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During a recent meeting, a CIO described a possible challenge he encountered in his chargeback process. The “unit prices” he was invoicing to the business units were sometimes higher that the ones proposed by external service providers. This was primarily due to the manner in which the IT expenses were allocated. There were sound reasons for this, and he considered explaining them to the BU leaders. But he experimented with another approach: With the agreement of his CEO (and CFO), he split the amount of the chargeback into two “buckets” and allocated a part of the costs to the corporate level rather than to the BUs.
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A few years ago, when a CIO client developed an IT chargeback system, he was confident that the implemented rules were fair to the business units (BUs). But salespeople from external service providers (ESPs) suggested that BU leaders should bypass the IT organization (ITO) and work directly with them because they would be able to offer better deals.
And indeed, the prices proposed by the ESPs were often cheaper than the unit costs displayed in the internal IT services catalog. BU leaders then began hassling the ITO and corporate executives, arguing that it would be more cost-effective to work directly with ESPs. Fortunately, the CIO was able to explain and to rationalize the “discrepancies” with a little help from his finance and accounting partners.
There are numerous reasons for this situation, and they are instructive to other CIOs attempting to establish chargebacks. The ITO allocated the costs related to the IT strategy, architecture, IT consistency, master data management (MDM), overall security, PMO, audit and a variety of other IT services. These activities and their costs were not included in ESP proposals, since most would continue to be incurred by the ITO after any outsourcing occurred (and thus should be considered and charged back separately).
The CIO decided that these “IT overhead costs” should not be bundled into unit costs, but instead broken out and allocated separately, almost like the G&A (general and administrative) line item in a company’s income statement. Moreover, the CIO explained that ESPs often underestimate some components of their services, such as organizational change management in application development projects. There was also a risk that the ESPs would drive price cuts on a first deal to secure the deal and then increase prices sharply on additional contracts, once they secured a strong commercial position with the company, as some ESPs do.
“I’ve tried to explain why it was not always relevant to compare such prices,” recalls the CIO. “The CEO and the CFO understood perfectly, but it turned out to be tougher with BU leaders.” As John E. Van Decker, Jim Duggan and Jack Heine wrote in a Gartner research note (please see below), “All chargeback mechanisms have detractors.”
So a new chargeback system was designed with the support of the CEO and the CFO. Only the costs strictly related to the delivered service were used to price the chargeback rates; all the other costs were allocated to the corporate level and included in the business expenses.
A communication, based on examples, was aimed at BU leaders to warn them against the “dumping” price strategy of some ESPs. They were informed that such contracts could eventually lead to higher costs.
CIO CALL TO ACTION
To improve the acceptance of the chargeback system and lower the risk of BUs dealing directly with ESPs, CIOs should take the following actions:
• Evaluate the allocation of IT costs and whether they should be incurred directly by BUs or be a shared corporate-level service (that may be allocated differently). This enables better comparisons with ESPs’ unit prices.
• Prepare a communication/PR kit to promote the approach with key stakeholders.
• Work with the CEO and/or the CFO to gain their support on the financial model.
• Communicate to the BUs about the pros and the cons of using ESPs directly, without the help of the ITO.
BOTTOM LINE
Carefully allocating IT costs between corporate and BU budgets, and enabling direct comparisons to ESP pricing, can improve BU chargeback acceptance and fair competition with ESPs trying to sell directly to BUs.
Business Impact:
A transparent IT chargeback system improves both the accuracy of cost computations and the commitment of BU leaders in IT cost control, and ultimately saves time and money.
Additional Insights:
• “IT Chargeback: Simple Models Often Better Reflect End-to-End Business Value,”
Jack Heine, Kurt Potter, 7 May 2009 (Research)
• “Business Application Chargeback 101″
John E. Van Decker, Jim Duggan, Jack Heine, 21 November 2008 (Research)
• Chargeback – How Far Should You Go?” Gartner EXP research team led by Marcus Blosch, Roger Woolfe and Jeremy Grigg, May 2003 (Research)
