Robert Gold: The Money Trail

Posted 11-15-2003

Robert Gold: The Money Trail

In working with leaders of dozens of companies, I have heard lots of complaints about their IT organizations. That dissatisfaction translates into a set of real problems that must be overcome when trying to execute strategy. The dissatisfaction stems from a lack of shared understanding. IT folks don't understand business folks as well as the business folks would like them to, and business folks don't fully understand how tough it is to manage IT. This isn't necessarily a problem; IT organizations exist because of their specialized knowledge, despite the fact that professionals outside IT have become more sophisticated in their understanding of technology. Yet only by making some effort to bridge the gap can companies hope to improve the alignment of IT spending with business strategy.

The purpose of IT organizations is to spend money on behalf of their parent companies and their business units. How IT organizations obtain the money they spend and how they decide to spend the money determines the impact of technology on the organization's ability to create value. Seems simple, doesn't it? Yet virtually every company struggles with the problems of ensuring a return on IT investments, managing the growth of IT spending and—most important—making sure IT is aligned with the company's business strategy. This last point, of course, is the key. How can businesses make sure they're getting the most strategic value out of their IT organizations? The answer: Follow the money.

I draw a sharp line between business unit managers, who are the primary consumers of IT, and senior executives, who are primarily responsible to shareholders or owners. They see things differently. Business unit managers understand intuitively that their businesses depend on information technology in terms of both day-to-day operations and long-term success. They know that if IT fails, they can't run their businesses.

On the other hand, senior-level executives generally understand the crucial role played by IT, but they also have to consider overall spending. And what they see is IT spending increasing faster than other key indicators of growth, such as revenue, and that, they instinctively believe, is a problem. Of course, carried to the extreme, it is a problem. If IT and all the other expenses overtake revenue, obviously there won't be any profit.

But the role of IT has evolved over the decades, from simply increasing productivity to connecting people with information inside the firm, to connecting the firm with its customers, to leveraging the value of information itself. Many IT expenditures are no longer an option. Organizations simply must have e-mail to communicate, they must have Web sites to reach their customers, they must play by the rules of other organizations (such as Wal-Mart) in order to survive. It is inevitable that IT increases as a share of expense as businesses use IT more intensively.

By following the money, it becomes clear that much of the problem of aligning IT with business strategy boils down to how business unit managers and senior executives make IT financing decisions involving three issues: overall IT spending, resource allocation and cost recovery. There is little conventional wisdom among companies; some have explicit spending caps for instance, while many do not. How companies allocate discretionary IT resources varies widely. And while many companies use some form of cost allocation and chargeback, others don't bother at all. Every company has a unique set of policies that are deeply rooted and hard to change.

Decisions, Decisions

Decisions, Decisions

Let's put all IT expenditures into two buckets, mandatory and discretionary. Mandated spending "keeps the lights on" to operate the business into the foreseeable future "as is," without making strategic changes. The level of mandated spending isn't really planned; it's the result of two factors outside the control of the IT organization: the unit cost of hardware, which generally decreases over time, and the demand for existing technology resources, which increases as the business grows. It is no more practical to limit mandatory spending than to tell an executive to stop making long-distance phone calls after the budget for those calls has been exhausted. Because mandated spending is the product of unit cost and demand, which are independent of each other, it is difficult to predict the amount and direction of change from one year to the next. And mandatory spending does not in and of itself improve alignment.

The path to IT strategic alignment follows discretionary spending—how an enterprise chooses to invest to change its technology capabilities. My first principle of IT alignment states that you can't execute strategy without IT. You can't change the way the business operates—and change is the essence of executing strategy—if you don't change the underlying IT. And if you inhibit a business unit's ability to go after change, then you inhibit its ability to compete in its marketplace. Following the money means understanding how companies make discretionary choices.

A third of all companies impose an annual cap on IT spending, according to this month's CIO Insight survey. At such companies, discretionary spending is limited to what's left over after the mandatory spending. Typically, the distinction between mandatory and discretionary spending isn't clear because IT accounting doesn't explicitly segregate them. The result is to artificially limit the level of discretionary spending.

Why a spending cap? When CEOs and CFOs see IT spending growing faster than revenue, they panic. Since most CEOs and CFOs can't tell the difference between legitimate investments and waste, they fear that something really bad is going on in the IT organization, and that it's becoming a black hole for money. Their natural reaction: Put a cap on it.

But capping IT spending across the corporation is a dangerous move, because each business unit requires its own technology investment to compete effectively. A cap puts either IT or top management in the position of making far-reaching decisions about which businesses are going to get the IT and which aren't. Thus, the IT funding decision becomes a proxy for deciding which strategic initiatives will and won't be executed.

My second principle states that the demand for IT resources in any organization exceeds the capacity to deliver them. To improve alignment, discretionary IT spending decisions must be made in the context of business strategy, not IT budgets. It's as simple as that. But most companies aren't very good at describing or executing business strategy, so there's little or no strategic context in which to make the decisions.

The IT organization does have an important role to play in influencing certain types of decisions. Under a business initiative to improve customer information, for example, IT can and should weigh in on which of three CRM systems is the best fit with the current and planned infrastructures. But IT should not be in the position of deciding whether the business unit should use a CRM system to pursue its customer intimacy strategy.

Too many corporate leaders abdicate their responsibility to make the tough decisions. They should be saying to business unit executives, "You haven't made a compelling business case for your strategy, so we're not funding it." Instead, they avoid the problem by capping overall IT spending at a level lower than needed to deliver on all proposed strategies, and let IT pick the winning strategies by proxy through its funding decisions.

Charge It

Charge It

My third principle states that you can't achieve alignment without a good relationship between IT and the business. A key is establishing confidence among executives that IT is distributing costs rationally and consistently.

Rationally doesn't mean perfectly, but it does mean that IT can explain why they're doing things, and that it was done deliberately as a result of a policy decision, and not arbitrarily. This issue's survey on IT alignment shows that less than half of larger companies (those with more than 1,000 employees) treat IT costs as a corporate overhead expense. The rest use some form of cost recovery, mostly a chargeback system based on the actual resources the business units use. The data shows no correlation between using chargeback and company performance.

At companies without a chargeback system, however, business unit leaders may view IT as "free," and demand far more of the IT organization than it can possibly deliver.

More requests mean more tough decisions and increase the likelihood that IT resources are wasted if the decisions are not well-informed. More significantly, treating IT costs as corporate overhead creates an accounting issue. In the typical company with multiple business units, the IT component of each business unit's true operating cost is not accurately reflected in its results. Only those companies where IT costs are fully allocated to the individual business units can managers and investors understand the true financial performance of each unit.

Yet many using chargebacks call it a "damned if you do, damned if you don't" proposition. Sadly, it's not quite so simple in the real world. One of my clients is typical. There is a lot of stress in the relationship between IT and the company's business units, primarily because of intense pressure on business unit leaders to deliver bottom-line results. The way the tension is manifested is by challenging the chargeback system. Of course, the leaders want more from IT for less money, so they challenge the rates. But allocation is also an issue. The company has three essentially independent business units that compete for resources from the IT organization. The leaders of each of those business units think IT is shifting costs to their bottom line that, in fact, should be borne by the other business units. But they can't all be right. And when business unit profits falls short, they blame IT.

Sit Down and Talk


Sit Down and Talk

It really boils down to trust. When the IT organization is trusted by its customers, it has more latitude to avoid the micromanagement and nitpicking about the dollars that is bound to alienate its business cohorts. If you can get to the core of the relationship between IT and the business and begin to diffuse the tension between the two, you will improve IT's ability to serve the strategy of the business. The most important step to improving the alignment of IT with business strategy is for IT leadership to open a candid dialogue with corporate and business unit executives. Together, they should challenge the effects and benefits of their IT finance policies. Together, they can consider whether current practices serve the best interest of the company as a whole, or if they constrain it. Together, they can commit not just to following the money, but to managing IT spending for competitive advantage.

Step by Step

The following prescriptions suggest a path to improved alignment through IT finance policy:

  • Eliminate overall spending caps on IT expenditures.

  • Divide the IT budget into mandatory spending (to keep the business running) and discretionary spending (investments to improve the business).

  • Manage mandatory spending by tracking unit costs, industry benchmarks and predicted demand.

  • Integrate discretionary IT spending decisions with their associated business cases, considering all costs and benefits that accrue to the corporation.

  • Depoliticize the discretionary decisions by taking them out of the hands of the IT organization.

  • Align discretionary spending decisions with corporate and business unit strategy.

  • Track actual discretionary costs and benefits compared with forecasts to manage strategic initiatives and improve forecasting.

  • Allocate and recover IT costs completely and transparently, according to actual consumption, from each part of the organization.

    Robert S. Gold, Vice President and Practice Leader for Strategic IT Management at the Balanced Scorecard Collaborative, Inc., has provided strategic and technology management advice to leaders in Fortune 500 firms for the past 14 years. He earned his MBA from Northwestern University's Kellogg School of Management. Please send comments on this story to editors@cioinsight-ziffdavis.com.