IT Financial Management: The Business of IT

This chapter is from the book

Business of IT, The: How to Improve Service and Lower Costs

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This chapter is from the book

This chapter is from the book 

Business of IT, The: How to Improve Service and Lower Costs

Learn More Buy

Improving IT Charging Based on Services

IT charging is the process of billing for IT services rendered to internal or external customers. The charging process uses two key sets of information: 1) rates based on accounting information, forecasts of current and future customer demand, and other relevant information; and 2) usage information based on actual measures and estimates. Together, this information is used to create a price, or assessment, for a given service, as shown in Figure 4-5.

Figure 4-5 Charging process develops rates, captures utilization, and results in a price or assessment.

Determining Cost Center Charging Methods

As organizations mature from a reactive IT organization to an IT cost center, they develop a standardized charge or assessment framework using a chargeback (or IT costing) model to define available costs associated with its services. Through the development and population of a chargeback or IT costing model, you will determine your service rates. There are many different definitions of chargeback models, but they combine IT accounting data to determine a service's cost with usage data from capacity management and other processes to develop a price. In an article on CIO.com, titled "Chargeback Demonstrates IT Value in the Enterprise," Mark J. Denne discusses a number of approaches to developing chargeback methods.¹⁰ They include subscription, peak level usage, user-based pricing, and ticket-based pricing.

Regardless of the pricing method you choose, cost centers, by definition, charge an appropriate level of fees for IT products and services to exactly equal the costs incurred by the IT organization to provide these IT products and services, which is considered "break even" from a financial perspective.

To help you develop your rate and a means for capturing utilization information, we have summarized a general method for developing a chargeback model. This method includes developing a chargeback model to determine the rate; populating the chargeback model with a mix of assumptions, averages, and actual costs; and determining utilization, or quantity of services. Developing measures of utilization is a key link to the demand management process.

Develop Chargeback Model to Determine Rate for Each Service

The cost center uses the chargeback rate and utilization method to develop a pricing or assessment method to recover these costs through a charge or assessment. To determine your service (or chargeback) rate, you should start by creating a chargeback template to determine your cost and populate the chargeback template with expense information. This will help you determine the cost of your specific service. Then, based on your pricing decisions and ability to determine service utilization, you can determine the rates you will charge for a given service.

To determine your chargeback rate, you first need to know your cost. We recommend that you develop a template for collecting information by service that allows you to provide a top-level summary sheet, while also providing significant detail on specific areas in the services inputs and buildup worksheet.

The top-level summary sheet can then be used as a common language between the business unit and IT unit regarding the cost of a specific service. Table 4-6 shows a simple framework to develop the top-level summary sheet. The top-level summary worksheet highlights the unloaded chargeback rate, applicable overhead rates, and published chargeback rate for your services. The unloaded chargeback rate, also often referred to as all direct costs, is the cost without any overhead applied.

Table 4-6. Top-Level Summary Sheet

This top-level summary sheet is useful to both the IT organization and the business group because it:

• Is simple to understand
• Demonstrates transparency of overhead costs, which can be a contentious issue between business units and IT organizations
• Provides detail to executives who might be reviewing their rates and budget

Next, the organization should develop a summary of key costs for each service, such as the service inputs and buildup worksheet in Table 4-7. These costs include hardware, software staff costs, and other cost types. If an organization has created cost types within its IT accounting practices, these costs should match these types within this sheet. This sheet is critical for transparency of IT costs and establishes a common understanding with the business unit. The business unit and the IT department can review the various inputs to a service to determine whether they are necessary.

Table 4-7. Services Inputs and Buildup Worksheet

As you will see from Table 4-7, the process can be used for transactional services, such as hosting, or project services, such as application development. These buildup worksheets are effective ways to account for the need to capture differences in types of services, infrastructure, networking, and application development. To provide additional detail, you should develop a service-specific worksheet that includes the detailed support for your service's inputs and buildup worksheet. Several options to develop these service-specific summary sheets follow:

• Use worksheet from accounting process: If your accounting process has grouped cost type information according to each service, this sheet can provide this role. For example, this accounting sheet can provide the detail you need regarding hardware, software, and personnel costs, which can be linked to the services inputs and buildup worksheet.
• Create new worksheet that includes accounting data and assumptions: Organizations must often make a number of assumptions related to key costs. You should consider developing a worksheet that includes both accounting data and key assumptions.
• External contracted (base) costs: The organization should then create a sheet that includes external costs, such as software licenses or vendor cost that are often external to the organization.
• Internal costs (for example, salary, overhead, and financial information): This sheet generally includes internal costs, such as overhead, staff time, and other inputs that are internal to the organization. These sheets also summarize service-specific assumptions, such as the staff time allocation cost estimates for staff activities discussed in the basic approaches in the earlier section "Basic Approaches to Improve IT Accounting."

The structure of these worksheets needs to be tailored to your organization. You should structure them based on the information you have available and the audience that will use this information.

Populate the Service Chargeback Model with a Mix of Assumptions, Averages, and Actual Costs

After the finance and IT organization complete the chargeback framework, they should then work together to insert costs into the model. We would like to reinforce our discussion in the accounting section on using estimates, averages, or actual IT expenditures to develop costs. Many cost centers use assumptions and averages, rather than cost accounting data. For example, instead of listing the exact price of a server, the IT organization might list an average rate, sometimes referred to as a blended rate. These blended rates are the average of a number of purchase orders to determine the typical cost. Also, instead of exact FTE estimates for system administrators, the organization might develop a blended rate that reflects the average cost of a system administrator.

In addition to the discussion of estimates, averages, and actual IT expenditure data in the accounting section, we provide key examples of benefits assumptions if actual data is not available:

• Estimates or averages provide a baseline set of data to continuously improve your chargeback or IT costing model each year. For example, the first year an organization develops a cost model, a large percentage of the data may be based on the best assumptions that can be made at the time using available source data. However, each year the organization can replace key data with actual data.
• Developing a mix of estimated and actual data creates a framework for enacting key process improvements. For example, it provides a common framework for the IT and finance departments to share information. This framework can help translate financial and operational information and help both the IT and business teams learn.

Determine Charge or Assessment Method through Standardized IT Pricing Framework

Reactive IT organizations charge their internal or external customers through corporate overhead allocations rather than direct invoicing. This lack of transparency in IT budgeting is often viewed as a tax on business units and creates resentment by the business units. As an IT organization matures to a cost center, it develops a method to estimate the service's cost and the customer's utilization. This standardized IT pricing framework captures a service's cost and utilization (where appropriate). This framework could also service as the customer invoice. A simple customer template could look like Table 4-8.

Table 4-8. IT Pricing Framework for Business Units

The previous pricing framework highlights the difference between transactional services and services, such as application development, that may be based on a statement of work (SOW). The final item, application development, is an example of a project-based service that employs staff or contracts. Some organizations may take an SOW approach, in which a defined SOW summarizes that payment that will result from a given set of deliverables, such as the completed application or software package. Alternatively, you could develop a per-hour rate for application developers and charge the customer this hourly rate.

After the IT organization has developed a framework, it should use this as a tool to engage its customers in a discussion of the charging process. These initial discussions will foster acceptance of this framework within the organization. The organization can then develop the inputs to the framework including the service (or chargeback) rate and the service utilization.

Determine Utilization or Quantity of Services

Because the IT organization has established its costs, it now needs to work with its existing customers to project out the near term the expected demand for each IT product and service, measured in projected quantity of IT products and services; to establish the projected overall demand, and to develop pricing for each IT product and service offered using project demand as a key assumption.

To recover costs, you must develop an accurate measure of the quantity of services used by a customer or service. The cost center often uses actual measures and estimates to measure the quantity of resources used by each customer. As with expenditures, you should use automated tools to collect actual costs of service utilization data whenever possible. Following is a summary of three methods to measure utilization:

• Metered usage: When the utilization can be precisely measured, the organization generally uses metered usage. This method is based on actual utilization, whereby the organization automates the collection of quantity of resources used by each consumer based on the agreed-upon metric. For more service-based estimates, this may include a time tracking system to track the time of application developers.
• Fixed- or user-cost approach: Many cost centers may also decide to simply divide a service's cost by this forecasted quantity to develop a unit price. This process, referred to in ITIL as fixed or user costs, is one of the most simplistic methods for determining pricing. This fixed price could include a subscription to use a specific quantity of services. The more accurate the demand forecast, the fewer risks the IT organization will incur a budget shortfall. This fixed-cost approach can also be used if an SOW specifies a specific price for a specific output, such as the development of a new ERP system.

• Tiered utilization: A hybrid approach includes tiered utilization, whereby an organization measures utilization of a specific service and groups customers into tiers. This utilization data may be gathered through either a demand management or capacity management process under ITIL. The use of an automated tool often supports this effort because one method to stratify the pricing of multiple tiers of IT product and service offerings is based on utilization versus resources.

  Developing tiered utilization can be combined with tiered rates, in which the IT organization offers tiers of IT products and services, such as stratifying storage into managed and basic storage. In other cases, the organization will offer premium and standard levels of support. Accurately presenting the tiers of IT products and services will help to clarify the pricing for internal and external IT customers.

Improving Your Charging Process to Become a Profit Center or Business Partner

To improve the charging process as the organization views IT as a positive ROI or a business partner, the IT organization captures more accurate usage and cost information, often using automated tools that track IT resources and link them to their costs. The IT organization also develops linkages with other ITIL processes to considers as it develops rates. For example, it effectively values services and develops pricing in concert with the IT service catalog and aligns its expenditures to the service levels outlined in the service level agreements (SLAs) developed through the service level management process. This process is discussed later in this chapter.

Many IT organizations also use chargeback models to price selected IT products and services, typically limited to the IT products and services provided in their IT service catalog. The cost analysis supporting the development of a chargeback model also provides operational information that IT organizations can use to manage their resource consumption, resulting in continuous improvement in IT operations.

Improve Your Service or Chargeback Rate to Improve Service and Lower Costs

To improve service or chargeback rate, your organization should use only exact costs to develop its IT costing model. The IT accounting process should provide exact costs that can be leveraged in the IT costing model. For example, the service-specific sheets discussed in the previous section should just be outputs of the IT accounting process. This data provides the organization with a true understanding of the provisioning value (or the cost) of each service. As a result, the organization can conduct service provisioning optimization activities to benchmark its costs against competitors.

As your charging and pricing process becomes more advanced, your organization's price per billable unit recovers your full cost and a surplus amount that is the hurdle rate, which is discussed earlier in the chapter. For example, if your hurdle, or discount rate, was 5 percent, your IT price would be 5 percent above the cost of your service. This pricing method subjects your IT services to the same project standards commonly used in other financial initiatives.

To improve service, an organization should link charging to the various internal contracts between the IT organization and its customers (SLAs) and internal contracts between organizational units within the IT organization (operation level agreements, OLAs) discussed in Chapter 2. This linkage helps the IT organization to clearly establish the value of its services to its customers. For example, if a customer would like more backups or quicker response time than the organization typically offers, the organization may want to develop a pricing mechanism to recover these costs.

Implement Automated Tools to Monitor Resources, Costs, and Utilization

To improve service, the organization should also charge customers for usage, rather than approximate consumption. As an IT organization matures from a cost center to viewing IT as an ROI or business partner, the IT organization often implements an automated solution to identify and monitor IT customers' utilization. These high-performing organizations often move toward resource-based chargeback software. There are a number of automated financial management tools. For example, Figure 4-6 summarizes how the IBM Tivoli IT Usage and Accounting Manager (TUAM) provides an IT organization with the capability to automatically monitor a given IT asset and attribute this asset to a given business unit.

Figure 4-6 Automated tools can link IT resources, costs, and utilization data.

Automated tools that link the IT business office with the IT operational assets can be powerful enablers of mature IT financial management practices, providing the IT organization with resource-based charging capabilities. Automated tools provide the IT organization with the potential to know the exact costs of any IT asset, tie this cost with the IT organization's service catalog, and evaluate IT spending based on exact costs.

However, implementing these tools can be challenging. As with any complex software implementation, the initial and ongoing costs can be substantial. Moreover, even if the IT organization implements these solutions effectively, the difficulty of applying them effectively can be substantial. The culture of the IT organization has to see the ongoing value of mature IT financial management practices and incorporate financial discipline into daily IT operations.