18 June 2012

Setting the right amount for the IT budget

I regularly see questions in the press and in social networks along the lines of: “What is the right amount to spend on IT?” Often the debate descends into variations of: “It depends.” For years I used to smile quietly to myself as I watched these debates. Why? Because I had the secret formula! Simply count the number of knowledge workers in the organisation (better still the number of full-time equivalents) and multiply by a unit price (until recently £4K - £5K) and you would be pretty much there. Oh, I know there is a lot to challenge with my formula but it was much quicker, easier and no less accurate than all the debate or a benchmark from one of the big analyst firms. Unfortunately, in recent years, my secret formula has stopped working so I turned to some of my trusted advisers to find out what had happened and help me fix it.

Muz Janoowalla and Joanna Jones are members of PA Consulting’s Decision Sciences team and are experts in helping organisations make high-value business decisions, including assessing the costs and benefits of IT programmes and whole departments. Marc O’Brien is CIO of GSTS Pathology, a former IT Investment Director for BAA and an expert in delivering high-quality IT services to businesses and their end-customers. In an evening of intense but good humoured discussion we tried to develop a new formula.

Marc highlighted the first stumbling block. Organisations now have very different ways of categorising IT and related technology spending. As an analogy consider how a list of retail banks must now include major supermarkets or how broadcasting and telecoms are merging into a single market. In a similar way the traditional boundaries of IT spending are breaking down. Is sourcing content for the company web site an IT cost? What about search optimisation services and other techniques to drive up web traffic? If you put a URL in an advert in an online magazine is that IT spending? Should switches and monitoring devices in the SMART grid count against the IT budget? If you decide RFID tags attached to consumer products are part of the product bill of materials does that extend to the mobile devices and back end systems which track them?

Another challenge we discussed is that my old formula relied on IT just being a back office support tool. Now IT is a core part of how organisations attract, retain and serve customers. For many organisations IT provides the delivery channel for key parts of their product and service portfolio. This transformation still has some way to go. We have already become used to phones and cars being computing powerhouses but even simple mechanical devices such as medicine sprays are being enhanced to keep track of usage and doses. As 3D printing migrates from an expensive technology for laboratory work and niche manufacturing to becoming a tool for home hobbyists the distinction between IT and physical worlds will continue to erode.

One solution to this problem is to abandon the formula all together. Muz argued that since IT is becoming intertwined with the whole business the IT budget is becoming the operating budget. Another issue is that in other situations simple calculations fail when applied to IT. Marc pointed out that on a strict shareholder value basis most IT investments appear to be value destroying. A multi-million dollar upgrade to your ERP system will not reduce costs further and a CRM upgrade is unlikely to develop any new customers. However, this does not mean that you should abandon these projects. It just means that the measurement paradigm is wrong and does not adequately capture this “value sustaining” work.

Unfortunately, for as long as the CEO, CFO and CIO posts are held by different individuals there will be a need to account for IT spending and a need for measures which can be used for forecasting and control.

We will keep working on a new formula but I came away from our first session with an outline shape for it. We think it will have a set of weighted factors covering:
  • knowledge workers as in my old formula
  • desired margin levels
  • desired customer retention levels
  • expected rate of revenue growth
  • grade of products/services (think Ferrari vs Skoda)
  • forecast balance sheet value of information assets.
Watch this space for an update when we have developed this further. In the meantime add a comment to this blog or use the Twitter button below to let us know your thoughts.

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