Identifying Red Flags in Your IT Spend

Posted 12-17-2012

Identifying Red Flags in Your IT Spend

By Mark Ball

How much money did your organization spend on IT products and services last year? What were the largest IT spend categories? Who were the top IT vendors in each category? These should be relatively easy and reasonable questions, but many IT executives do not have a firm grasp of the answers. There are three fundamental reasons behind this challenge: 1) the IT organization often does not have complete control over the entire IT spend, as some hardware, software and IT services are procured by other departments without IT’s blessing or knowledge; 2) spend data, pricing details and contract information often exists on multiple data platforms (or in desk drawers), making aggregation and analysis even more complex; and 3) IT spend analysis can be a time-consuming endeavor, particularly upfront, without a robust spend management tool or system in place to ease the burden. Despite these challenges, IT spend management is a critical exercise in the overall effort to improve an agency’s return on information technology.

 

The value of a comprehensive IT spend management initiative cannot be understated. The increased spend visibility will enable the IT organization to:

·        Organize IT spend data into distinct sub-categories (e.g., database software, server hardware and systems integration services) so IT executives may understand the detailed allocation of costs and resources.

·        Categorize IT spend by vendor, allowing the organization to understand its degree of vendor fragmentation, identify which vendors dominate specific categories, and determine whether the vendor mix is appropriate.

·        Analyze IT spend history, trends and pricing variability, and determine what factors are driving these changes.

·        Identify savings opportunities, which may be achieved by consolidating vendors, rationalizing the product or service mix, eliminating waste, negotiating deeper discounts and/or achieving greater economies of scale. The savings opportunities may then be prioritized based on their size and complexity.

Successful organizations periodically assign resources to conduct an analysis of their IT spend. From this effort, organizations are better prepared to identify the “red flags” in their IT spend and take corrective actions to address them. Examples of common red flags include:

1.      Supplier fragmentation. Organizations often leverage too many suppliers within a spend category, which prevents them from achieving volume discounts that may be available if they were to consolidate their spend into fewer suppliers. IT executives need to carefully consider the ideal number of vendors for each category, and determine which categories may be ripe for vendor rationalization. The 80/20 rule is typically a good guideline to measure fragmentation: If 80 percent of the category spend is split among more than 20 percent of the number of suppliers in the category, then there may be excessive supplier fragmentation.

2.      Single source monopolies. The opposite of excessive fragmentation–an abundance of categories where the entire category spend is dedicated to one supplier–can also be sub-optimal. While occasionally it is necessary or unavoidable to source an IT category from only one vendor (e.g., email or ERP systems), it is generally ideal to carry at least 2-3 suppliers in each category to ensure competitive pricing and to keep vendors motivated to deliver high-quality service.

Identifying Red Flags in Your IT Spend

3.      High-growth vendors. IT spend analysis will enable the management team to identify vendors that have benefited from significant spend growth in recent years. These vendors, in return for their larger footprint and customer loyalty, should be offering increased volume discounts to the IT organization either because they are contractually obligated to do so, or because they want to continue this growth trend, and they recognize that passing their own scale economies to the customer will foster deeper relationships. If no new discounts have been negotiated and unit costs remain constant despite significant spend growth, the IT organization should seriously consider renegotiating or re-competing these expenditures with selected high-growth vendors.

4.      Silo departmental spend activity. This typically occurs with larger organizations where multiple departments are each empowered to purchase IT products and services. These organizations are often guilty of the “left hand not knowing what the right hand is doing,” which is exemplified by overlapping contracts with the same vendor for the same product or service, often at different price points. Vendors welcome the opportunity to become embedded with multiple business units, and the lack of coordination often works in their favor. Furthermore, since this spend is conducted in smaller bundles rather than larger consolidated blocks, this silo purchasing activity is obviously not strategic and is often very costly.

5.      Unmanaged maintenance spend. Often described as “the gift that keeps on giving,” IT maintenance can be a source of wasteful IT spend. It is common practice for IT vendors to under-bid the cost of their base product in order to justify a higher maintenance rate, which typically results in a higher total cost of ownership. Furthermore, the more IT assets under maintenance, the greater the likelihood that some assets are under-utilized, and the IT organization is needlessly paying maintenance on unused assets. Without a proper understanding of the organization’s IT asset inventory and related maintenance costs, this can be a primary driver of IT inefficiency.

6.      Excessive “temporary” resources. In the short term, consultants and contract resources can serve a valuable purpose, either because they provide specialized skill sets to support a short-term project need, or because they are filling resource gaps that will be eventually staffed by full-time employees. But in the long run, these “temporary” resources can be expensive; first, because their labor rates are typically higher than those of full-time employees; and second, because the longer the temporary resource remains in place, the more institutional knowledge they acquire, which becomes increasingly difficult to replace once the resource eventually leaves. Smart organizations continuously review their contractor spend to determine which resources they should maintain, phase-out or bring in-house.

Launching an IT spend management initiative requires an upfront investment of time and resources.  This upfront cost can be reduced if the organization already has a robust spend management system in place. Regardless, the savings captured from identifying and addressing the aforementioned red flags should easily justify this investment, and improve the organization’s overall return on information technology. 

About the Author

Mark Ball is the managing director of Emerging Sun LLC, a Washington, DC-based management consulting firm that offers an array of IT strategic services, enabling clients to reduce costs, improve performance, and make intelligent business and technology decisions.