Maximizing IT Investments: Cost Recovery Strategies

1. Chapter 15 Measuring IT Investments and Returns

2. Introduction • With increasing competition, cost pressures, and outsourcing opportunities, organizations increasingly focus on Return on Investment (ROI) • Firms need an objective financial measure for understanding costs of IT as well as the benefits • IT accounting is difficult, but, given the strategic nature of this expenditure, necessary for sound decision making

3. Accounting for IT Resources • Accounting is the process of collecting, analyzing, and reporting financial information about an organization • Financial Accounting – information available to outside organizations (banks, stockholders, government) • Follows carefully crafted rules; results in a balance sheet and an income statement • Managerial Accounting – information useful internally in support of the management process • Firms establish own rules and tailor to internal processes

4. Objectives of Resource Accountability • The objectives help measure the progress of the firm’s operational and tactical plans • They form a basis for management control • Control is the process in which employees act in accordance with the firm’s policies and plans • Effective control must be preceded by policy setting and planning • Budgetary control is the process of relating actual to planned expenses

5. IT Accounting Establishes • Continuity between planning and implementation • A mechanism for measuring implementation progress • A basis for management control actions • Linkage of IT actions to the firm’s goals • Communication of plans and accomplishments • A basis for performance appraisal information • Financial benchmarks

6. Recovering Costs from Client Organizations • IT cost accounting and cost recovery provides a basis for clarifying the costs and benefits of IT services • Helps to reveal the important role IT plays within the firm • Strengthens communication between IT and client organizations • Helps to objectify organizational alignments

7. IT Cost Recovery Benefits 1. Helps clarify costs/benefits of IT services 2. Highlights IT’s role within and contribution to the firm 3. Strengthens communication between IT and user organizations 4. Permits IT to operate as a business within a business 5. Increases employees’ sensitivity to IT costs and benefits 6. Spotlights potential unnecessary expenses 7. Encourages effective use of resources 8. Improves IT cost effectiveness 9. Enables IT benchmarking 10. Provides a financial basis for evaluating outsourcing

8. IT Cost Recovery Disadvantages • Administrative overhead • Some managers prefer to keep their operations opaque • Cost sensitivity is not an issue for IT • Organization is not concerned with expenses • Not in the organization’s culture

9. Goals of Chargeback Systems 1. Be easily administered 2. Be easily understood by customers 3. Distribute costs equitably 4. Promote effective use of IT resources 5. Provide incentives to change behavior

10. Alternative Accounting Methodologies • Two major alternatives exist for handling IT cost recovery • Profit center approach • Cost center approach • Both distribute IT costs to users but vary in the impact and incentives placed on the IT organization

11. Profit Centers • IT operates as a business within a business • By charging customers for services, the IT organization recovers its costs and expenses • The organization can generate a profit or incur a loss • IT managers must be business managers

12. Advantages of IT Profit Centers 1. Easy to understand and explain 2. Promote business management 3. Provide benchmarks and comparisons 4. Establish financial rigor 5. Enable outside sale of services

13. Cost Centers • Each client organization budgets its anticipated IT services during the corporate budgeting and planning cycle • The sum of the budgets is IT’s cost support • This approach encourages interaction between IT and clients during the planning stages

14. Characteristics of the Cost-Center Method 1. Promotes intensely interactive planning and budgeting 2. Establishes prices in advance of known support 3. Forces IT and client managers to handle variances 4. Exposes the planning process to manipulation 5. May lead to conflict (which may be beneficial) 6. Forces decision making 7. Reinforces the SLA and capacity-planning processes

15. Additional Cost-Recovery Considerations • No single scheme for recovering costs works for every type of service • Managers must tailor the chosen cost recovery method to take advantage of and optimize for the specific service characteristics

16. Funding Application Development and Maintenance • These functions are well suited to customized or unique cost-accounting or cost-recovery approaches • Commonly funded as a long-term contract for support • Has inherent flexibility • Accounts for work in a general way • Projects accounted for in this manner create incentives for thorough planning and disciplined phase-review processes

17. Cost Recovery in Production Operations • Attempt to recover cost by charging for resources used in the production of useful output • Pages printed, memory used, CPU cycles consumed • Difficult to develop the charging algorithms • Pricing creates incentives and can affect users’ consumption of resources • Less cost for overnight or weekend CPU cycles

18. Network Accounting and Cost Recovery • Network accounting is difficult because the interactions between applications, processors, and storage make it difficult for clients to understand the incentives • Corporate network managers must understand operational costs and expenses, and the effect expenses have on service levels • This knowledge can be used to help optimize applications and their network demands to decrease costs for clients and the firm

19. Relationship of Accounting to Client Behavior • The goal of user-chargeback processes is to encourage and promote cost-effective use of IT services • Cost-recovery actions can create powerful financial incentives that modify behavior • Motivations present in accounting and chargeback mechanisms can help improve the firm’s performance

20. Some Additional Considerations • The purpose of the managerial accounting system is to serve managers, not to devise highly precise accounting processes • If the system controls, communicates, motivates, and helps measure and plan as management desires, then additional accuracy and precision in the accounting processes may not be justified • Sacrificing accuracy can reduce administrative overhead

21. Managers’ Expectations of Accounting Systems • Cost-recovery systems should be designed for clients • Clients expect fair distribution of IT costs and consistency • Frequent or unusually large price changes upset plans and diminish confidence in the IT organization’s ability • IT managers expect these systems to help them understand how IT is spending resources to advance the firm’s goals

22. Special Considerations for E-Business Systems • E-business strategies originate from and are justified at the firm’s highest levels and are strategic in nature; they are less amenable to ROI calculations at lower levels in the firm • what matters most is that costs are identified, controlled, and justified in some manner • who does the work or who owns the assets is far less important

23. Measuring IT Investment Returns • For many IT projects like those leading to improved quality or customer service strict ROI calculations frequently show a negative or low return • Due to the nature of the calculation not able to capture the business dynamics resulting from the investment • Henderson’s Option Model may provide an alternative assessment

24. Measuring E-Business Investment Returns • “ROI is a simple tool, but it may be [too] simplistic in the context of e-business projects.” • Measures investment returns to the firm but fails to account for possible returns to customers and suppliers • Fails to measure improved responsiveness or increased collaborator satisfaction • B2B or B2C e-commerce

25. Summary • IT resources are widely dispersed, making accounting processes difficult • Accounting for IT resources helps managers with planning, controlling, communicating, and assessing performance • Chargeback methods are very important to IT managers • IT accounting systems are not an end in and of themselves but a means