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Perspective Eduardo Alvarez

Cynthia McNeese

No Place Left to Squeeze


Rethinking IT Cost
Management Strategies
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CONTACT INFORMATION

Chicago
Eduardo Alvarez Cynthia McNeese
Partner Partner
312-578-4774 312-578-4638
eduardo.alvarez@booz.com cynthia.mcneese@booz.com

Originally published as:


No Place Left to Squeeze: Rethinking IT Cost Management Strategies,
by Cynthia McNeese, Eduardo Alvarez, and Chris Disher, Booz Allen Hamilton, 2003.
1

No Place Left to Squeeze


Rethinking IT Cost Management Strategies

Current economic conditions are forcing companies to significantly rebase General &
Administrative costs. For many organizations, the cost cutting in the IT function is expected
to deliver 40% or more of overall savings. The problem is, many organizations are already
struggling with budgets that are barely adequate to the demands being placed on their IT
function. With no place else to squeeze, the traditional approaches to IT cost management
aren’t effective anymore. It’s time for a new approach. Our recent experience indicates that
managing the “demand” for IT services yields as much, if not more, benefit than traditional
“supply” focused cost reduction programs.

We are sure it comes as no surprise that current economic conditions are forcing companies to
search for ways to reduce G&A costs—and that for many organizations the IT function is expected
to deliver a large proportion of the anticipated savings. Our customers tell us that typically they are
being asked to find 30%-40% or more of overall savings from cutting costs in their IT function.

The problem is, many of our clients are already struggling with budgets that are barely adequate to
performance demands being placed on their IT function. There doesn’t appear to be any place else
to squeeze. The traditional approach to IT cost management—belt tightening across the board, a halt
on all discretionary projects, and some limited business process reengineering for IT to address the
more structural side of the performance challenge—isn’t effective anymore, for three good reasons:

• The cuts are starting to “hurt” or have a significant impact on the business.
• The cuts are creating a pent-up demand that will roll back into next year’s planning cycle
or be met another way by the business. As one client put it, “You can’t call it shadow IT
spending when it’s that big—it creates its own shadow.”
• Large systems renewal efforts (ERPs) have created an IT cost structure that is not
variable with the business; as the business reduces its head count, there is not an
associated reduction in IT of the same magnitude.

We believe there is a solution, but it requires some new thinking. It’s an approach that’s working
for our clients, because it achieves cost-containment goals without sacrificing the high level of
functionality needed to keep business moving. Here we lay out the basics, and offer a starting point
for taking a fresh look at IT cost reduction efforts.
2

Traditional Approaches vs. the Supply/Demand Equation


Traditional approaches to IT cost containment concentrate on internally focused cost reduction
programs. In short, they focus on managing the supply of IT services. From our recent experience, we
are finding that managing the demand for IT services yields as much, if not more, benefit than the
traditional supply focused cost reduction programs (see Exhibit 1).

Exhibit 1
IT Supply and Demand Savings Drivers


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Supply-side approaches to G&A savings focus on operational efficiencies. In the past, they typically
have been expected to yield 20%-30% savings. However, many of our clients have already pursued
internal efficiency initiatives that have wrung those savings from their departments. They are finding
additional incremental savings required to meet budget objectives difficult to attain. With our new
demand management techniques, we are seeing up to 40% of the total IT savings. These approaches
are by no means mutually exclusive. In fact, maximum cost efficiencies come from using a strategy
that manages both the supply and demand.
3

This chart lays out the two sides of the supply/demand equation.

Supply Driven Performance Demand Driven Performance


4 Get the basics rights—know your economics, 4 Drive a performance dialogue with the
provide stewardship of every dollar, manage business on the economics of IT choices
the cost structure in line with business (how much, how delivered, at what quality,
performance requirements, etc. and at what cost).
4 Take advantage of the economics provided 4 Align the investment strategy with
by the commercial IT market—which the opportunity. Don’t treat the entire
has some significant differences from budget as G&A; recognize that many IT
outsourcing of the 1990s (a.k.a. paying a investments are better managed as cost
vendor to operate your assets at a premium) of goods sold—a direct and variable cost of
doing business (COGS).
4 Tailor the offering to meet demand. The
one-size-fits-all approach overserves some
while underserving others.

To understand how this approach results in greater cost and service efficiencies, organizations
need to understand the basic economics of their services: cost structure, cost behavior, price
performance of the underlying technologies, capital requirements, and capital relationship to
the O&M run rate (e.g., if I build it, I must maintain it). Only then can the IT spend be segmented
effectively in order to manage it for maximum return on investment.

For example, renewing the infrastructure through sporadic capital outlays usually produces a
fragmented, complex, and aging infrastructure. An aging infrastructure drives a high total cost
of ownership (TCO) through added support requirements, increased hardware and software
maintenance, and so on. In this economy, IT cannot be assured of the needed capital (or ready cash)
to manage the refresh required to drive down O&M costs.

As an alternative, clients are aggressively pursuing commercial and public infrastructure providers
to help them “decapitalize” their infrastructure costs. It is important to note that we are not
referring to the model pursued in the 1990s. That sourcing approach yielded some very unfavorable
economics. Here’s the typical scenario: Company A sells its assets to a vendor who operates them
at a premium. More than likely, Company A pays for the assets again in its bill by trading noncash
depreciation for a real cash bill from the sourcer, and the assets are not updated or refreshed
frequently enough to more cost-effective technologies.

Today we are pursuing IT service models where the technology vendors are integrated into an
organization’s service delivery chain in new and highly economical ways that ultimately defray
direct costs. For example, imagine that a company’s “road warrior” users get to pop into the local
electronics store to purchase needed supplies or get minor repairs, including software reloads, and
charge any non-warranty work to their corporate P-Card (which is verified through the company’s
purchasing system and checked against its asset inventory). This and other service scenarios are
being developed today.

The demand dialogue gets more interesting—it leverages what IT management knows about a
company’s economic performance, bringing the business into a whole new conversation. Primarily,
the dialogue has to demonstrate the economic impact of business service choices and include them
in the prioritization of work. For example, one client’s business leadership could not understand the
impact their “simple” requests had on the cost TCO of the ERP system—until we put in their terms
(see Exhibit 2).
4

Exhibit 2
Client ERP Investment – Retail Operations
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One-Size-Fits-All No Longer Suits


Another new dimension to demand strategies is an answer to the age-old one-size-fits-all debate that
IT organizations inevitably face when trying to reduce costs. The old argument is that a standard
solution puts the IT function at the lowest part of the cost curve. What we’ve found from client work
is that this approach actually overserves many in the business while underserving others—a problem
most CIO’s can appreciate: Many are complaining about the bill while the others are complaining
about the service. The one-size-fits-all approach results in higher than necessary costs, and users who
are not receiving the appropriate level of service. Conversely, IT ends up offering each business unit
a different set of services, and without scale or standards, finds itself on the inefficient part of the
operations curve.

We’ve been applying some basic marketing discipline to one-size-fits-all problems with much
success. Customer segmentation allows IT to understand how to tailor its services from the customer
perspective—and manage the problem from a cost-to-serve and ability-to-serve perspective.

The first step is to define distinct segments in the user population. The new offerings target key
service and economic drivers: access methods, support levels, reliability, etc. The resulting clusters, or
segments, tell IT which users have similar needs and which have meaningful differences to serve. This
allows the IT function to:

• Create distinct service bundles, priced and sized according to the segment, e.g., site-light
offerings, etc.
• Tailor the actual delivery model of the services for the segments, e.g., why have dedicated
staff when the Best Buy store up the road can do the warranty work for employees who
use their corporate P-Card for payment of accessories.

As a result, our clients are creating tailored but efficient delivery models that integrate vendors, users,
and self-serve tools and which can be lower cost and provide more aligned service (see
Exhibit 3).
5

Exhibit 3
Segmentation Savings Analysis
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A New Funding Approach: Mix Traditional Project and Self-funded Models


Another important challenge has been the “do more with less” budget. In recent years, that has
meant reductions of 20% or more. Our experience is that self-funding has become a key element in
the funding and prioritizing of new technology investments. This is in reaction to the tighter economic
conditions, and also in recognition that previous technology investments that have not delivered
the promise. We are finding that by taking a TCO over the service view we can identify the right
conditions and trade-offs to make these type of renewals self-funding .

Furthermore, other clients are rethinking the funding model and role altogether. If the entire IT
budget is placed in the G&A cost bucket, it will inevitably be treated as such, i.e., cut by some
percentage each year. That is why our clients have benefited from stratifying their investments by
type of spend. If, for example, the investments are related to COGS, the spend is better managed
by the COO than the CIO. That way an increasing percentage of the IT spend can be attributed to
new products and channels—and the cost-reduction tactics can be managed accordingly. Imagine
the business reaction of assigning the typical G&A reduction target to their production costs—the
business users will take notice. As a solution, we recommend at least recognizing the differences in
the IT spend. Then, it is possible to pick the best “owner” and management strategy.

Returning to Basics
What we’ve been prescribing isn’t rocket science. In fact, it’s a return to basics that run any service
business: offerings tailored at a cost and performance level to specific segments based on cost and
ability to serve. These are the same fundamental analyses that allow a business to choose between
a channel expansion and a capital investment in a new plant. Applying these analyses allows
the IT function to define which technology services and support costs are associated with actual
products or channels; understand the meaningful differences to serve the customer base across the
enterprise; and identify opportunities to “right size” services offered and delivery models to reach
each customer segment. The end product is a business plan with measurable results.
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