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HP Software's community for IT leaders // March 2013
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The business advantage of service-based costing

An IT financial management expert explains the value of delivering—and discussing—services in a way the business can understand.

A service-based costing model gives IT the perspective and vocabulary to speak the language of business. It allows IT to present its offerings as business services, rather than IT components. This puts the emphasis on IT’s value, not its costs. And it enables IT to more effectively benchmark its services against external SaaS providers, an important step in becoming a true service broker.
 
Service-based costing incorporates all activities, resources, and processes required to deliver a service or function within the enterprise. By more accurately allocating “overhead” and support costs, budgeting is more accurate and the true costs of business are better understood.
 
Myles Suer, an expert on IT financial management and product strategist with HP Software, offered Discover Performance his insight on service-based costing.

Q: In your mind, why is it important for IT leaders to adopt service-based costing? What are the main benefits?

Myles Suer: To capture it in one word, transparency. I cannot count the times that I’ve heard the same word from each and every customer. It’s my opinion that this all goes back to Nicholas Carr’s book, “Does IT Matter?” Carr asserted that IT has become a utility, and that there was no unique value in IT. To be fair, there are industries where IT has a limited value. But in general, I say the book is just dead wrong.
 
You know what happened after the book was published? Business leaders evaluated their IT investments and determined that IT did in fact have value. After all, it enables what Booz & Company calls the “capabilities system of the enterprise.”
 
However, these shrewd business leaders also reasoned that some aspects of IT must have more value than others. So business leaders started moving into IT. As a result, the value discussion around IT investment shifted to terminology and categories of investment that the business could understand. But most importantly, it focused on allowing a business discussion to take place around IT investment.

Q: Are there any organizational or operational changes that an IT leader needs to make before moving to a service-based costing model?

MS: Yes. First of all, they need to establish leaders that can communicate and interact with the business and, most importantly, understand business problems. IT leaders today must drive agreement about what services are offered and how they relate to enterprise business processes.

Q: Does service-based costing require any changes in how IT leaders manage their vendors and suppliers, including SaaS and cloud providers?

MS: Yes. Everything needs to be included. Moreover, it makes sense to group costs of vendors and suppliers by services as well. But since you asked about SaaS and cloud providers, they’re forcing IT to create comparable pricing models and to be able to explain the value when it costs more. But more importantly, if IT has a comparable model and it is as good, then discussions with business leaders change—the reality is, no one can argue with a benchmark.

Q: Why is it important for IT to be a service broker?

MS: In today’s environment, IT needs to become a service broker. IT should not view this as a negative event. It’s just like marketing deciding whether to have a direct or indirect sales force. And in both cases, the respective department must own the strategy and measure performance against it.
 
For IT, as was suggested in ITIL Version 3.0, you need to determine where IT has a comparative advantage—or doesn’t. This requires that IT evaluate the value and cost of its services relative to an external SaaS provider’s, and then choose whether to outsource the service or host and manage it internally. A range of criteria plays into such a decision, of course, such as security, whether the service enables competitive advantage, the cost savings of outsourcing, and so on. The point, however, is that, as a service broker, IT is advising the business on where and how to source IT services. This allows IT to provide value to the business.

Q: In service-based costing, how does cost allocation work?

MS: IT has costs at the atomic layer. But they mean nothing to the business. Hunter and Westerman, in their book “The Real Business of IT,” say that IT is like an exercise bike. The true value of an exercise bike is not the seat, handlebars, and pedals; it’s how those physical parts work together to help you lose weight. Similarly, it’s not the parts of IT that are valuable, it is how the parts of IT work together that make them valuable. And costs need to be declared at the value point.
 
IT needs to move away from charging for the transactions rather than the delivered service. The business doesn’t care about the component costs. This in its most simple form is what allocation does. IT takes costs and builds up the key components, infrastructure services, applications, and finally business services, and then allocates business services to customers.

Q: Could you briefly explain how the costs are allocated at each stage of the process?

MS: It breaks down like this:
IT services = server cost + maintenance cost + server people cost + server project cost.
Applications = pro rata portion of IT service cost + application cost + application people cost.
Business services = application cost + business service people cost + related project costs.
Customer bill of IT = list of services and service costs.

Q: Lastly, is there one critical success factor to service-based costing that you would mention/explain?

MS: Yes, you need to build consensus with the business on the names of business services and how they relate to business processes. Several years ago, customers told me about fistfights happening over business service definition. We need to mature and improve this.
 
Myles Suer is a senior manager for field and partner evangelism for HP’s IT Performance Management Suite. For more information on bringing transparency to your IT costing, see our IT Financial Management page.


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