The Bottom Line

Is Virtualization Clouding Your IT Cost Transparency?

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Getting a handle on the true costs for IT services continues to plague companies even though many have implemented server virtualization and cloud technology as a cost reduction strategy.  While companies may have been able to consolidate physical resources to reduce cost and increase resource flexibility, these same efforts have only made it more complicated to determine the true costs of the services provided to the business.  In his recent CFO Magazine article The New Star of IT Cost Allocation, David McCann discusses the challenges with IT cost allocation methodologies and their utility for managing consumption of IT resources.   He cites a CIO Executive Board study that shows 72% of organizations surveyed who use a lump sum allocation method for IT related costs, which provides little or no connection to the amount of services consumed.  This provides consumers of these resources absolutely no incentive manage and consume fewer IT resources.  Only a small percentage of respondents indicated that they used a granular chargeback method based on actual resource consumption and a unit price for these services. 

There are 5 critical aspects of a successful management system for shared services such as IT:

• Streamlined Processes - the level of effort required to track and report usage charges needs to be automated
• Transparency - the allocation methodology must traceable by the consumers or they will assume it's a lump sum (or arbitrary) allocation
• Accountability - it's important to hold the service provider accountable for keeping costs low
• Empowerment - it's important for consumers to understand how their activities affect their utilization of services that are provided to them
• Capacity - understanding capacity utilization is the key to operational efficiency

The prevailing method of chargeback can at most only accomplishes 2 out of the 5 key objectives: Streamline Operations and provide insight into Capacity.  What's missing are the 3 most important elements: Cost Transparency, Accountability and Empowerment.  Without these, the IT will never be able to demonstrate the value they provide to the business.  The missing link here is that they fail to map the resources to the processes (or activities) that consume them.   For example, it's easy to understand how to manage your mobile phone plan because the units of cost are expressed in terms of minutes of talk time and number of text messages  What if your provider billed you based on CPU utilization, server storage and bandwidth utilization (both internal and external)?  Would you be able to manage your plan usage?  Probably not.  Only by linking the resource consumption to business processes that consume them, blurring the lines as David refers to it, can you better align your IT organization to the business and empower the business to manage their utilization of IT effectively.

Don't underestimate the size of this divide.  It's enormous.  David McCann's article highlights the fact that any of the companies surveyed still had trouble linking the resources to the actual business processes that consumed them, so they didn't really understand how they could manage their consumption.  However, the solution he highlights addresses only one aspect of a successful shared services management process, namely empowerment.  That's because you've only linked the drivers of consumption to the business processes and determined the cost using a price based on actual expenses. So you can successfully charge out your services using unit costs that your customers understand, but they have no assurances that this is really the best price for that particular service?  Would it be more cost effective to outsource that particular service?  Can you even determine the true unit cost of this service using this methodology?  Unfortunately, the answer is no.

This is why accountability is also important because without it, most companies will never achieve their desired efficiencies in IT I&O.  The best way to determine the actual unit cost is detailed in Brendan Fox's white paper, Using Activity-Based Costing to Improve Shared Services Allocations, where he describes how to use Time-Driven Activity-Based Costing (TDABC) to identify capacity rates to establish pricing as well as a cost recovery methodology that holds the service provider accountable for the actual costs and the charged out costs.  This best-practice approach is currently in use at several leading financial services organizations.

The key to enabling both empowerment and accountability requires transparency or no one will believe the numbers.   This turns out to be much more complex than you might imagine because the service provider organizations (inside and outside of IT) often have reciprocal consumer and provider relationships with one another.  Finding a solution that can perform reciprocal allocations can be difficult (hint: Excel is not one of them).  Finding a solution that can demonstrate how costs got allocated at every step of the way across these complex relationships narrows down your choices even further.  The cost of not providing this level of transparency is enormous because without it, it is nearly impossible to drive the kind of operational change management that leads to meaningful efficiency gains. 

So, if you really want to do more with less, don't overlook empowerment, accountability and transparency.  A key enabler for these is linking the drivers of consumption to your business processes.  IT and the business will need to reach out to one another to bridge this gap or these three most important elements of a chargeback system will never be realized.  This is even more critical in organizations that have embraced virtualization and other forms of cloud computing that obscure visibility into IT infrastructure and operations.