2013: Not The Year Of The CIO – Yet Reply

It is highly unlikely that this will be the year of the CIO.  Tom Curran is entirely correct that CIOs need to get closer to business units to prove their value.  After years of uncontrolled IT budgets and then recent vicious cost reduction programs CIOs need to prove that they are more than email, storage and security.  CIOs need to be proactive in supporting the cost of businesses and that means developing capability.

Firstly, there are 3 types of business tech: (i) embedded systems such as robotics, (ii) operational systems such as customer ordering systems, and (iii) management information systems  such as email, ERPs, ERMs, collaboration tools etc.  The first two are largely accounted for in the cost-of-goods-sold but the latter is usually accounted for as overhead in SG&A.  Although their worth is unquestionable (could a large company really do without email these days?), it is these MIS systems which are notoriously hard to prove the value of.

There is still little evidence that MIS directly increase profitability.  Corporate IT spending largely increases in accordance with SG&A costs which tells us 2 things: (a) that as companies grow and increase their revenue they increase their management commensurately, and (b) IT is bought to connect this management.  There is not some inflection point where systems are bought, magic happens and companies become organised.  Organisation is the job of the business but enabling that by bringing distributed human communities together through electronic communications is the primary purpose of MIS.

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In order to become the critical enabler that it has always wanted to be IT needs to focus on capability and not just costs.  Although Tom suggests that this will be achieved through in-house architects I would suggest that in-house capability is too hard and costly to maintain at the requisite level to actually analyse and build business capability.  The only function that should be retained and honed, in-house, is information mangement.  Businesses need to be absolutely certain about exactly what information (at an atomic level) actually makes them money  – and how.  Outsiders without the context, peripheral information, subtext and political insight cannot adequately contribute to this role.  Only once the business understands its financial the anatomy of its fianancial dependencies can it adequately source architectural support in order to build business capability.  The business which misses the point and only develops architecture is just gilding the lily and will just be rewarded with a higher overhead burden which they need to chargeback to disgruntled internal customers.

Is this achievable in 2013?  The likelihood of this belies my underlying assumption that CIOs do not belong in the C-Suite.  As critical as technology and information is to business it is only a critical enabler and not a separate function in itself.  Due to the radically different skills which the technical community possess I do not believe that they will ever be able to set the agenda in non-digital industries.  Putting CIOs in the C-Suite merely overemphasises the importance of technology as an end and not merely the means.  It is here I think that standard operations should stop abdicating its responsibility and start setting the technical agenda and this will certainly not happen in 2013.

The Failure of Risk: lessons from the GFC Reply

risk management. hop scotchWe live in uncertain times. The failures in risk management which lead to the global financial crisis have created an unprecedented set of circumstances. Not only are regulators imposing heavier compliance burdens but shareholders and investors are demanding greater reporting and higher levels of information transparency. On top of all this operational costs are too tight to carry the overhead of separate risk and assurance functions.

When the analysis is done there are 6 key lessons to learn from the global financial crisis:

  1. Integrate G, R & C.  In medium and large corporations isolated risk management practices actively work against the business.  Technical and operational experts will identify risk from experience and create risk slush-funds to mitigate them.  These increase the cost of business and in many cases price the company out of the market.  In an integrated GRC system the firm is able to manage risks across business units so that the risk funds are held centrally and do not add a premium to initial project costs.  Risk identification and analysis percolates from the bottom up but governance is driven from the top down.  In an integrated system they both to work within the business lifecycle to add the right mix of checks and balances so that no additional drag is added to investment/project approvals.
  2. Make Passive GRC Active.  Systems need to be active.  They need to hunt out risk, define it, quantify it and measure the dependencies of the risk.  Then, those same systems need to bring it to the attention of the executives so that they may make informed investment decisions.  In the end, humans follow the law of least effort:  employees will follow the path of least resistance in designing and gaining approval for their projects.   GRC must not follow a system of honour & audit but rather one of  active assurance.  When GRC systems are passive the business lifecycle becomes clogged with nugatory and useless program reviews that turn into technical sales pitches by design teams.  Such events and practices only serve to affirm the belief that GRC is a legal burden and one which only serves to satisfy the needs of regulatory compliance.  Raytheon, for instance, have an excellent system of governance-by-exception.   Their Integrated Product Design System (IPDS) has active governance measures and allows Raytheon to manage a pipeline of thousands of critical projects dynamically and by exception.GRC
  3. Get Granular.  When projects fail it is not usually because the risks have not been adequately managed.  The primary problems in risk practices are the failures of risk identification and analysis.  Managers are simply unable to deal with risks at a granular level and then weigh them up on a per project basis.   This is largely because the technical skills needed to do so are not within the standard sets of most executives (but they are within the more mathematical ones of the FS&I industry).   Where this disparity exists then businesses need to develop separate Red Teams or Assurance Teams, either from the existing PMO of from hand picked executives.
  4. Bottom Up & Top Down.  Risk management is bottom-up but governance is top-down.  The technical skills and software reliance involved in effective risk management mean that the entire practice usually percolates from the bottom of a business, upwards.  Consequently, unless it fits within a comprehensive governance framework it will be open to being gamed by senior executives.  This is why major projects which are seen as must-win are often approved with little or no governance or assurance.
  5. Risk Ownership.  Risks need to be owned at the lowest responsible level.  This is to say that when things go wrong the person at the lowest level who has the greatest amount of operational responsibility must be able to take charge to mitigate all aspects of the risk.  It is vital that the person owning the risk be able to recognise the variables which may see the risk realised.  It is also critical that the risk owner understand the corporate decision points, i.e. the points at which the contingency plans should be triggered.
  6. Invest in the Right Type of Risk Culture.  Risk should not be a dirty word.  Risks are inherent in every project and balancing them quantitatively and qualitatively is an essential skill for all senior executives.  Risk should be as much about seizing opportunity as it is about guarding profitability.  Businesses need to invest in top talent in order to drive good risk practices from the top.  Effective, Active-GRC involves a complex array of tools, practices, structures and processes which need an experienced senior executive to drive them constantly and consistently in the business.  The softer side of risk management cannot be neglected.  The nature of risk forces people onto the defensive as they attempt to justify all aspects of their project designs.  CROs need to help executives understand that all projects must balance risk if they are to attempt to push profitability.  Otherwise, risk cultures will mire companies in conservative, risk averse cultures which only act to add friction and reduce profitability.

Risk practices need to work together inside a single, comprehensive risk framework that goes beyond simple probabilistic modelling and disjointed regulatory compliance.   Businesses need to implement processes which not only integrate the business lifecycle but actively increase both liquidity and opportunity for risk to be seen to add real value to the company.   Only once this is achieved can risk management cease to be an operational drag for the business and become a value-adding proposition which works actively to increase the profit and performance of a company.

 

Information Outsourcing Reply

Although the Gartner article deals with the monetisation of information assets, the sentiments may lead many businesses to outsource their entire information management responsibility.

The volume of data that most businesses can – or think they should be able to – manage is reaching an inflection point.  Businesses which grasp how analytics supports their revenue model will be able grapple with the continuing demands of information management (IM).  Businesses which cannot cope with the perceived threat of information overload may seek to outsource this responsibility.  The former will survive, the latter will fail. The research is clear:

  • IM is critical business:  derogating from one’s IM responsibility leads to an overall loss of revenue as businesses are unable to respond to market trends, develop appropriate differentiators, design suitable new products and services as well as leverage their information and knowledge for wider benefit.  Information is a firm’s core business, whether they like it or not.  Outsourcing the responsibility to understand the intricacies of a company’s business model and dependencies into the extended value net is a recipe for disaster.  Businesses should use all available software and technical expertise to do this but must do so with internal resources.
  • Outsourcing accounts for cost differentiators not key value drivers:  Firms which seek to cut costs by outsourcing their IT function do not recoup their losses.  The lessons of Ford, GM and Levi Strauss still remain.  Businesses which outsource their entire IT function continue to lose economic-value-added (EVA).  Although it is a good idea to outsource platforms and infrastructure it is rarely beneficial to outsource applications and services which are deeply intertwined with the more social aspects of a company’s business processes, i.e. if your process isn’t rigidly vanilla and perfectly understood then don’t outsource it.  Banks have well documented electronic processes which allow customers to manage their money and transactions remotely.  Even so, they manage these processes internally because it’s core business.

Businesses which purport to leverage economies of scale in order to be able to make sense of a firm’s information are not telling the whole story. It is virtually impossible to crunch structured and unstructured data to squeeze out additional value unless the vendor has also programmed the client’s value chain and key differentiator’s into their big-data algorithm.

“IM is not a software problem it is a business problem.  Regardless of the promises by vendors they will never be able to support management in their daily needs to navigate the subtleties and complexities of corporate information.”

It is highly likely that by 2016 the next fad, after Big Data, will be the monetisation of a firm’s information assets.  No doubt that in the low-end of the market there will be some level of commoditisation of information which will support more targeted marketing and the procurement of specialist advertising services.  However, businesses which outsource critical IM functions (largely through cost pressures)  in their business will turn unprofitable (if not already) as they become unable to respond to the market.

Building a Risk Culture is a Waste of Time 3

The focus of a good risk management practice is the building of a high-performance operational culture which is baked-in to the business.  Efforts to develop risk cultures cultures only serve to increase risk aversion in senior executives and calcify adversarial governance measures which decrease overall profitability.  The right approach to risk management is a comprehensive, holistic risk management framework which integrates tightly with the business.

risk management. waste of timeThe financial crisis is largely due to the the failure of risk management and over-exposure in leading risk-based institutions.  More specifically, the failure of risk management is linked to:

  • The failure to link link risk to investment/project approval decision making.  The aim of risk management is not to create really big risk registers.  Although, in many organisations one could be forgiven for thinking that this is the goal.  The aim of identifying risks is to calibrate them with the financial models and program plans of the projects so that risks can be comprehensively assessed within the value of the investment.  Once their financial value is quantified and their inputs and dependencies are mapped – and only then – can realistic and practical contingency planning be implemented for accurate risk management.
  • The failure to identify risks accurately and comprehensively.  Most risk toolsets and risk registers reveal a higgledy-piggledy mess of risks mixed up in a range from the strategic down to the technical.  Risks are identified differently at each level (strategic, financial, operational, technical).  Technical and Operational risks are best identified by overlapping processes of technical experts and parametric systems/discrete event simulation.  Financial risks are best identified by sensitivity analysis and stochastic simulation but strategic risks will largely focus on brand and competitor risks.  Risk identification is the most critical but most overlooked aspect of risk management.
  • The failure to use current risk toolsets in a meaningful way.  The software market is flooded with excellent risk modelling and management tools.  Risk management programs, however, are usually implemented by vendors with a “build it and they will come” mentality.  Risk management benefits investment appraisal at Board and C-Suite level and it cannot be expected to percolate from the bottom up.

RISK MANAGEMENT IS COUNTER-INTUITIVE

All this does not mean that risk management is a waste of time but rather it is counter-intuitive to the business.  It is almost impossible to ask most executives to push profits to the limit if their focus is on conservatism.  Building a culture of risk management is fraught with danger.  The result is usually a culture of risk aversion, conservatism and a heavy and burdensome governance framework that only adds friction to the business lifecycle and investment/project approval process.  Executives, unable to navigate the labyrinthine technicalities of such a systems achieve approvals for their pet programs by political means.  More so, projects that are obviously important to the business actually receive less risk attention than small projects.  Employees learn to  dismiss risk management and lose trust in senior management.

If risk management is to be an effective and value-adding component it must be a baked into the business as part of the project/investment design phase.  If not, then risk management processes  just build another silo within the business.  The key is to forget about “Risk” as the aim.  The goal must be a performance culture with an active and dynamic governance system which acts as a failsafe.  The threat of censure is the best risk incentive.

risk management. immature disciplineAWARENESS IS NOT MANAGEMENT

risk management. immature disciplineManagement has long been aware of risk but this does not always translate into true understanding of the risk implications of business decisions.  Risk policies and practices are often viewed as being parallel to business and not complimentary to it.

Why is it that most businesses rate themselves high on risk management behaviours?  This is largely because businesses do not correlate the failure of projects with the failure of risk and assurance processes. 

In a 2009 McKinsey & Co survey (published in June 2012 “Driving Value from Post-Crisis Operational Risk Management”) it was clear that risk management was seen as adding little value to the business.  Responses were collected from the financial services industry – an industry seen as the high-water mark for quantitative risk management. 

COLLABORATION IS THE KEY

Risk management needs to become a collaborative process which is tightly integrated with the business.  The key is to incentivise operational managers to make calculated risks.  As a rule of thumb there are 4 key measures to integrate risk management into the business:

  1. Red Teams.  Despite writing about collaboration the unique specialities of risk management often requires senior executives to polarise the business.  It is often easier to incentivise operational managers to maximise risks and check them by using Red Teams to minimise risks.  Where Red Teams are not cost effective then a dynamic assurance team (potentially coming from the PMO) will suffice.  Effective risk management requires different skills and backgrounds.  Using quantitative and qualitative risk management practices together requires a multi-disciplinary team of experts to suck out all the risks and calibrate them within the financial models and program schedules in order that investment committees can make sensible appraisals. 
  2. Contingency Planning.  Operational risk management should usually just boil down to good contingency planning.  Due to the unique skill sets in risk management, operational teams should largely focus on contingency planning and leave the financial calibration up to the assurance/Red teams to sweep up.
  3. Build Transparency through Common Artefacts.  The most fundamental element of a comprehensive  risk process is a lingua franca of risk  – and that language is finance.  All risk management tools need to percolate up into a financial model of a project.  This is so that the decision making process is based on a comprehensive assessment and when it comes to optimise the program the various risky components can be traced and unpicked.
  4. Deeper Assurance by the PMO.  The PMO needs to get involved in the ongoing identification of risk.  Executives try and game the governance system and the assurance team simply does not have the capacity for 100% audit and assurance.  The PMO is by far the best structure to assist in quantitative and qualitative risk identification because it already has oversight of 100% of projects and their financial controls.

Traditional risk management practices only provide broad oversight. With the added cost pressures that businesses now feel it is impossible to create large risk teams funded by a fat overhead. The future of risk management is not for companies to waste money by investing in costly and ineffective risk-culture programs.  Good risk management can only be developed by tightly integrating it with a GRC framework that actively and dynamically supports better operational performance.

Wall Street Beat? The Fiction of 2013 IT Spending Forecasts Reply

Wall Street Beat: 2013 IT Spending Forecasts Look Upbeat.

If this is the case then an organisation with a $USD 100m IT spend is set to increase their capex by $3.3m this year and $6.1m next year.  This represents almost $10m increase in capex in the next 2 years.

I am not sure where they get these figures from?

technology spending. tech rebound. mckinsey chart

If we assume the standard wisdom that economies traditionally take 2 years to recover from recession and a further 2 years to return to trend growth then it will be 2017 before IT budgets hit 3.4% growth.  Given the savage cuts in IT budgets after the recent recession(s) I think these figures are conservative.  A further factor to consider is that the ICT industry is so highly segmented that generalised growth is meaningless.

Looking at the finances of the tech rebound of 2003/3 (shown above in the Mckinsey & Co chart) we can see that – at the high end – IT capex of $73m accounts for 12% of the overall budget.  At this rate, 6% growth equals a $36.5% growth in capex by 2015.

This is, of course,  nonsense.  The moral of the story is:  don’t look at reports of astonishing growth in the tech sector.  Research has shown that the ICT sector is made up of so many tiny segments that even McKinsey’s figures are to be viewed with caution.

In summ, the burst of the 2001 tech bubble saw IT budgets plummet roughly 70%.  There are no reliable current fugures as to the general sum of cost cuts per sector in ICT budgets.  However, if we count on 10-25% overall budget reductions then it will be well beyond 2017 before we see budgets returning to pre-2008 in real terms. If anything is certain, however, tech always surprises.

 

ALIGNMENT: Building a Closer Relationship Between Business and IT Reply

alignment. team workjpgThe business gurus Kaplan and Norton describe “Alignment” as a state where all the units of an organisational structure are brought to bear to execute corporate strategy in unison.  When Alignment is executed well it is a huge source of economic value.  When it is executed badly it is a colossal source of friction which can cripple the business.  The authors go on to note:

Alignment

IT DOESN’T NEED ALIGNMENT, IT NEEDS BETTER UNDERSTANDING

IT and the Business speak of alignment in two radically different ways.  The Business talks about alignment between business units.  When speaking of tech they use words and phrases such as ROI and operational performance.  IT talks about alignment in a way that makes them feel as though they matter to the business.  That profitable, customer facing business units could achieve more if the corporate centre where to align business units under a single, cohesive strategy is one thing.  That IT depts fail to execute strategy or even deliver operational effectiveness through poor understanding of requirements, an inability to see the technical reality of commercial value or realise some of the social cohesion which enterprise software systems need is not mis-alignment – it is just bad practice.

THE RELATIONSHIP BETWEEN THE BUSINESS AND ICT IS DIVERGING

The increasing capabilities of a smarter, more mobile , more virtual workforce means a greater commoditisation of knowledge work.  With this comes the polarisation of Business and ICT.   A broader ICT function with a wider array of narrower and deeper areas of expertise will, increasingly, be incapable of coding the more subtle and complex social aspects of human collaborations.  In such a world the ICT agenda must be set by the corporate centre.

mis-alignment

ICT NEEDS TO FOCUS ON EXECUTION NOT ALIGNMENT

ICT’s economic value will be realised when it (and therefore Enterprise Architects) can support business units to reach across each other to create valuable products and services which justify the corporate overhead.  McKinsey & Co, for instance focus heavily on central knowledge management.  This enables research to drive service line improvement in relevant sectors.  IBM spends over 3 Bn GBP on R&D and the development of leading-edge products way beyond their years.  ICT needs to focus on the execution of corporate strategy and not alignment. Alignment is a structural issue whereas execution is a functional issue.  Stop tinkering with the structures and focus on the functions/operations.

GOVERNANCE – ALIGNMENT AT A PRICE

Moves to improve the business relevance of ICT usually result in heavier, more burdensome technical governance.  The finance function imposes capital project controls on technology projects and insists that benefits be quantified.  Although greater cost transparency will bring IT closer to the Business, heavier ICT governance only serves to drive ICT investment underground.  Pet-projects abound, useless apps proliferate and ICT costs continue to rise.  In the meantime, in a perverse inverse relationship, assurance becomes even lighter on larger programs. 

Alignment takes strong leadership and clear definitions of business intent.  A fancy set of IT tools are not necessary for alignment rather they are important when it comes to agilityMis-alignment is the fault of deep rooted cultural divisions which can only be overcome through the strict adherence to financial value and the use of a lingua franca engendered through a common architectural framework.   If ICT is to realise its potential and add real financial value then it must actively support the real-time execution of business operations.

BUSINESS PROCESS FAILURES: the importance of logical architectures Reply

business process risk. chart

In a recent 2012 survey by McKinsey & Co, IT executives noted that their top priorities were ‘improving the effectiveness and efficiency of business processes’.   One of the critical failings of IT, however, is to implement effective and efficient business process architectures in the first place.  The IT priorities to the left only serve to highlight what we already know:  that IT service companies implement processes badly.

Why?

Whether through a failing of Requirements or Integration (or both), IT service companies often implement inappropriate business process architectures and then spend the first 6 to 12 months fixing them.  This is why those companies ask for a 6 month service-credit holiday.  It is also the same reason those companies differentiate between Transition and Transformation.  The former is where they implement their cost model but the latter is where they implement their revenue model.

The failing is not within the design of the technical architecture.  Very few senior executives report that failed projects lacked the technical expertise.  Likewise, project management is usually excellent.  Requirements, too, are not usually the problem with business process implementations as most commercial systems implement standardised Level 1 or 2 business processes very well.

Logical Archtiectures instantiate the subtleties and complexities of social systems which the software must implement

The first failing in the development of a technical architecture to implement a business processes is the design of the Logical Architecture.  Logical Architectures are critical for two reasons: (i) because requirements are one hundred times cheaper to correct during early design phases as opposed to implementation, and (ii) because logical systems are where the social elements of software systems are implemented.  Requirements gathering will naturally throw up a varying range of features, technical requirements, operational dependencies and physical constraints (non-functional requirements) that Solution Architects inevitably miss.  Their focus and value is on sourcing and vendor selection rather than the capture of the subtleties and complexities of human social interactions and the translation of them into architect-able business constructs (that is the role of the Business Analyst).

The second failing is the development of Trade-Space.  This is the ability to make trade-offs between logical designs.  This is the critical stage before freezing the design for the technical architecture.  This is also vital where soft, social systems such as knowledge, decision making and collaboration are a core requirement.  However, trade-space cannot be affected unless there is some form of quantitative analysis.  The usual outcome is to make trade-offs between technical architectures.   Like magpies, executives and designers, by this stage have already chosen their favourite shiny things.  Energy and reputation has already been invested in various solutions, internal politicking has taken place and the final solution almost eschews all assurance and is pushed through the final stages of governance.

With proper development and assessment of trade-space, companies have the ability to instantiate the complex concepts of front and middle office processes.  Until  now, business analysts have hardly been able to articulate the complicated interactions between senior knowledge workers.   These, however, are far more profitable to outsource other than more mechanical clerical work which is already the subject of existing software solutions.  The higher pay bands and longer setup times for senior information work makes executive decision making the next frontier in outsourcing.

Service offerings

Logical architectures are not usually developed because there is no easy, standardised means of assessing them.  Despite the obvious cost effectiveness logical architectures most Business Analysts do not have the skills to design logical architectures and most Technical Architects move straight to solutions. Logical Architectures which are quantitatively measurable and designed within a standardised methodology have the potential to give large technical service and BPO organisations greater profits and faster times-to-market.

The future is already upon us.  BPO and enterprise services are already highly commoditised.  The margins in outsourcing are already decreasing, especially as cloud-based software becomes more capable.  If high cost labour companies (particularly those in based in Western democracies) are to move to more value-added middle and front office process outsourcing then they will need to use logical architecture methodologies to design more sophisticated offerings.

In the next blog we will show one method of quantitatively assessing logical architectures in order to assess trade-space and make good financial decisions around the choices of technical designs.

The Cost of Capability: a better way to calculate IT chargebacks Reply

IT_Profit_Centre

THE VALUE OF SHARED SERVICES

Almost every C-Suite executive will agree that shared services, done well, are a critical factor in moving the business forward.  The problem is that implemented poorly they can potentially overload good processes and profitable service lines with villainous overhead allocations.

IT chargebacks are important because, used well,  they can assist the business with the following:

  • help IT prioritise service delivery to the most profitable business units,
  • help the business understand which IT services are value-adding to the market verticals, and
  • reduce the overall vulnerability of IT-enabled business capability.

OVERHEAD ALLOCATIONS CAN RUIN GOOD PROCESSES

However, many shared service implementations are poorly received by the business units because they add little or no value and are charged at higher than the market rate.  As Kaplan pointed out in his seminal work “Relevance Lost: the rise and fall of management accounting” the result of poor overhead cost allocation is that perfectly profitable processes and services, burdened by excessive and misallocated overhead costs seem to be unprofitable.  Kaplan goes further and points out that all overhead which cannot be directly incorporated into the cost-of-goods-sold should be absorbed by the business and not charged back to the market verticals and service lines.  This is the fairest method but most businesses avoid this method because high SG&A costs has a negative impact on financial ratios and therefore investor attractiveness.

HIGGLEDY-PIGGLEDY 

In a recent article (shown below) McKinsey & Co pointed out a variety of methods which their client firms use to calculate IT chargebacks.   Even though they differentiated between new and mature models it is worth noting that very few companies charged their business units for what they used (Activity-Based Costing).   Rather, they used some form of bespoke methodology.  This is usually (i) a flat rate, (ii) a budget rate with penalties (for behaviour change), or (iii) a market rate (usually with additional penalties for IT R&D costs).

IT Chargebacks. McKinsey. IT Metrics

 

 

 

 

 

 

 

 

 

 

 

 

 

ALIGNMENT & ACCOUNTABILITY

Chargebacks are essential.  They are a critical means for companies to take charge of their IT costs.  Otherwise, a ballooning IT overhead can destroy perfectly good processes and service lines.  However, chargebacks can obscure accountability.  If they are not calculated transparently, clearly and on the basis of value then there will be no accountability of IT to the business and whose capabilities they enable.  Without  accountability there can also never be alignment between IT and the business.

CHARGEBACK AS AN INDICATOR OF MANAGEMENT-VALUE-ADDED

Traditional methods of IT cost modelling, on which standard chargebacks are calculated, only account for the hard costs of ICT,  namely infrastructure and applications.  It should be noted that chargebacks should only be applied for Management Information Systems (eg, knowledge bases, team collaboration sites such as MS Sharepoint, CRM systems, and company portals etc).  All other systems are either embedded (eg, robotics etc) or operational, (ie mission critical to a business unit’s operations).  MIS are largely used by overhead personnel whereas operational systems and the finance for embedded systems should be accounted for in the cost-of-good-sold.  The real question therefore, is: what is the value of the management support to my business?  The question underlies the myth that Use = Value, which it does not.  Good capability applied well = Value.

THE COST OF CAPABILITY

The cost model, therefore, needs to determine the cost of capability.  Metrics based on per unit costs are inappropriate because the equipment amortises so rapidly that the cost largely represents a penalty rate.  Metrics based on per user costs are unfair because each user is at a different level of ability.  In previous blogs we have outlined how low team capabilities such as distributed locations, poor requirements, unaligned processes etc all have a negative and direct financial correlation on project values.  We have also written about how projects should realise benefits along a value ladderdelivering demonstrable financial and capability benefits – rung by rung – to business units.

It is reasonable to say, therefore, that managers should not have to pay the full chargeback rate for software which is misaligned to the business unit and implemented badly.

It is unfair for under-performing business units to be charged market rates for inappropriate software which the IT department mis-sold them.  If that business unit where a company in its own right they be offered customisation and consulting support.  In large firms the business often scrimps on these costs to save money.  Given the usual overruns in software implementations business units are traditionally left with uncustomised, vanilla software which does not meet their needs.  The training budget is misallocated to pay for cost overruns and little money is ever left for proper process change.

In order to create a fair and accurate chargeback model which accounts for the Cost of Capability, use the following criteria:

  • Incorporate the COSYSMO cost coefficients into software and service costings so that low capability business units pay less.
  • Only charge for  professional services which the business doesn’t own.  Charging for professional/consulting serrvices which are really just work substitution merely encourages greater vertical integration.  This is duplication and duplication in information work creates friction and exponential cost overruns.
  • Watch out for category proliferation, especially where the cost of labour for some unique sub-categories is high.  Don’t let the overall cost model get skewed by running a few highly specialised services.  Remove all IT delivery personnel from the verticals.  Where there are ‘remoteness’ considerations then have people embedded but allocate their costs as overhead.
  • Do not allow project cost misallocation.  Ensure that cost codes are limited.

In order that businesses do not fall into the “Build and they will Come” trap a clear and precise chargeback model should be created for all IT costings.   Businesses should start by charging simple unit costs such as per user.  Everything else will initially be an overhead but firms may then move to a more complex chargeback model later.

It is important that low capability business units do not pay full price for their software and services.  As Kaplan is at pains to point out, where businesses do this they are at risk of making perfectly good processes and service lines seem unprofitable.  The only way to properly broker for external services is to account for the cost of capability.

 

The Complexity of Cost: the core elements of an ICT cost model Reply

cost model. financial modelThere are 2 reasons why IT cost cost reduction strategies are so difficult:  Firstly, many of the benefits of ICT are intangible and it is difficult to trace their origin.  It is hard to determine the value of increased customer service or the increase in productivity from better search and retrieval of information.   Secondly, many of the inputs which actually make IT systems work are left unaccounted for and unaccountable.  The management glue which implements the systems (often poorly and contrary to the architecture) and the project tools, systems and methods which build/customise  the system (because IT, unlike standard captital goods, is often maintained as a going concern under constant development, e.g. upgrades, customisation, workflows etc) are very difficult to cost.

Standard IT cost models only account for the hard costs of the goods and services necessary to implement and maintain the infrastructure, applications and ancillary services.  Anything more is believed to be a project cost needed to be funded by the overhead.

This is unsatisfactory.

The value of technology systems – embedded systems excluded – is in the ability of information workers to apply their knowledge by communicating with the relevant experts (customers, suppliers etc) within a structured workflow (process) in order to achieve a corporate goal.

Capturing the dependencies of knowledge and process within the cost model, therefore, is critical.   Showing how the IT system enables the relevant capability is the critical factor.  A system is more valuable when used by employees who are trained than less trained.  A system is more valuable when workers can operate, with flexibility, from different locations.  A system is more valuable where workers can collaborate to solve problems and bring their knowledge to bear on relevant problems.  So how much is knowledge management worth?

The full cost of a system – the way they are traditionally modelled – assumes 100% (at least!) effectiveness.  Cost models such as COSYSMO and COSYSMOR account for internal capability with statistical coefficients.  Modelling soft costs such as information effectiveness and technology performance helps the business define the root causes of poor performance rather than subjective self-analysis.  If a firm makes the wrong assessment of capability scores in COSYSMO the projected cost of an IT system could be out by tens of millions.

Financial models for IT should therefore focus less on the cost of technology and more on the cost of capability.  The answer to this is in modelling soft costs (management costs), indirect costs and project costs as well as the hard costs of the system’s infrastructure, apps and services.

 

The Complexity of Cost (Pt.2): a 3-tiered strategy for an effective ICT cost reduction program Reply

cost-reduction

In our last blog we recounted that most ICT cost reduction programs fail.  More to the point, we noted how they fail in larger businesses through a vicious cycle following increased overhead from poor process analysis.  All this stems from a limited view of direct and indirect ICT spend.

In summ, the answer is detailed cost modelling of ICT which analyses the firm’s technology in its place as a business capability enabler. This is vital in the current economic climate otherwise businesses will simply benchmark their costs against similar firms rather than try to pare ICT costs to the bone.

The results of traditional IT programs?

  1. ICT cost reduction programs usually only attack the easy and obvious.  For sustained cost management in ICT the cost reduction program needs to attack:  (i) soft costs (indirect spend), (ii) managerial costs and (iii) program costs as well as all the standard hard costs.
  2. Cost cutting reduces capability.  Traditional approach is to cut applications and services as well as heads but capability will eventually suffer.  Senior people are often made redundant was work is pushed from higher to lower paybands.  With them also goes much of the firm knowledge capital and goodwill of the firm.  If we want to quantify this cost of lost knowledge it is the difference between the market value and the book value of a business.

The problem is that IT is usually seen as a black box.  Few senior executives understand the subtle dependencies which stretch from technology throughout the business.  More importantly, few understand that actual capex and opex of ICT  just represents the hard costs of ICT.  In addition to the hard costs are the soft costs, the management costs and the program costs of ICT.  In more detail:

  • Soft Costs relate to all the indirect spend which flows from ICT procurement.  This may include travel for non-IT personnel involved in change, training and customisation or process change etc.
  • Managerial Costs is the accumulated cost of decision making from management.  This is pure overhead and is not accounted for in the Cost of Goods Sold but rather shows up in bloated Sales, General & Administrative (SGA) accounts.
  • Program Costs are the costs of running ICT programs beyond the costs accounted for in the various cost allocation systems.  These can be the cost of running distributed teams, the cost of low development capability etc.  Such cost coefficients are statistically generated.

On top of all these are the hard costs of ICT.

Borrowing diagrams from Accenture  the solution is to run a 3-tiered cost reduction strategy:

strategic cost management.accenture

After the easy stuff is done, the business must ultimately streamline its processes (and align cost structures accordingly) and then lower it non-discretionary spend.  The key is to (i) see the whole process, (ii) understand the dependencies, and (iii) engage locally.

  • Minimise (Hard Costs) –  Tactical Cost Reduction. Grab the low hanging fruit and take out the obvious costs; the costs in plain sight.  Engage locally with account managers and business unit leaders to reduce headcount but understand and model the dependencies by seeing the whole capability.  The Boston Consulting Group advise that managers proceed on third of a third rule, ie 1/3 of all FTEs are non customer facing and 1/3 of those can be removed without adverse impact on the business.
  • Optimise (Soft & Program Costs) –  Proactive Cost Governance.  This involves detailed spend analysis and process optimisation.  Indirect process costs grow like barnacles on a ship.  The longer they are there the more they are accepted but ultimately they increase the financial drag on a business.  Remove all the invented tasks by modelling the firm’s value chain and seeing where the processes fit into larger business capabilities.  Once this is done executives can optimise the key cost drivers and their inputs.  This improves the delivery model for ICT and enables better demand management.  Accompanying these operational actions the business should improve cost governance.  It can achieve this by removing the management structures around excessive process governance.  This requires a more active and dynamic GRC system but ultimately the business feels a lighter GRC touch.  Most importantly, simplify processes and remove the  ‘cost of complexity‘ ie vertical integration and convoluted workflows which increase process time and transactional costs.

cost reduction level.accenture

  • Re-design (Program & Managerial Costs) –  Strategic Cost Management.  In order to achieve significant and lasting cost reduction benefits the business must lower its discretionary spend.  However, managerial cost structures (which are significant) can only be made redundant when the overall complexity is reduced.  Once this happens shared services may be implemented and rationalised.  The ICT offering can be standardised and the business can create re-usable technology components.  Then the business can change its transfer pricing models and look towards offering the customer-facing SBUs a more sophisticated multi-channel mix of capabilities, ie give them the agility to increase their high-end customer offerings.   Only once this is achieved can the business look towards modernising and streamline technical architectures.

The key is to look at ICT as a capability enabler and not as a business unit in its own right.  ICT should have to justify its very existence.  However, once it does and develops full cost transparency then and only then can it move forward in real partnership with the business.