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12/16/2010
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The Morphing IT Budget: It's About More Than Opex

Buying computing resources as services shifts expenditures from capital to operating. What does that mean for CIOs and their financial clout?

There's fundamental change coming in how IT organizations spend money. The biggest shift is from capital to operational expenses, but the buck doesn't stop there. Respondents to our InformationWeek Analytics IT Budget Survey are increasingly focused on calculating per-transaction service costs and implementing chargebacks. CIOs are aware that business executives know technology and that corporate IT is no longer the only game in town.

Concerns that internal initiatives, and the CIO's clout, will be gutted and most funds redirected to the cloud are overstated--for now. But we are at an inflection point: IT has money to spend, but it can't be allocated using the same old budget process that's kept us in a rut of dedicating a third or more of our resources to keeping the lights on. Business leaders have little patience for high-priced, long-term IT slogs. They've seen massive 18-month projects fail and experienced success with lightweight software-as-a-service offerings.

CIOs must look at each expenditure and think, "Will this buy us flexibility and advance the business?"

"In the current environment, it may be that you have to spend money to make or save money," says Art Coviello, president of RSA, the security division of EMC. "Some capital expenditures will let us move to a more opex-centric cost structure." One example: buying new, higher-capacity equipment and virtualization software as CIOs undertake data center consolidation projects in preparation for adopting cloud services.

This all sounds reasonable, yet there's a weird cognitive dissonance between how the IT pros we surveyed perceive the financial landscape--in a word, bleak, with layoffs, frozen positions, furloughs, and hacked line items--and the reality that 45% of the 422 respondents to our October IT Budget Survey will see increases in fiscal year 2011, compared with 24% expecting decreases. Our November InformationWeek Analytics Outlook 2011 Survey shows an even brighter picture, with 55% of those 552 respondents expecting increases vs. 19% facing cuts.

Why the disconnect? Mostly, we haven't yet figured out how to navigate a new budgetary environment, one peopled with executives who are much more savvy with technology, what it costs, what it can do, and different ways to pay for computing resources.

Our top-line advice: Internalize the notion that there are no technology projects, just business projects with technology components. Given that, it's clearly critical to identify how any given IT activity supports the business. However, just 16% of our respondents align their budgets with a service catalog. For those smart few, when a request comes to cut the IT budget, they can simply ask, "Which business service do you want to give up?"

Most of us aren't there yet, but the age of the service catalog is upon us. We say this with confidence because the rise of the cloud in conjunction with other modes of outsourcing means that everything--everything--can be delivered as a service. Business leaders are going to ask the 66% of IT organizations that have less than 20% of operations outsourced: Why? What is so darned important that you have to personally handle 80% of our operations? Service-based budgeting will let IT leaders answer that question. Maybe there are tasks that are better done by outside suppliers. Maybe not. But you can't have that discussion if you haven't even attempted to assign costs to services and business units.

In fact, CIOs must have the same conversation with business units that internal raw-material suppliers have long had with manufacturing divisions. The dialogue can't be, "It's not fair to compare us with external suppliers" or, "We're just better than external suppliers." To have a credible position, it must be, "We have a high-quality supply of internal raw materials, with a given supply capacity. Our raw materials are, through their life cycle, less expensive for the organization. Once your demand exceeds our supply, or when you need specialty items, then we go to the outside."

In coming years, if business units can get a higher- or comparable-quality supply of a given type of IT service from an outside partner, for less money up front, they will. It's fiscal responsibility 101. Again, it's not just about the cloud. Service providers of all types, whether last decade's offshore application developers or new voice-over-IP providers, will continue to perfect their art, and internal IT had better keep up and demonstrate value to increasingly discerning executives. Demonstrating value means having hard numbers in your pocket. If the CEO asked you today, "How does our IT spending compare with others in our industry?" what would your answer be? When's the last time you compared notes with peers? While 86% of our survey respondents do some level of benchmarking, almost half don't regularly schedule this activity--a euphemism for "not very often." Yet disciplined benchmarking is a must.

And whatever your IT spending is, one other thing is clear: It needs to be less. Yes, companies that use technology strategically will tend to spend more than those that view IT as overhead, but the rapid pace of technological change almost guarantees that today's budget for a given line item will be less than yesterday's. Smart organizations reduce their IT spending before being asked.

Then the question arises: Should CIOs be looking to cut technology expenses that don't appear in their budgets but rather are owned by business units, across the entire company? After all, 27% of our survey respondents say 50% or more of their organizations' IT investments come outside of IT's budget.

Our answer is a resounding yes. In fact, it's often easier to reduce expenses on IT functions that are allocated to business units because they have skin in the game. You won't have to plead with a business leader to make a capital investment that might reduce an operating expense (or vice versa) if it's her money you're talking about.

Conversely, nobody changes the oil on a rental car.

Now, benchmarking is difficult. But there are several steps you can take to make the process easier.

>> Network: Unless you work in government or a not-for-profit, details on spending and profit numbers are proprietary. The only way to get the goods for comparison is to go out and meet others in your industry. Attend trade events. Build relationships.

>> Serve: Do business units know you're there to serve them? They'd better, or they'll duck and cover when you bring up reductions. You absolutely need to have conversations with them about how business growth has, for example, caused central IT to budget more for virtual machines. Should you cut back these resources and increase response time, or consider strategies to reduce prime-time computing load? You can't have that type of conversation if IT is viewed as the enemy.

Get Granular

Here's the other thing that drives finance officers crazy and makes it difficult for IT to reduce expenses. Walk into a typical corporate data center and ask: How much does it cost you to run that server? Or ask an admin how much, per mailbox, it costs to run corporate e-mail. You'll get a funny look, and if you're lucky, a roll-up budgetary figure that reflects the sum total of the entire data center. But that's not the same as the ability to accurately represent transaction costs. This is important, because granularity lets IT--and business units--understand which activities create which types of costs, and reflect those in the budget.

More than half of our survey respondents don't work that way. But they must get ready to. Cloud services have executives champing at the bit to gain a predictable, understandable, usage-based method of budgeting for IT services. Accountants call this "activity-based costing," or ABC, and it's coming soon to a data center near you. Be aware that costing doesn't mean chargeback. ABC merely says, "We understand what we're spending." You don't have to charge back to business units based on utilization. But you do have to know how much service X costs per unit of usage. The boss may not be asking today. But trust us, you will be asked in the not-too-distant future. Items to keep track of include cost per mailbox, per PC, per minute of processing time, per unit of analyst or technician time, and so on.

Does this sound like it takes some overhead, some tracking effort? Well, yes, it does. But it's the only way a company can make informed budget decisions. Perhaps the most important of those will be to stop blindly agreeing with the overly generalized and hyped cloud meme that opex is always better than capex.

The best model depends on conditions. Yes, when capital is scarce, operational expenses tend to be inevitable. And when operational expenses are minimal and potential capital expenses are high, as with many cloud offerings, opex can be preferable to capex. Many companies are sitting on cash right now because they don't need to use it and are worried about capital markets. In these cases, capex might be just fine if it doesn't come with a significant burden of opex.

Point is, have a rational discussion about a project--including preferences for capex versus opex. "I would rather pay for something over time with a predictable budget item and SLAs than have a large, one-time outlay with lots of execution risks," says David Guthrie, CTO of PGi, a virtual meeting company. Point taken, but we counter that the most important consideration is managing risk. If the company isn't committed to the business process that the project addresses, outsourcing is the right mentality. But if all you're worried about is execution risk, you may want to buy a performance bond, to warrant the contractor that's executing the project. Various insurance firms sell these bonds, which pay out a set amount for projects that fail. Think of it as an SLA on steroids.

In addition, timing is everything. The idea of "rent instead of buy" is attractive, to be sure, especially if there's no 72-month contract with penalties for early termination. With cloud computing, that's usually the case. But it's worth noting that the humorless little man who collects the checks for your telecommunications infrastructure isn't going to let you out of a contract without a penalty. Bring up the subject of early termination as a standard part of any negotiation and decide whether it's worth paying a premium for an escape clause. Half of our survey respondents think not, but it depends on the magnitude of the contract. Or it could be that a provider wants a premium on top of the monthly fee to be "pay as you go." There may be situations where paying the extra cash is useful as a risk management strategy and an exit clause is always advisable.

Whatever you do, make sure that you're having an ongoing conversation with business managers. You really don't know which scenario would make sense unless you have the big picture.

IT Meets Transparency

It's a bellwether of how business leaders are thinking that there's now an entire product segment of the business process management tool market devoted to IT cost transparency. Does that mean that IT is fated for a full slate of chargebacks? Maybe, maybe not. It's interesting that our survey respondents are 50/50 split about this concept. We discuss some best practices on p. 20, but whether or not you do chargebacks, it's in IT's interest to start being transparent now, in a rational, pragmatic way. If you're not doing chargebacks, consider doing "showbacks"--that is, showing cost allocations to business units. You don't collect the money, but you do say, "Business unit XYZ cost the organization $1,385,000 in IT costs in fiscal 2010." Note that to do this credibly, you'll need to engage in the service-based costing that we mentioned earlier and delve into in our full report.

Education will also be necessary as you morph your budget to match modern realities. Business leaders don't always understand, for example, that IT must build in overcapacity. Sure, cloud to the rescue in some cases, but IT must often keep licenses or other resources in reserve that it can provision quickly to meet business growth needs.

Our recent InformationWeek Analytics Cloud ROI Survey revealed that 45% of those using or evaluating cloud services need elasticity for business technology "frequently" or "often." Seventeen percent of those respondents said that they build 40% or more extra capacity into systems; 13% said they build in 31% to 40%; and 25% build in 21% to 30% extra capacity. On the face of things, this may seem wasteful to business leaders. If you can't logically explain your internal capacity policies, it may be time to work that out--you'll be justifying them one day soon, particularly if you charge back.

Ready, Set, Shine

How much IT costs and what results IT is getting will become more and more public. It's the corporate equivalent of sunshine laws. But what are you so worried about? IT organizations that have survived outsourcing 1.0 are typically well thought of, at least 68% of the time, and doing at least OK 87% of the time, according to our data.

CIOs must embrace the supply chain mentality and be OK with competing with external providers sometimes, and stepping aside and getting service from the outside sometimes. Sure, you may not have a big pile of capital funds to spend, but the upside is moving to the next level of partnership with the business. From a staffing perspective, maybe you don't need as many router jockeys, but you do still need people able to monitor services delivered by partners for performance and security, and able to negotiate and manage those relationships to get the most for your opex budget dollars.

Here are some keys to dealing effectively with the rapidly morphing IT budget:

>> See reducing expenses and reengineering as a continuous, year-round process.

>> Start now to track expenses by activity and service, and be transparent about this process.

>> Rent instead of buy where appropriate.

>> Benchmark against other industries, and those companies within your industry, and engage governance bodies in the budgeting process.

It's a new, crazy, mixed-up world of transparency, supply chains, cost-based accounting, and service-based budgeting. Get an early start on what matters, and you'll be well positioned once the dust settles.

The Phoenix Group, a light-manufacturing and construction logistics company, isn't using cloud computing services yet. But Todd Kenworthy, IT manager for Phoenix, has broadened his scope by working with manufacturing automation technologies that weren't previously part of IT's portfolio, with the result that his team is now tightly interwoven with the company's manufacturing strategy. While he still has to justify his expenses, Kenworthy isn't experiencing the budget crisis that some of our survey respondents are, because the IT organization has helped Phoenix's business to the point that it has measurably impacted the bottom line. "Our success in quality allowed us to grow our customer base tenfold in four years," he says. Now that's the kind of budget outcome we'd all like to see.

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