CIO Update: Use Creative Cost Containment

Transcription

1 IGG L. Sechrest Article 1 October 2003 CIO Update: Use Creative Cost Containment CIOs and other executives need to know the major trends in IT costs, the most effective techniques being used to control them, and how IS organizations can continue to promote and deliver value while controlling costs. CIOs and other executives need to know the major trends in IT costs, the most effective techniques being used to control them, and how IS organizations can continue to promote and deliver value while controlling costs. Changing IT Spending Patterns Because of the weak economic conditions of recent years, IT spending patterns have changed dramatically. Across all industries, IT spending was down 7.1 percent in 2002, and will likely be flat in 2003 (dropping another 0.2 percent). Total IT spending as a percentage of gross revenue was 3.94 percent in 2002 and it is projected to be 3.88 percent in That is down from 4.43 percent in Nevertheless, Gartner projects that IT spending as a share of corporate capital budgets will continue to increase. This trend reflects the recognition of IT s transformation from a tactical overhead expense to a strategic enterprise asset with investments, benefits and value that will be felt over a life cycle of several years and across the different business units. With regard to creative cost containment, Gartner research yields three significant conclusions: The major trends in IT costs are maintaining and expanding the present infrastructure to support key business initiatives. Some of the most-effective techniques in controlling costs include gaining efficiencies through maturity, architecture consolidation and organizational structure. Outsourcing will not be undertaken to control costs. IS organizations that fail to articulate the value they deliver are perceived as utility providers, and will be subject to the harshest cost management spotlight. Increasing IT Capital Budgets Gartner Entire contents 2003 Gartner, Inc. All rights reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 Gartner projects that IT s share of the corporate capital budget will continue to increase during the next decade, as IT investment solidifies its place as a permanent part of the corporate-planning process (see Figure 1). For most enterprises, the increase will continue because of factors such as: Figure 1 IT Capital Budget as a Percentage of Corporate Capital Budget 60% * 2010* *Projected Business model changes Enterprise resource planning (ERP) investment Changes in the IT adoption profile within the enterprise Those are major changes, and IS management must be ready to prepare other corporate leaders for the transformations. Also, IS leaders must work with business process leaders to build consensus and set expectations about future increases in IT spending. The level of IT spending should be a decision that is entrenched in the business plans of business process leaders, and the final total should be treated as incidental. That will happen only as long as strategic plans are being properly funded and revenue targets met. However, Gartner Measurement finds that this is often not the case, because most business leaders perceive IT to be a utility function rather than a strategic, revenue-generating partner. Technology Initiatives Gartner s IT Spending Snapshot has found that the percentage of IT budgets spent on specific business and technology initiatives is shifting in 2003 (see Figure 2). The findings show that ERP and e-commerce spending is decreasing as a percentage of the IT budget. Wireless continues not to be a key focus of IT spending, but customer relationship management (CRM) has shifted more into the forefront of this spending. Figure 2

3 IT Budget for Business and Technology Initiatives Percentage of Budget 45% * Trend in ERP CRM E-Commerce Wireless Infrastructure * First three months CRM ERP customer relationship management enterprise resource planning Infrastructure will continue to account for the largest percentage of IT spending during the next two years. In addition, many organizations will find that, to fully exploit e-commerce, they must first undergo an ERP implementation, which will keep the spending on ERP high for the next three years. Also, along with ERP implementation, enterprises are finding that some additional drivers of IT spending increases are the investments in IT consolidation, business process re-engineering and infrastructure upgrades needed for successful ERP initiatives. Action Items: Understand that ERP and e-commerce are not inexpensive, and that the skills required for those initiatives are in high demand meaning that enterprises will have to pay a premium in terms of higher salaries for the skills. Use internal and external benchmarking to better anticipate future IT spending levels driven by ERP and e-commerce. Resources Tactical Guideline: Less of the IS budget for leading-edge enterprises is devoted to internal staff than in other adoption profiles. That is because leading-edge enterprises invest periodically in infrastructure upgrades, which decreases percentages in other budget line items, such as internal staff. According to Gartner s IT Spending Snapshot, the largest percentage of the IT budget will continue to be allocated to internal personnel, possessing specific technical expertise and demanding increasing salaries (see Figure 3). The percentage allocated to internal personnel will continue to

4 increase because of the business demands for better, faster, mission-critical initiatives, such as e- commerce. Figure 3 Percentage of IT Budget Distribution by Resource Category Percentage of Budget 35% * Trend in Hardware Software Internal External Voice Network Facilities *Firstthreemonths In contrast, many enterprises will be looking to leverage external service providers (ESPs) where internal resources are not sufficient to fulfill requirements; however, this percentage is continuing to decrease. The data also shows that software will stay flat as a percentage, and, in contrast, hardware costs are estimated to increase because spending on hardware has been down during the past few years. As the economy stays soft, spending on tactical business requirements, such as voice communications, facilities and hardware, will continue to increase. Action Item: Be prepared to communicate an IT strategic plan and IT s value to all levels of the organization to offset the perspective that IT is strictly an overhead cost that is increasing, and that the IT staff is growing out of proportion with the rest of the organization. Server Support Tactical Guidelines: The IT labor requirements for technical-support expertise will continue to be significant, with the greatest impact on Windows NT installations. The improvement of system management tools will mitigate some of these issues, but labor costs will continue to be the key drivers of data center costs. As the economy continues to recover and the labor situation continues to be saturated with available expertise, IT vendors should be prepared to take advantage of the available expertise.

5 Gartner Measurement s Data Center database shows that support costs for midrange environments increased in 2002, following decreases in 2001 (see Figure 4). The primary contributor to these increases has been additional expenses for system management (operations) and storage (technical support) solutions personnel costs. Unix operations and technical-service labor costs (staff salaries) per full-time staff member have increased at an annual average rate of 8.5 percent (up from 7.3 percent). Figure 4 Average Cost per Full-Time Staff for Unix and NT $in Thousands $ System Operations and Support Technical (System and Storage) Services 2002 In contrast, mainframe support costs have increased by only 3.1 percent, while NT costs have increased by 7.9 percent over the same time period. The large increase in NT support costs is being driven by the high demand for NT resources and the shortage of skilled IT resources. Another driver of increased costs will continue to be the move of applications from the mainframe to client/server or Web-based platforms and the cost of managing storage, which is inexpensive to acquire but expensive to support. Also, a lack of system management processes used in new initiatives (such as e-commerce) is driving up staffing costs. Distributed Computing Tactical Guidelines: While the economy stays soft, organizations are more likely to buy purely off-the-shelf applications (or, at least, to customize such applications) than to rely on purely home-grown products for business-unit-specific needs through 2005.

6 Understanding total cost of ownership (TCO) at the desktop will be a critical driver to understanding and managing costs for IT. Enterprises that are proactive in managing TCO will be able to better manage their desktop environments. At the desktop, Gartner Measurement s Distributed Computing database shows that software costs will continue to increase, while other desktop costs (hardware and support) will decrease (see Figure 5). The decrease in hardware and support costs is being driven by enterprise steps such as reducing the variety of desktop devices, standardizing desktop environments and moving to a four-year refresh rate; however, costs for software and, in many cases, for software support are continuing to increase because of the demands of ERP and e-commerce initiatives. Figure 5 Direct Cost per Internal Customer Administration Support Operations Support Hardware $4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Software Some enterprises are experiencing decreases in software costs. In many of those enterprises, the strategy is for IS to push the same software out to everyone through image management, instead of trying to buy just what everyone needs. In some enterprises, hardware costs are increasing (despite falling prices) because of faster refresh rates, purchases of higher-end machines and mobile devices for the end users. Cost Trend Drivers Tactical Guideline: CIOs and other executives need to think and work differently to meet the requirements of ERP, e-commerce and CRM. That can be accomplished through the use of governance models and the development of a partnership between the lines of business and IT. Regardless of the promise of benefits that can be delivered through IT investments, the inability to reduce the level of IT spending is a difficult message to deliver to any CEO or executive during difficult economic conditions, and it is a difficult concept for an executives to accept. With the growing importance of ERP and e-commerce requirements, the enterprises that will be the most successful will have developed a deep understanding of the effects that infrastructure design, scale, technologies and management will have on the enterprise s IT budget. Also, the increase in

7 investment in IT and in corporate cost structure is a red flag to corporate leaders that IS needs to be ready to address. The simple explanation for such an increase in IT costs is that efficiencies are not being harvested within the IS organization the complex answer is that ERP, e-commerce and CRM have transformed many enterprises, and are not inexpensive. In today s economy of heavy cost cutting, those messages are tough for executive leadership to accept. Strategic Cost-Cutting Initiatives The initial, knee-jerk reaction of enterprises facing a downturn in the economy is to cut costs by decreasing staff levels (rationalization) and deferring the purchase of leading-edge technology and upgrades for another year. Simply cutting staff and deferring the purchase of technology may show initial returns in the form of cost savings, but this has also shown a staggering long-term effect in terms of crumbling infrastructures that can t keep pace with business requirements. Gartner Measurement has worked with many enterprises that implemented these cost-saving strategies in the 1990s and are now simply managing to maintain current service levels, rather than meeting business needs. In contrast, Gartner Measurement is also working with several companies that have implemented long-term cost-cutting strategies that still address business needs without affecting the infrastructure. These strategies include consolidation of data centers, clearly defined and implemented asset management and centralization of organizational structures. It is important to examine some of the more-strategic cost-cutting initiatives that enterprises are implementing (see Figure 6). That includes analyzing the different inherent strengths and weaknesses of these initiatives, as well as some actual cost-saving data from Gartner Measurement s databases. Figure 6 Levers to Cost Savings Strategic Organizational Structure Asset Management Sourcing Consolidation Standards Maturity Defer Purchases Process Maturity Rationalization Tactical IT Issue Enterprise Issue

8 Maintaining Service Delivery Effectiveness Tactical Guideline: An inherent risk is associated with cutting IT operations costs. Many enterprises have discovered that, in the long run, no one cares how much money was saved when revenue and customer services are negatively affected by historic IT cost cutting. Gartner Measurement is finding that enterprises attracted by the allure of lower costs have implemented midframe solutions only to discover that hidden costs often more than offset the savings. Worse yet, many enterprises brought their mainframe-level of expectations with them to the open systems. The lack of adequate system management tools and the maturity level of the technology have combined to create many environments that, although robust in functionality, are sorely lacking in service delivery (see Figure 7). Figure 7 Cost-Effectiveness of Service Delivery Overdelivery of services Effectiveness Scale 0.00 I - Reduce costs II - Maintain costs and efficiencies Meeting service levels 1.00 S/390 Unix NT Underdelivery of services 2.00 III - Reduce costs and requirements IV - Increase costs or reduce requirements High Costs Low Quadrant II is where IT organizations should target their cost-effectiveness, because there costs are lower than the database on average, and business requirements are being met. Quadrant I residents are meeting and exceeding their business requirements, but are doing so at a higher-thanaverage cost. That may be acceptable, particularly in business systems that require special or proprietary technologies. Those in Quadrant IV have lower than average costs, but are not meeting the requirements of the business system.

9 Many organizations in Quadrant IV are finding that service delivery events have occurred infrequently or not at all, which provides a false sense of security. In these cases, IT needs to be prepared to proactively communicate with the lines of business to gain greater alignment and understanding. Centralizing Data Centers Tactical Guideline: The savings inherent in data center consolidation will not be realized within and during the transition stage of the implementation, nor during the first year of the consolidation. One way to contain costs is by limiting redundancy through the centralization of data centers. Gartner Measurement s database provides insights into potential cost savings and cost increases that can occur through consolidation. The goal of any consolidation is to decrease overall costs, but this is often not the end result. Gartner Measurement has created an example that compares the aggregate cost of an organization s multiple data centers to the typical cost structure of an enterprise already operating in that organization s post-consolidation environment (see Figure 8). The initial comparison, or base case, is based on average expected return from Gartner Measurement s database. Next, the top quartile of the database displays a best-case scenario of the potential savings in operating costs. The bottom quartile of the database displays the worst-case scenario what the potential cost increases may end up being if the consolidation is improperly implemented and managed. Figure 8 Data Center Consolidation Example Current State Multiple, unconsolidated data centers Transition State Investments include: Site selection Employee relocation Employee outplacement Additional equipment Consultants/contractors Planning staff Future State Consolidated data center Current Costs Current State for this Organization Total MIPS 800 Total Cost ($000) $14,644 Total Staff 51.6 Cost per MIPS $18,305 Potential Future Costs Potential Future States for This Organization Base Case Best Case Worst Case Total MIPS Total Cost ($000) $13,839 $10,481 $20,715 Total FTEs Cost per MIPS $17,299 $13,101 $25,894 FTE MIPS full-time equivalent million instructions per second Ways exist to mitigate the risk of bad decision-making for consolidations, but in some cases, the consolidation alone offers little or no cost savings.

10 Action Item: Implement measurement analysis that provides an estimate of a post-consolidation environment. This can save millions of dollars by mitigating the risk of making a poor decision and avoiding a consolidation effort that could yield little or no cost savings. Furthermore, the best-case scenario can be used as a stretch goal for the post-consolidation operating environment. Centralizing Services The three attributes that drive down cost of ownership are consolidation, simplification and automation. In today s economy, these may be key options for many organizations. Centralization of services within the organizational structure affords the luxury of direct control, which simplifies decision making and reduces the complexity of the management problem. Where cost efficiencies are a primary goal, consolidation of functions is an appropriate practice. The chief risk in operating a fully centralized model is that the model rarely changes quickly enough to reflect the changing requirements of the business. The centralized model is often static and slow to respond to change. To the business units, the enterprise s IS organization may seem like the typical, monolithic IS organizations of the 1980s. User frustration over decreased IS effectiveness in meeting the business units needs may drive a compromise between centralization and decentralization of the IS organization. Action Item: Weigh the value of centralization of services prior to making changes because, by default, decentralized shared-service models are more competitive and agile. Sourcing Strategically The relationship between IS and business units needs to be defined (for example, as utility, enhancement or transformation ) to understand where IT should be focusing. Once this relationship has been defined, enterprises should use the IT Service Management Decision Framework to understand where to source strategically (see Figure 9): Figure 9 IT Service Management Decision Framework Strategy Business Development Strategy Service Fulfillment Strategy Sourcing Strategy Business and Execution Planning Services Processes Capabilities Activities Skills Ultimate Goal Organize to This Hire to This Train or Rent to This Business development examines the competitive environment; the relationship with, and needs of, the client base; market potential; and core competencies. Business and execution

11 planning for this phase focuses on service identification and design, along with more-explicit demand forecasting. Here, the viability of specific service offerings is determined. Next is service fulfillment, which brings an operational focus to what has been more of a marketing exercise. During business and execution planning, planners articulate how service commitments will be met, by addressing the question: What processes and capabilities will be required to support each service? Finally, sourcing studies the specific kinds of activities that will be executed in the identified processes as well as the technical skills required to perform them. The business and execution planning performed during this phase answers the question, What work will be performed under what circumstances; and what roles, competencies and skills will be required? Ultimately, the goal is to: Organize to services and processes Hire to processes and capabilities Train or rent (that is, outsource) for specific activities and skills Determining IT Value One way to get a handle on the dimensions of IT value is to examine the three basic payoffs that can be achieved from the use of IT. The three categories used to measure value are distinguished by their relative degree of contribution toward superior enterprise performance: Utility means little contribution is made toward enhancing services, applications and infrastructure. The key source of value here lies in lowering the base operating costs for the essential services and the supporting infrastructure. Enhancement means substantial contribution is made toward enhancing the IT infrastructure to drive the business. The key source of value here involves enhancing enterprise performance in some demonstrable way, such as enabling faster performance or lowering the operating costs of doing business. Transformation refers to IT having a very large impact to the business. The key value in this category entails providing new freedom for the enterprise to make decisions and take advantage of opportunities that would otherwise not be possible. All of these categories reside and depend on tactical-level infrastructure and service requirements being in place, and on obtaining consistently high levels of efficiency and effectiveness across the organization. Action Item: Ensure that the strategic business value of IT has been communicated to business unit leaders. The return on this type of communication is measurable, and is a prerequisite for increasing alignment. Transformation: Investing to Be Ready The transformation value category is the least clear-cut and hardest to justify. However, clear value is attained in being able to do new things, and do them faster than before, because of an IT

12 investment. In the world of e-business and collaborative commerce, such value may involve the ability to form partnerships and alliances more quickly and easily. An enterprise with great talent here can adapt its own systems to accommodate the systems of others and desired partners. For example, what if an enterprise not only had the ability to create its own knowledge management systems to share its intellectual capital and know-how internally, but could also use these systems make this knowledge readily available to its customers or suppliers? This could be a huge advantage in terms of partner loyalty and cooperation, but the ability must be there because the prior investment has been made. Some enterprises are investing to gain the prospective value of responding quickly to expected competitive threats, especially in the world of e-business. Enterprises must invest to be ready, whether in the public or private sectors. Action Item: As IT becomes a critical component of competitive performance, build consensus with enterprise leadership to ensure that a steady stream of future capital funds is earmarked for infrastructure upgrades and new development activities. Enhancement: Evaluating Business Impact The enhancement dimension of IT business value has taken over as the critical assessment factor for most enterprises with regard to their choice of IT investments. This assessment process begins with a clear set of business objectives. Potential IT investments are then evaluated based on their relative impact toward the achievement of an objective. For example, if an ERP system will cut average shipment time from three days to three hours, that may be crucial to being competitive and, therefore, extremely valuable. However, such judgments must come largely from the business side of the enterprise to establish the relative value, for example, of improved quality by a given percentage. Each improvement must constitute a real, measurable change in enterprise performance that business unit managers understand and want. The potential types of improvement should not be unknown or surprising to the IS staff. Only a finite number exist including more revenue (whether from acquisition, more products, higher prices, additional market share or new territories), better service or lower costs and all must be understood. Action Item: Recognize that cost cutting will be forestalled as IT s function switches from controlling costs and increasing productivity to generating revenue. Utility: Determining Efficiency Tactical Guideline: Within the utility sector there will be several candidates for outsourcing. Lowering IT operating costs is the most-traditional method to gain value. Historically, the key questions have typically included: How can we limit the number of PCs being used or reduce the total cost of ownership? That is certainly a reasonable request, but the target should be efficiency in getting the job done. Determination of efficiency is important, and should address the question: How much should it cost to run a specific IT workload? That is best examined by benchmarking against other enterprises doing similar things. Benchmarking can be broken down into several functional tasks, such as

13 networking, enterprise operations and desktops. The first goal is high reliability and the second is low operating costs. Determining effectiveness is also important. Questions to consider in this determination include: Is the IS organization doing the right things? Are the IT services being delivered to internal customers enhancing their ability to work, and enabling them to accomplish the enterprise s goals? Recommendations Tactical/Utility: Measure cost savings vs. the risk of deferring purchases of noncritical technology. Gain efficiencies with established technology through greater utilization and training. Strategic/Enhancement: Focus on organizing around services. Develop an ESP-like business model. Innovation/Transformation: Develop partnerships between IS and lines of business. Find new ways to combine established technical and human capabilities. Written by Edward Younker, Research Products Analytical source: Lynn Sechrest, Gartner Research This article is an excerpt of a chapter from a new report, Winning Asset Management Strategies. The report is an offering of the Gartner Executive Report Series, a new business venture of Gartner Press that provides buyers with comprehensive guides to today s hottest IT topics. For information about buying the report or others in the Executive Report Series, go to For related Inside Gartner articles, see: Management Update: Lower TCO via Effective Software Contract Terms and Conditions, (IGG ) Management Update: Ten Major IT Asset Issues Managers Should Address, (IGG ) Management Update: IT Asset Management Is Mandatory, Not Optional, (IGG )

14 Management Update: Asset Managers Should Assess How Their IT Spending Stacks Up, (IGG ) CIO Update: To Control TCO, It Must Be Measured and Managed, (IGG ) Management Update: Five Sure Ways to Reduce IT Asset Costs, (IGG )