IT directors will have to get a firm grip on usage-based chargeback to operate an internal market. Some end-users are better placed to understand and implement this model than others. Despite their conservative image, lawyers and accountants have a head start, points out Mark Reynolds, managing director of unified communications specialist Topcall.
In preference to dedicating teams of economists to working out optimum algorithms, Cappelli advocates looking at how IT functionality is being bought and sold on the open market. "The reason that IT used to be so difficult to price is that it did not exist on an open market and had to be managed by Soviet-style planning committees. Increasingly, chargeback will look like external supplier contracts and will be pegged to open market prices," he says.
Creese says the difficulties of pricing IT services can be overcome by adopting a pragmatic attitude and by remembering the ultimate purpose of being an insourcer, "There is a critical differentiator between being an insourcer and being an outsourcer. At Hampshire, our purpose is to serve the organisation and not to make a profit. Our primary motivation, after solvency, is to serve the business, not the shareholder."
Changing fashions in IT charging
Internal pricing was relatively simple in the mainframe era when end-users were charged by the millions of instructions per second for IT processing, says Will Cappelli, vice-president with analyst firm Meta Group.
Bills were easy to calculate because of the inherent tracking functions built into mainframe operating systems. Until the late 1980s, IT costs were recovered completely because the mainframes could track usage of applications to individual terminals.
"The charge-back model was not only in place, it was also unquestioned," he says.
The arrival of distributed data processing ushered in an era of liberalism that did not have commerce as its chief concern: multi-tasking Unix applications were destined for universities and academia, and Windows catered for individual requirements.
The advent of distributed end-users also introduced vagueness into the equation. Technical difficulties of measuring the usage of distributed applications prompted the introduction of the allocated cost.
"Distributed data processing did not have tracking in its genes," says Cappelli. In the 1990s, the perception of IT as providing mission-critical capability challenged perceptions about IT charging. "The 1990s introduced a philosophical revulsion at the notion of charging for IT."
How to create an internal market for IT
"You cannot just tear up your budget and publish a price list," says Jos Creese, head of IT services for Hampshire County Council, which has been operating an internal IT market for 20 years.
"If it is seen as that simple a move it probably will not work." Instead, he advises would-be IT insourcers to appreciate the culture of the organisation and in particular the views of the chief executive and the finance director.
He also advises against a mix-and-match approach to cost allocation and charge-back. "You are not operating within the risks of being a business and so dilute the focus on the bottom line and the customer. It becomes an exercise of playing shops," he says.
Pricing is difficult, but not impossible, and requires a cost analysis that demonstrates transparently what services cost to end-users. "There is no doubt that there are overheads," says Creese.
His IT department employs a business support team, which is 6% of its headcount, to support IT managers with financial analysis and forecasting. But he warns insourcers against straying into bureaucracy, "Do not aim for perfection," he says.
The insourcer is not immune to the impact of world affairs, such as a shrinking telecoms industry. "If you know what is going to happen and how much it will cost, you can gradually introduce prices that will reflect the situation. The key thing is to maintain solvency," Creese says.
If economic recession affects demand, the IT department has to adapt to it. "We have agreements in place that protect the individual employee, but nothing protects the department. If it is not effective to be running an in-house service, then we should not be doing it," he says.