This is part 4 of a running series on how to pull together key service management activities to support executive business decision making. Part 1 provided an overview of a 5-Step approach for pulling together actions and data for executive decisions. Part 2 addressed how to identify company services. Part 3 looked at how to apply service discovery and mapping, or “bill of materials” that support each of those services. In Part 4, we will look at how to translate all this into service costs and unit costs. The outcomes of this effort are where executive leadership can see transparency in how their IT investments are being applied to support decision making and IT strategy.
A recap of what we are doing in this step, is to present a picture of how costs are consumed. Simply presenting costs in terms of assets and cost pools indicates what the IT spend is but provides only a cost overhead view of IT. Looking at costs by service can uncover hidden waste as well as a view of how the business is actually consuming those costs.
IT Cost Dimensions
IT costs are typically viewed in ways that do not give the business an understanding of what they are buying. Most IT organizations will take an “asset” based view of their costs (the columns in Figure 1). This merely provides the business with an accounting for what is being spent but leaves the business (as well as IT) blind as to how these costs are being consumed and whether that consumption is even valid. As an example: If we determine that Email services are costing $500,000 per year with a unit cost of x% per mail, we can compare those costs to industry observations. If they are deemed above those, there may be an opportunity to reclaim those additional costs.
The goal of this step is to identify the current costs for delivering each service and the unit costs that drive each service. A suggested approach for this is as follows:
Step 1 – Gather Known Current Costs
Gather all known cost information and assemble it in one place where it can be easily obtained and referenced. This involves collecting all the relevant IT financial documentation and existing budgets, cost pools and allocations. These may include items such as:
- IT budgets
- Asset costs
- Costs by cost pool
- Capital budgets
- Fully burdened personnel costs
- Project costs
- Indirect costs
- Costs for 3rd party vendor services
- Chargeback revenue
- Cost forecasts
The above will become your baseline cost model. That will be the source of truth for any cost discussions as it comes from company accounting systems and sources. Our service model is just an allocation of that information from a service perspective.
Step 2 – Apply (Group) Those Costs To Service Assets
We’ll illustrate this using the spreadsheet example for service mapping described in Part 3 of this series. In this case, we have previously identified which assets underpin each service. This step now translates those assets to costs. Remember that we indicated that assets with percentages that indicate whether an asset is 100% dedicated to a service, shared amongst services, or not used at all for a service.
The illustration below shows our spreadsheet populated with allocation of costs to each service. It takes the cost of each service asset and apportions it by the percentages in the spreadsheet converting them to dollars:
Service Cost Allocations Example
In the above example, the Control Total represents the sum of all costs for each asset in each row. This total should match the asset costs identified back in Step 1 when the costs were originally identified. The grand totals of all costs should be equal to what was collected in that step. The result of this step merely presents those costs in a different view.
Note the Totals row at the bottom of the spreadsheet. This total now represents the estimated costs by each service being delivered. At this point, services have been identified and costs have now been aligned with those services delivered.
Step 3 – Add In Project Costs
A project is a creation, enhancement or removal of a service. Add in project costs for each service by identifying costs for each project and adding that cost to the service that the project has been associated with.
Step 4 – Determine Business Drivers
Business drivers are business events that drive the consumption of each service you have identified. The volumes of these are key. For example, if the costs/consumption of a service is driven by the number of employees in the company, then indicate that Employees is a business driver for that service, what the current number of employees is today, and what the number of employees is forecasted to be in the future. Examples of business drivers can include:
- Number of employees
- Sales Revenue
- Sales Transactions
- Number of widgets or products manufactured
- Number of customers served
- Number of customers orders
- Number of warehouses or locations
- Pattern of business activity (e.g. number of product tests run)
Step 5 – Calculate Service Unit Costs
Calculate the unit costs for each service by taking the business drivers for each service and dividing their volume into the total cost for each service. As an example, look at the HR Support service in our spreadsheet example. If we have determined that the driver volume for this service is 1,000 employees, then the IT unit cost for the HR Support service is $2,980.00 for each employee. If manufacturing is producing 3,500,000 widgets, then our unit cost is $0.85 per widget.
Also think about the insights from modeling the future volumes! If the number of employees is expected to rise from 1,000 to 1,250, then our predicted costs would be $3,725,000 for HR costs or $745,000 more that would be needed for HR to accommodate this growth. Likewise, if widgets made goes up to 4,000,000 then costs would be $3,400,000 or a $420,000 increase to make more products.
Step 6 – Validate Your Cost Model
Use the information collected in Step 1 to ensure that your total IT costs match those from the company financial information. Remember that those are the records of truth in the actual spend for IT activities. The exercise we’ve done here merely recategorizes those costs by services and units.
Step 7 (Optional) – Creating Service Cost Ledgers
At this point, the information developed earlier can be translated into an IT Service Ledger. A separate ledger can be created for each service showing its costs and contribution. The contribution can be made up of actual revenue gained from chargeback for the service or can be expressed as a value amount in terms of the business revenue it helps bring in.
An example of this can be shown as follows:
IT can now articulate not only costs by service, but the contribution of those investments to the bottom line of the company.
By the end of this step, you can see that we have developed extremely valuable information for the IT leadership. For senior executives we have now identified:
- The services that IT is delivering to the business
- The costs for each service being delivered
- The demand and unit costs that consume each service
This is invaluable information for forecasting future IT costs, identifying unreasonable unit costs and justifying business cases for IT spend. Typical excitement starts to build amongst executives, sometimes in the following areas:
- Executives may see services that are not worth the costs being put into them.
- Executives can see a clear delineation between how IT costs are impacted or changed based on business activity.
- Executives may see opportunities to address costs that appear to high, or to shift these to more higher value activities.
- Executives may see the kinds of investments that need to be made to support key business decisions.
The next step is to determine what to do about the information that has been obtained. If we see services out of whack, what should be done about them? The actions taken will help drive the IT strategy. Part 5, our last part in this series, will take a look at how IT strategy can be driven from the service models and cost information derived so far.