Use this cost/benefit model to prove IT value to clients

 by Rick Freedman

Takeaway: More now than ever, IT consultants are being required to demonstrate real, quantifiable benefits for the IT dollars that their clients are spending. Columnist Rick Freedman shares his own cost/benefit analysis model as well as some other examples.

As consultants, we're constantly being asked by customers—both internal and external—to justify those big-budget IT expenditures with more than fuzzy platitudes about increased productivity and enhanced communications.

How do IT consultants help their clients calculate the worth of the IT initiatives they implement? Variables related to the success of our solutions—such as the client's readiness for change and willingness to act on our recommendations—make committing to a quantifiable financial benefit risky. Yet, in this new environment of conservatism in IT expenditure, our ability and eagerness to apply measurable financial yardsticks to our work can mean the difference between selling that project and not. This column provides reasons why it's crucial to prove IT value, some models and examples for measuring "net value," and my own cost/benefit analysis worksheet that I use for client engagements.

Why now?
Earlier incarnations of IT spending were easier to justify, but now there's a whole industry dedicated to the substantiation of such expenditures. Douglas Hubbard, a principal at Hubbard Ross—a firm that specializes in applying financial metrics to IT projects—recently told CIO Magazine, "When you had a new mainframe program that replaced 30 workers, the benefit was obvious. But with e-business, groupware, and expert systems, you're not doing a head-count reduction—you're communicating better."

Hubbard Ross, with its Applied Information Economics methodology, is just one of a host of firms offering IT justification services. The Balanced Scorecard Collaborative is another firm that works with CIOs and other IT pros to develop cost/benefit analyses of IT programs. David Norton, one of the two original developers of the Balanced Scorecard and president of the collaborative, said: "There isn't a first-order relationship between IT investment and financial outcome. Investment in IT typically has a third-order financial effect."

While increases in customer satisfaction and loyalty can obviously have a positive effect on business, directly measuring that effect is challenging at best. Other firms, such as Cutter Information Corp. and QSM Associates, have developed their own proprietary models of IT value measurement. Even Microsoft has weighed in, with its Rapid Economic Justification (REJ) model, which is used to illustrate the benefits of implementing Microsoft products in the enterprise.

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Download Freedman's cost/benefit analysis
A supplementary worksheet illustrates the ideas Rick discusses in this column. He has incorporated the most obvious costs and benefits that he describes here, and he has set up the sheet to present the "net value" of an IT investment. He's also included an example of one of his own recent projects, wherein he helped a telecommunications provider implement billing software that captured additional revenue and helped the client to gain efficiencies and enhance productivity. The new software was much easier to use and manage, thus ending an employee retention problem. All of these benefits were quantified, with the client's assistance, and are illustrated in the example worksheet. Download it now.

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IT expenditures must align with business goals
A focus on the alignment of IT spending with corporate strategy is the first key element to justifying costs. As Microsoft states in its REJ white paper, "The goal is to ensure that any IT investment decision can be shown to be consistent with the organization's business objectives."

Directing justification efforts towards the organization's critical success factors and strategies makes obvious sense, especially in an environment where IT investment has been accused of being "technology for technology's sake."

Measuring costs and benefits is especially tricky. IT managers and consultants are usually skilled at estimating costs, based on experience in budgeting for projects and for ongoing operations. Many cost models, such as Gartner's Total Cost of Ownership (TCO) model, are well known and in widespread use for cost estimation. This model calculates project costs, such as capital outlays like hardware and software costs; labor costs for IT staff, consultants, and developers; training and support costs; hardware and software maintenance fees; and vendor fees such as data communications. There are some preexisting estimates that planners can use to plug in some of these numbers rather than trying to figure them out from scratch. For example, Gartner estimates that, for each user on an enterprise local area network (LAN), costs in 2001 will range from $7,091 to $13,485, including all labor and capital-related costs. Using this as a baseline cost number can be a start toward developing a value measurement for your IT project. (TechRepublic is an independent subsidiary of Gartner.)

The benefit side of the ledger is much more difficult. Once you get past the reductions in labor costs that some systems can provide, the financial benefits are much more slippery. Some possible IT system benefits include the following:

• Increased revenue
• Increases in productivity
• Enhanced speed of processing
• Enhanced customer satisfaction and loyalty
• Reduction in support costs
• Increased flexibility
• Increased employee retention

Show them the money
Turning these ambiguous value statements into measurable dollar figures is the challenge. Let's take, for instance, a scenario where an organization is considering the migration to a new help-desk automation package, which promises to cut the time to process a customer support call in half. If that firm has 10 customer service reps, each earning $30,000 a year, cutting call time in half equals the addition of 10 new reps, with a total value of $300,000. Of course, until the software is implemented, we can't guarantee that the benefits will be as advertised, but a calculation like this at least gives us a rough starting point for our benefits calculations.

One thing the Internet bubble has taught us is that projections of revenue on the Web were all wet. Many companies made large investments in e-commerce systems in the Internet frenzy, and for some, such as Dell Computer, the payoff in increased revenue was real and substantial. For many others, the benefits were more ambiguous. We need to apply some cold reason to this area and make sure that our clients are being realistic about the revenue possibilities of Internet investments.

It's key in this benefit calculation scenario to encourage participation by the client. As an advisor, it's your responsibility to collaborate with the client and develop some similar financial metrics that apply to the project at hand. The clients understand the business requirements and are the appropriate source for ideas and metrics around their own key performance indicators. While we, as the consultants, should offer the framework for calculating IT value, there's no substitute for the client's participation in developing the figures for the hard-dollar estimates of value. Only the clients know what that extra communication or employee retention is worth in their environment.

Rick Freedman is the founder of Consulting Strategies Inc., a training firm that advises and mentors IT professional services firms in fundamental IT project management and consulting skills. He is author of The IT Consultant: A Commonsense Framework for Managing the Client Relationship and two upcoming works: The e-Consultant and Building the IT Consulting Practice, both scheduled for publication later this year.

How to communicate IT needs to management

by Rick Vanover

Takeaway: You're too busy managing your network to brief management about the needs and goals of the IT department, right? Think again. Communicating IT needs to management is a key prerequisite for IT success. Rick Vanover offers advice to help you do it right.

How many times have you been deadlocked with management over the direction of technology and the need to spend money on IT projects or upgrades? One way to address this problem is to get management informed—and keep it informed—about where technology is going and how it may affect the organization. In this article, I’ll give you some practical advice on communicating with management in order to keep your IT department on the right track.

Taking a look at your organization
Many organizations have slowly made IT a separate department within their organizational hierarchy. Often, IT departments report to a financial group (comptroller, CFO, etc.) or a general manager. The executives whom IT departments report to may or may not have the best understanding of what IT does.

IT is different from other departments in that executives may not always see the tangible benefits of where the money is going—but they’ll certainly notice the absence of IT spending if operations become inconsistent and productivity suffers.

This evolution of IT within an organization’s hierarchy may have created certain limitations. The people we report to may not really know what the management of technology in an organization requires. Life would be great if the CFO or comptroller of a company checked up on IT to see if it needed to include space in the budget for hardware end-of-life cycles, maintaining and updating support contracts, upgrading software platforms, or standardizing hardware platforms.

However, that’s not usually going to happen. We have to be proactive in keeping management informed of IT needs such as the ones mentioned above.

Most management personnel are aware of what other departments are doing and should be doing. For example, the general manager has a pretty good idea what marketing or sales does and what those departments need to meet their objectives within the organization. That’s not always the case with IT because IT is often fairly new as a department and its responsibilities are technical in nature. We must overcome this obstacle by a continuous stream of communication and education.

An opportunity for initiative
IT departments need to make management aware of the day-to-day affairs of the IT staff and keeping it informed of the changing trends and possibilities of the IT industry. Ways to accomplish this include getting management involved in meetings with vendors and IT planning sessions. This can keep management informed of what really goes on in IT and help it understand why we make some of the decisions we do. This can also help management in succession planning since there is generally a high turnover in IT. Figure A lists some suggestions for fostering better communications between IT and management.

Figure A

Management doesn’t need to be at every meeting or see everything that goes on, but select meetings and events that will allow management to see the big picture and understand why things occur the way they do will certainly help. If management can grasp some key technology concepts, it can become a partner that allows IT to do its job better. This collaboration can ultimately let IT better serve the organization itself, as well.

Some organizations, most notably IT companies, have created a new executive position, the CIO, who oversees IT operations and reports directly to the CEO or president of the organization. Organizations that have large, widespread IT departments should definitely consider changing their management structure to include a CIO. It may be worth approaching management executives about the possibility of having a CIO as part of your organization.

A scenario you may be experiencing
Let’s look at a real example of IT working with management. I can see many IT departments having a hard time convincing management that a technology such as Active Directory Services (ADS) for Windows 2000 should be implemented. From a technology standpoint, ADS for Win2K will set a framework for many next-generation software applications, such as Exchange 2000, and it will be a good platform for future implementations of enterprise applications and other distributed systems. From a business standpoint, ADS will not immediately affect the objective of the organization, although it may liberate time from system administrators to focus on more important things instead of dealing with domain trusts and network rights issues.

In the future, ADS will make network services such as e-mail, remote files, remote applications, and other resources truly beneficial to the enterprise. An organization that is Microsoft-friendly should strongly consider making Active Directory Services testing and planning for its environment a priority. Nevertheless, convincing management that effort and funds should be allocated to such a project may be difficult because it doesn’t offer a lot of immediate return on investment.

In this example, management may not need to know the details of what’s involved with moving an organization to ADS, but it would be beneficial if it understood and accepted that all future Microsoft enterprise software solutions, and thus many third-party solutions, will benefit greatly from this framework being correctly and carefully implemented. This will create a solid foundation for future IT projects and will eliminate the more daunting and costly task of having to implement ADS at the same time you deploy your next enterprise application, such as Exchange 2000.

Critical responsibility in decision making
IT management must be a good judge of technology and the needs of its organization, because, as you probably know, IT departments have made poor decisions in the past and consolidated around technologies that crashed and burned in the market.

10 ways to effectively estimate and control project costs

Author: Jeff Relkin 

Estimating what a project will cost is only half the battle; controlling those costs during the project and after delivery is equally critical.

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Note: This information is based on a previously published article and is also available as a PDF download.

Building a better bottom line is just as important for an IT department as it is for the whole organization at the enterprise level. Implementing sound financial management within an IT framework is broader than simply being more efficient. Many factors are involved: an understanding of the main drivers of IT costs, aligning IT spending plans with overall business strategy, using financial resources efficiently, viewing IT expenditures as investments and having procedures to track their performance, and implementing sound processes for making IT investment decisions.

Estimating what a project will cost is only half the battle; controlling those costs during the project and after delivery is equally critical. In this article, we examine some methods to predict and manage costs, part of a sound basis for overall IT financial management.

1: Control baseline costs

Nondiscretionary money spent maintaining established IT systems is referred to as baseline costs. These are the "grin and bear it" costs, those required just to keep things going. Baseline costs constitute around 70 percent of all IT spending for the average organization, so this is a good place to start. These costs tend to creep over time due to the addition of new systems, meaning there's less money available for discretionary project work. Worse yet, this creep gives the appearance that IT costs are rising while the value derived from IT investments stays the same or actually goes down.

Fortunately, baseline costs can be easily controlled. Renegotiate vendor contracts, reexamine service levels, manage assets effectively, consolidate servers, sunset older applications, maintain a solid enterprise architecture, and practice good project and resource management. By so doing you can lower the percentage of the IT budget allocated to baseline costs and keep them in line, avoiding problems with opportunity costs. Think of IT projects as an investment portfolio; the idea is to maximize value and appreciation. Baseline costs are food, clothing, and shelter; we have to spend the money but it doesn't have to overwhelm the budget.

2: Acknowledge hidden IT spending impacts

Gartner estimates more than 10 percent of corporate technology spending occurs in business units, beyond the control of IT. Several factors contribute to increasing hidden IT spending:

• Flat organizational models more difficult to rein in and control
• Virtual enterprise structures ostensibly set up as nimble, agile organizational constructs but without regard for policy and procedure
• Changing organizational authority where business unit managers are given (or take) responsibility for decentralized technology spending
• Selective IT outsourcing, in which a business unit will independently decide it doesn't need to participate in overall enterprise architecture to fulfill its departmental mission

The impact of all this hidden technology spending can be profound and prevents IT from being able to control project costs. Architectural pollution from rogue projects can delay change, resulting in cost overruns and lost opportunities. Business unit-sponsored systems eventually become the responsibility of IT, increasing the cost of support and maintenance (there are those baseline costs again). Cultural biases in business units may conflict with overall strategic goals, increasing costs and resulting in the destabilization of information and knowledge. This is just as important for small companies as well as large; fundamental business decision-making is driven by solid information, and if we don't have it we can't do it.

3: Understand long-term application costs

As a general rule, ongoing application costs are about 40 percent to 60 percent of the original development cost for each year in an application's life cycle. Sound like a lot? These are the costs associated with application support, maintenance, operations, software licenses, infrastructure, and allocated help desk and operational staff. Controlling these ongoing costs is critical; as a component of baseline costs, they're necessary evils. Collect and maintain information about all new development work underway throughout the entire enterprise and actively participate in all projects as a value-added business partner. Communicate effectively and relentlessly; report to senior management anticipated costs both at the start of projects and at appropriate intervals thereafter. Don't forget to maintain a historical record of all costs.

4: Understand IT cost estimation truths

How good an estimator of project costs are you? I'm sorry to disappoint you, but no matter how good you think you are, you're not that good. None of us is; your crystal ball is just as cloudy as anyone else's. This is the single biggest reason IT projects have such a high failure rate. Remember: The cost of IT initiatives will typically exceed original estimates by an average of 100 percent.

Institutional knowledge is lacking as to the result of major initiatives, the advice and counsel of IT is routinely omitted or ignored, and business process change relies too heavily on IT ownership of those business processes. How often have you been called upon to estimate, if not virtually guarantee, a project cost before the scope has been fully defined?

As an IT professional, whatever your role on a project, you must provide business managers with parameters for setting funding expectations and force those business managers to explain why their assumptions are valid. If you're an IT manager, track all major development efforts throughout the enterprise and regardless of your role, participate in the creation of a knowledge base of maintenance and support costs to drive future verifiable and credible estimation. Don't underestimate the future costs of maintenance and support and whatever you do, don't make the classic cardinal error: Do not, under any circumstances, pad budgets in anticipation of an underestimation. Keep track of project costs as the project unfolds and communicate, immediately and vociferously, the instant you detect even the potential for an overrun.

5: Leverage current system investments

Applications, purchased software, networks, infrastructure, and any IT investment should all be regularly reviewed, at least on an annual basis, to ensure maximum value is being extracted and that original ROI goals are being met. Start with the original requirements and review them to ensure return on investment goals were delivered. Examine changes in the business and review new requests to determine whether they fit with the existing systems. Consider business reengineering. Review embedded processes to determine whether they're consistent with new organizational models and make changes where necessary. Review vendor and product features, making sure they still fit within the organization. Enterprise architecture is organic; it's not once and done. It changes over time. Keeping up with those changes allows for adjustments either at the periphery or by making modifications to existing components. This is an effective way to control overall costs.

6: Implement short-term cost cutting measures

Often we can control costs by putting in place tactical solutions. Short-term thinking can also be an effective tool in project cost estimation, in that it focuses us on the details. Getting from New York to Tokyo involves a fairly long flight, but we can't forget that we still have to figure out how we're going to get to the airport to begin with.

Try to postpone capital purchases as long as possible. This may not only provide time to negotiate better costs, but an idea for a less expensive solution may present itself after the project has begun. Always control project scope. Come to agreement as quickly as possible with business unit customers and sponsors as to the overall project scope and put that in writing. Have an effective change management process for the inevitable "just one more thing" discussions, which will limit or postpone until after project delivery the single biggest reason for cost overruns.

Try to control human resource spending. There are only two reasons to use external consultants–to fill a knowledge gap (we don't know how to do something) and to fill a resource gap (we have too few to complete the project on time). Negotiate the best possible rates and where possible, use fixed-price agreements rather than T&M (time and materials).

7: Implement long-term cost cutting measures

Be tactical, but don't forget to be strategic at the same time. Make sure there's an enterprise architecture; it's hard to put the puzzle together when you have no picture on the front of the box to go by. Eliminate duplicate processes and systems, eliminating unnecessary costs in the process. Reprioritize and rejustify all IT projects on a regular basis. Just because something made sense in January doesn't mean it still does in August, so why waste the budget? And outsource selectively. These are the costs that typically are the most controllable yet too often lead to the highest cost overruns.

8: Implement pricing and chargeback mechanisms

I once worked for a CIO at a Fortune 500 company who decided an internal chargeback process was needed to make business units more accountable for technology costs. He successfully implemented the new approach and was credited with saving the corporation many millions of dollars. He was also fired, because this approach is the one most fraught with political peril.

Absent a chargeback mechanism, business units tend to look upon IT as a giant free toystore. Put one in place and those same business units feel free to go to the outside to get more competitive technology pricing, and IT loses control and becomes marginalized.

If your company is going to consider this, there are ways to achieve both goals: making the business units accountable and maintaining central technology architectural control. Internal IT must be competitlve with external service providers. Periodic benchmarking exercises are key. Don't underestimate the substantial resources needed to effectively administer chargeback mechanisms to ensure that business units have all the information they need and no one feels at a disadvantage. IT must have a clear understanding of all costs and manage the demand appropriately. Use client satisfaction surveys and service level agreements (a good idea no matter what the circumstances) and always show a balance between costs and benefits.

9: Use governance to drive IT investment decisions

Too many organizations fly blind, with little synergy between IT and the business. In most organizations, IT is a discretionary expense center; there's a fundamental framework (baseline costs again) but most, if not all, of what's required beyond that isn't necessarily mission critical.

Enlightened organizations understand that IT is a value-added strategic business partner, and a successful collaboration between IT and the business drives significantly increased stakeholder value. Establish, or if one exists become a participant of, a strategy council to examine enterprise-level issues of strategy, politics, priorities, and funding. Set up a business council to define priorities, oversee projects, and measure (and communicate) project success across business units. This group must, of course, have the courage to cancel projects when that becomes necessary; not everything that starts must finish. Put together a technical council to develop guidelines and principles for technology standards and practices. These are three very different organizational constructs, and while there may be some overlap in terms of participation, the mission of each is mutually exclusive.

10: Quantify the value/benefit proposition for IT investments

Why do we do what we do? That's not an existential or rhetorical question. IT exists to provide value, to participate in the achievement of organizational strategic goals. How can we prove we've done so? Just because we've built a thing, that doesn't mean much. Does the thing work? Does the thing provide value? Is that value measurable and consistent with the corporate mission?

Some quantifiable benefits of IT work can be improved operating efficiencies, enhanced personal productivity, enhanced decision quality, and/or enabling or supporting organizational strategic initiatives. What's most critical is to ensure the credibility of any measurements used to justify IT investments and provide after-the-fact valuations. You may be working on a project that will reduce a process from five person-days' worth of work to two. Does that mean three people are going to be fired, with the resulting compensation cost saving attributable to your project? Probably not. Those folks will most likely be reassigned, so don't take credit for expense reductions that aren't going to happen.