There 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.
In a crisis the company P&L statement can be a useful starting point for cost reduction programs. Over the long term, however, general ledger entries do not have the required level of detail to garner the requisite per unit analysis (McKinsey, May 2010). Unfortunately, few companies do not have systems which can analyse the complexity of cost and spend in order to make accurate and detailed changes.
In the following series of blogs we will highlight the problems with standard ICT cost reduction & management programs and detail how to structure and run one effectively.
The key to an effective ICT cost reduction & management program is detailed cost modelling. Most financial systems do not capture costs at the right level of detail for businesses to perform accurate and detailed cost reductions. Businesses need to perform intricate spend analyses and build up intricate cost models for ICT which highlight the following:
- The capabilities which various ICT components support (and where in the Value Chain they lie). Only through this level of visibility can the business consolidate their ICT spend.
- The HR and process dependencies which are indirectly attributed to various ICT elements. Only with this level of detail can ICT remove duplication and redundancy.
In the absence of this granularity, cost reduction programs invariably fail or fail to stick. In fact, McKinsey & Co note that 90% of cost reduction programs fail. Only 10% of these programs actually succeed in realising sustained cost management three years on.
In a typical IT cost reduction cycle the following happens:
- Headcount is reduced. The remaining people then have to work harder (but with fewer skills, because tasks are pushed to the lower pay bands) to achieve the same amount of work.
- Many, often unique, soft skills are also removed (from experienced people in the higher pay bands) in the redundancies.
- Overall service levels decrease.
- Further cost reductions are then required and some applications and services are axed.
In simple businesses this is not a problem. In large and complex businesses the outcome usually follows a vicious cycle, namely:
- The firm still needs to retain a significant management overhead in order to deal with complexity.
- In these cases, poor transfer pricing and high overhead allocations mean that perfectly good, competitive core business process seem cost-ineffective.
- Critically, Kaplan notes in his seminal work “Relevance Lost: The Rise and Fall of Management Accounting” that the increased costs of processes leads to outsourcing of perfectly good processes.
- Capability suffers and the business loses competitive advantage.
- The business is no longer able to deal with the level of complexity and complexity reaches an inflection point. The business outsources the whole problem (eg, large ERM programs with much customisation), getting locked into horrific terms and conditions.
- Core business is lost and competitive advantage is reduced. Remaining managers pad out their budgets with excessive risk and contingency in order to shield themselves from further cost reductions.
- Overheads increase again and the business eventually prices itself out of the market.
In a recent (2010) Accenture survey on general cost reduction effectiveness in the banking industry, 40% of respondents noted that the program has reduced overall ICT effectiveness and impacted adversely on both customer service and general management.
in order to reduce costs effectively without impinging on capability as well as making new costs stick, it is essential to view costs and spend at the most granular level possible.
In our next blogs we will go into detail how to structure and run an effective ICT cost reduction and cost management program including effective ICT cost modelling.