Mark McDonald

Measuring the relationship between IT expenditure and business activity is a challenging subject.  While measuring IT as a percent of revenue is a popular comparative benchmark, it is a measure that can provide a misleading indicator, particularly when it is considered in isolation.

IT as a percent of revenues is a ratio and therefore subject to changes in the numerator or denominator.  As revenues fall, due to the global recession, the ratio of IT spend to revenues will increase as the denominator declines.  This is happening now as the global economic crisis as consumer revenues are falling faster than IT budgets.  

According to the Gartner Executive Programs Q1 2009 IT budget survey IT budgets  have declined a weighted average of 4.7% which is substantially less than adverse changes in many company revenues.  

For example a company with a 2.4% IT budget to revenue number could expect that number to rise to 2.8% if revenues fell 20% while the IT budget only declined 5%.   Retaining a 2.4% budget ratio would require a 20% cut in IT spending.  

Such a core of action, cutting IT spend in proportion to changes in revenue would seem reasonable financially, if the entire IT budget were a direct factor of revenues.  This is not the case for several reasons including:  

• IT has a heavy contractual and fixed cost component which on average is (60-80%) of the IT budget  therefore not readily adjustable to revenues.  Depreciation is an example which can account for 20-30% of the IT budget.
• Many of IT’s costs are not driven by revenue, but other business factors.  For example, investments in new business capabilities – many of which are intended to generate new revenues – would be discontinued in the face of linking IT budget changes to revenue changes.
• The traditional connection between IT costs and revenues has been breaking down significantly over the past five years.  (explanation below)

Given these changes, IT as a percent of revenue represents a comparison metric but not a management metric – from the perspective that it would be a secondary metric to change the IT budget or priorities based on movements.  

A better management metric here is the historical cost of IT operations compared to transaction volumes – the average/marginal cost of IT transaction processing today as compared to those costs historically.  

If we are moving into an environment where transaction volumes are disconnected from revenues, then the goal is to process these transactions at a managed and lower average cost – else the volumes will eat into profits.  Metrics along these lines also better fit with the investment/payback cycle associated with infrastructure investments that are spread out over business activities rather than calendar years.

The transaction/revenue growth gap
 It used to be that IT transaction volumes and operational requirements were strongly correlated to business revenues.  This was largely due to the fact that these volumes came from employees in putting transactions – fewer revenues, fewer employees, less IT volumes.  The same in opposite when revenues grew – more revenue, more employees and increased IT volumes.

However as companies opened up systems to customers, suppliers and trading partners via portals, web sites, EDI etc.  This relationship has broken down so while revenues are decreasing, IT transaction volumes and operational requirements (e.g. Data storage) are actually growing.  Banks provide a good example of this issue as “balance lookup” is one of the fastest growing transactions as customers check their bank balances without any corresponding increase in revenue.
 

Longer explanation in the following Blog entry http://blogs.gartner.com/mark_mcdonald/2009/02/02/do-you-have-an-emerging-capacity-gap/

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Category: 2010 CFO budgets     Tags: 2010 planning, IT Finance, IT Leadership, Metrics, stupid management tricks

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