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The Catch 22 of IT Cost Management

  • April 01 2001, 1:00am EST
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Over the last few months, the number of companies issuing warnings with respect to current and future business performance has turned into a flood as economic growth slows. Once-high-flying stock market stars such as Lucent, Dell, Motorola and even mighty Intel have all acknowledged that estimates of future business growth were overly optimistic. In many cases, these announcements have been followed by promises of significant cost reductions and layoffs.

We have been here many times before. However, the circumstances in which information technology (IT) finds itself this time appear a little different, and that poses an interesting challenge. In past downturns, the standard operating procedure has been to dramatically curtail selling, general and administrative (SG&A) spending and severely limit spending on projects. This usually means hiring freezes, tight time and expense (T&E) controls and the cancellation or deferral of IT projects. Today, many senior IT executives are caught in a tough situation. Along with their colleagues in finance, human resources and other business support functions, IT is under pressure to reduce costs. However, at the same time, the rest of the business is predicating its own cost or productivity improvements on the deployment and leverage of new technology, be it through completing full deployment of enterprise resource planning (ERP) or customer relationship management (CRM), Web-enabling core business processes or other such technologies.

On one hand, the challenge for IT managers is to cut costs. On the other hand, IT managers must meet significantly increased demand for their services which are seen as critical to meeting overall cost-reduction goals. How are companies solving this conundrum? We are seeing three trends.

First, it is no longer possible to isolate IT spending from overall business process costs. The convergence of process and technology is such that they are indistinguishable. Hence, when considering IT spending, it only makes sense to do so in terms of the direct impact on overall business process costs and metrics. In essence, there is no such thing as an IT project anymore. Reaching this conclusion leads to a different perspective on the evaluation of IT investments. Instead of the historically vague link between investments in IT and business benefits, companies are adopting a much more rigorous assessment process. Step one involves directly linking the technology-enabled cost, productivity and quality improvements expected to the investments being made. Step two is to then tie incentives and rewards for IT directly to the realization of those benefits. This in turn can lead to more effective planning and sourcing of technology services to manage the risks of failing to realize the expected return. Many companies are still wrestling with a significant skill shortage in key enabling technologies such as the Web and wireless. The result is an increasing and often expensive reliance on third parties for such skills, which only heightens the need to aggressively emphasize return on investment in these cost-conscious times.

Second, some companies are viewing IT cost management on a different basis than simply controlling the growth in absolute spending. Whereas most cost-reduction targets given to business support functions are expressed as percentage reductions in budgets, some companies now address IT costs in relation to overall business efficiency. For example, increases in IT spending are tied to improvements in key metrics such as gross margin, new customer acquisition and time to market. This recognizes the increasingly direct relationship between IT investments and measurable changes in key performance indicators. By balancing absolute spending limits with measures of return on investment, it becomes easier to establish clear accountability and reduce the risk of making short-sighted choices when prioritizing projects.

At one major high-technology company that is adjusting to the new reality of lower growth, senior management has set targets for IT expenses to grow at two to three percent less than revenue while demanding absolute cost reductions in other areas. While this may seem like a recipe for major spending growth, it is balanced against a requirement that all IT projects be based upon a clear causal relationship between the investment and the business return. Such is the focus that IT management's incentives are almost wholly based upon the realization of the projected business returns, not on adherence to an IT expense budget.

Finally, speed matters. Companies are seeking to dramatically reduce the cycle time before benefits start to be realized. Gone are the days of commissioning projects and then waiting two or three years for the first benefits to be realized. It is simply too risky. Business management is demanding tangible results every 90 days. IT and its business partners must establish a clear and sustainable stream of benefits over the life of a project. This is especially true of long-term infrastructure or research initiatives that are often susceptible to cancellation or deferral when belts are tightened. In many situations, this can be a shortsighted decision which simply creates problems for the future. The risk of such deferral can be reduced if the initiative is shown to have short-term as well as long-term benefits. This also serves to reduce the overall project risk and increase management confidence in making the investment.

Adopting more balanced techniques for evaluating and prioritizing IT investments is crucial if companies are to reduce cost through technology-enabled transformation of their business processes. The introduction of tools such as benchmarking, real options and strategic sourcing can all drive greater linkage and clarity between IT investments and business results. Now, more than ever, the application of such an approach is necessary if arbitrary IT budget cuts to meet near-term cost reduction goals are not going to translate into long-term performance issues.

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