Enterprise IT: A cost center or value driver ?
Many established organisations still regard IT as a ‘service’ function to the business. IT as a ‘service’ – makes good sense from an organisational design perspective, right? Cost is one aspect. Question is, where’s the value lie? Can you identify the business value driver for each IT initiative?
The world of enterprise IT is substantially different to that of a decade ago. The changing IT landscape has been reshaped by factors such as the democratisation of technology, massive reduction in compute and storage costs, cloud computing, mobility, analytics, cybercrime or never-ending data breaches – all in a hyper-connected, globalised world.
Established businesses need to be keeping a careful eye on the ongoing disruption of whole industries due to the uptake of new, innovative technologies. Far cry from the focus of most IT departments being on owning, running and maintaining in-house systems of a earlier decades, where changes occurred at a far slower pace.
Let me explain my rationale for challenging this legacy approach of treating IT as a ‘service’.
Why understanding how IT costs are reported is important
Firstly, I would like to take a minor diversion into the exciting world of company accounting. By understanding the rationale for how IT costs are managed and reported through the management hiearchy, we will be better placed to understand why many business leaders continue to regard enterprise IT as a ‘service’.
For diverse, multidivisional organisations, IT departments are often tucked under a centralised ‘shared services’ division, alongside together enterprise service functions such as human resources, finance and accounting, administration support, legal and so on.
This helps segregate the direct costs from the indirect costs (also referred to as ‘overheads’), which fits in nicely with traditional accounting and organisation design practices.
Who cares about direct and indirect costs, really?
Direct costs are typically correlated with the activity level in the organisation (e.g. sales volumes, units shipped, etc.). In other words, and using the factory analogy, to double the factory output would increase the direct cost because you’re using more raw materials – but your indirect cost may remain the same. This approach lies at the heart of the so-called ‘break-even’ point. That is, the point beyond which your organisation’s costs or expenses and revenue are equal. Once your organisation has recovered the costs of its ‘overheads’, and from that point on, any additional revenue past the breakeven point is highly ‘profitable’. That’s why running a ‘low overhead’ business is good business sense. Minimising the indirect costs then becomes an ongoing focus for business leaders.
Now, through the lens of financial reporting, if enterprise IT is regarded primarily as an indirect cost, these are to be minimised.
Put another way, if the business value of IT is not directly related to its cost, IT cost minimisation will most likely be the default managerial response, not value maximisation.
Now that we’ve got a handle on the perception of IT costs, what about the value of IT?
Enterprise IT’s value proposition has changed. Or has it?
For those senior executives who came through the university education system in the 1990’s and early 2000’s, and/or worked their way up through the ranks, may not have had the first hand experience in fully exploiting the opportunities that the latest digital technologies offer. The then-prevailing model of IT Departments were mostly based on the need to have IT (or even their outsourced IT provider) keep their hardware and software running and ensuring the organisation’s transactional systems (ie: the ‘life blood’ of the organisation) operated as intended.
Enterprise IT delivered the platform on which the organisation could run its various internal business functions such as warehousing, supply chain, order entry, payments processing, invoicing, financial and accounts reporting, and so on. Given that, for the most part, enterprise IT costs were largely constant, it was logical to treat IT as an indirect cost. These IT costs were then associated with the ‘overhead’ of the organisation. Additionally, the purchase of IT infrastructure and software licenses was typically on a ‘buy and depreciate’ basis. Hardware and software financing was also part of the mix. All contributing to the comparative inflexibility of IT costs, further reinforcing the fact that IT should be seen as an indirect cost, and grouped in with the other overheads of the business.
The line-of-business could then get on with the real job of ‘running the business’ – such as finding new customers, markets and business opportunities, expanding sales, developing new products, and so on. The costs associated with these activities could (for the most part) be are associated with the ‘value’ part of the organisation, and therefore treated as a direct cost.
Question is: Is this model for investing in IT still appropriate for your organisation in today’s globalised, technology enabled environment?
* Being a ‘service’ function to the business should not to be confused with the ‘-as-a-Service’ paradigm which underpins the cloud computing business model (or any other demand-based delivery or revenue model, for that matter).