Establish a Service-Based Costing Model

Not knowing your costs is an expense you can’t afford.

Our understanding of the problem

This Research Is Designed For:

• CIO with IT budgets <$20M, all industries
• IT Finance Head

This Research Will Help You:

• Define the relevance of service-based costing to your organization.
• Identify your current service-based costing needs and level of maturity.
• Improve your service-based costing capability.
• Determine the cost of your IT services.
• Use costing information to drive business value.

This Research Will Also Assist:

• CFO
• IT Financial Analyst

This Research Will Help Them:

• Recognize how IT investments are deployed to support business services.
• Allocate IT costs fairly across IT services.

Executive Summary

Situation

• While IT departments provide valuable services to their organizations, it is frequently unclear how much these services cost. CIOs often find themselves in a position where they cannot articulate exactly how much it costs to deliver a given service in order to justify the service’s value.

Complication

• IT capital and operational costs are captured in accounting ledgers using financial constructs that lend themselves well to financial reporting, but obscure the true cost to deliver each IT service.
• Translating accounting ledgers to IT service costs is a difficult process that may sometimes appear arbitrary.
• The data required for detailed service-based costing is often unavailable.

Resolution

• Use a method of determining the full cost of services that provides a reasonable level of accuracy without overburdening staff with excessive analysis and investigation.
• Optimize the balance between analytical effort and accuracy of service costing by understanding your service cost accuracy needs and matching them to an appropriate level of service-based costing capability.
• Develop the right level of service-based costing capability by applying the methods in this blueprint.

Info-Tech Insight

Not every organization needs perfect service-based costing.

Tailor your service-based costing to your requirement for transparency, your need for accuracy, and your capability to act on them.

How to use this blueprint

Do-It-Yourself Best-Practice Toolkit

Do-It-Yourself Implementation

Use this Best-Practice Blueprint to help you complete your project. The slides in this Blueprint will walk you step-by-step through every phase of your project with supporting tools and templates ready for you to use. You can also use this Best-Practice Blueprint to facilitate your own project accelerator workshop within your organization using the workshop slides and facilitation instructions provided in the Appendix.

Leverage each of the tools in this blueprint to complete the optimization of this project.

Free Guided Implementation

We recommend that you supplement the Best-Practice Toolkit with a Guided Implementation.

Guided Implementations are included in most advisory membership seats. Our expert analysts will provide telephone assistance to you and your team at key project milestones to review your materials, answer your questions, and explain our methodology.

Enroll in a GI for your project.

Email GuidedImplementations@InfoTech.com

Or call 1-888-670-8889 and ask for the GI Coordinator.

Onsite Workshops

Info-Tech Research Group’s expert analysts will come onsite to help you work through our project methodology in a 2-5 day project accelerator workshop. We take you through every phase of the project and ensure that you have a road map in place to complete your project successfully. In some cases, we can even complete the project while we are onsite.

Book your workshop now!

Email WorkshopBooking@InfoTech.com to get started.

Info-Tech is ready to assist. Book a free guidedimplementation today!

Book a Guided Implementation Today: Info-Tech is just a phone call away and can assist you with your project. Our expert Analysts can guide you to successful project completion. For most members, this service is available at no additional cost. (Guided Implementations are included in most advisory membership seats.)

Here are the suggested Guided Implementation points in the Service-Based Costing project:

Section 2: Assess Your Maturity and Need

Know where you are – and where you’re going: Use the Info-Tech Service-Based Costing Maturity Model to recognize your current level of capability as well as where you need to be in order to meet the needs of your organization.

Section 3: Establish a Level 1 Service-Based Costing Model

Start off on the right foot: Service-based costing is complex and difficult; Level 1 will help you get results quickly, without having to transform all of IT to a service-based delivery model.

Section 4: Establish a Level 2 Service-Based Costing Model

Be fulsome: Enhance your Level 1 capability by evolving from categories of services to individual services, recognizing even service-to-service consumption, to reach a level of service cost accuracy sufficient for benchmarking against industry.

Section 5: Establish a Level 3 Service-Based Costing Model

Get accurate and precise: By this point you are fully committed to service-based costing and it is time to bring in sophisticated software and skills to take your service-based costing to the next level.

Section 7: Use a Service-Based Costing to Drive Business Value

Show management how to drive value from service-based costing: Drive value from service-based costing by enhancing business decision making, increasing service use accountability, and improving cost forecasting.

Conduct a workshop, with us or on your own

Onsite Workshops offer an easy way to accelerate your project. If you are unable to complete this project on your own and a Guided Implementation is not enough, we offer low-cost deliveries of each Blueprint.

Our expert analysts will come onsite to help you work through our project methodology over the course of 2-5 days. We step through each phase of your project and ensure that you have a road map in place to realize success. In some cases, we can even help you to complete the project while we are onsite.

1. Enroll in a 2-5 day workshop for your project

Send an email to WorkshopBooking@InfoTech.com or call 1-888-670-8889 Ext. 3001. Your account manager will contact you and quote you the cost of the workshop.

2. Book your workshop

A Workshop Coordinator will contact you to book a workshop planning call with one of our facilitators and arrange dates for your workshop. We can hold the workshop in Info-Tech’s world-class facility in Toronto or at your location.

3. Participate in your workshop

Our experienced workshop facilitators will take your project team through your tailored slides and exercises and will summarize all the workshop outputs into a final report.

Key Insights

Don’t begin without purpose

• Know how you intend to make use of your service-based costing results before your begin; if there is no clear purpose, it will be a waste of time.
• Service-based costing is complex, difficult, and lengthy.
• Service-based costing requires a serious commitment in order to do it right.
• Service-based costing is useful to achieve certain objectives, but it is not a panacea for all costing woes.

Service-based costing (SBC) is not for everyone

• Do only what you need. If your capability is already sufficient to meet the needs of the organization, don’t embark on improving your service-based costing capability.
• The Info-Tech Service-Based Costing Maturity Model can help you determine where you are today and where you need to arrive in the future; do only what you need!

Everybody can benefit from basic SBC

• Business value and decision making can be enhanced even with a small increase in SBC maturity.
• Even Level 1 SBC maturity can help to focus your attention on the categories of services that consume the greatest amount of IT spend.
• Level 1 SBC can simplify the service-based costing analysis to minimize the amount and complexity of data collection.

Key Insights (cont.)

Level 2 SBC is accurate enough for many organizations; however, few have achieved it

• Align your service catalog with common industry practices to enable benchmarking of your service costs.
• Understanding the makeup of your services and how they interact with one another is key to establishing an accurate costing.
• Simplifying assumptions can greatly reduce the effort involved and can often be used without introducing excessive error.

Bring in extra help if you want a truly accurate SBC

• Level 3 SBC is a large and complex effort; you need the right combination of skills, experience and knowledge, some of which may require sourcing externally, both from an IT service perspective and a finance perspective.
• Full service-orientation is critical and a pre-requisite for accurate and precise costing.
• Think both top down from the general ledger and bottom up from the configuration items, and reconcile finances through services; automated data collection and analysis will help.

Nobody trusts a “black box”

• Documenting your SBC model will help to bring transparency, authority, and acceptance of your model.
• Keep it current! And keep a written history of all of your SBC decisions and the rationale behind them.
• Communicate all changes early and simply; nobody likes surprises on their IT bill.

Key Insights (cont.)

Understanding true service costs can improve business efficiency

• Many IT consumers are unaware of the costs they incur; exposing the cost can reduce unnecessary consumption.
• Understanding service utilization can help with capacity optimization; you’ll have the right balance of cost and flexibility.
• Knowing services costs allows better planning and budgeting; you can boil it down to unit cost * utilization.
• Properly costed IT services can be compared against industry benchmarks and alternative service delivery methods; there may be a less expensive way to deliver the services users rely upon.
• Outsourcing may improve the overall efficiency of your IT department, allowing you to focus on delivering services that provide competitiveness and outsourcing commodities.

Section 1: Make the Case

Sections:

Make the Case

• What's in this Section:
  • Define Service-Based Costing (SBC)
  • Benefits of SBC
  • Risks of SBC

Assess Your SBC Need and Maturity

Establish a Level 1 SBC Model

Establish a Level 2 SBC Model

Establish a Level 3 SBC Model

Document and Maintain Your SBC Model

Use SBC to Drive Business Value

Section 1: Make The Case

Insight

• Don’t begin without a purpose.
• Know how you intend to make use of your service-based costing results before your begin; if there is no clear purpose, it will be a waste of time.
• Service-based costing is complex, difficult, and lengthy.
• Service-based costing requires a serious commitment in order to do it right.
• Service-based costing is useful to achieve certain objectives, but it is not a panacea for all costing woes.

What You Will Achieve in this Section

• The opportunities service-based costing can afford will be defined.
• Differences between SBC and traditional costing will be highlighted.
• The challenges of service-based costing will be explained.

Deliverables

• None for this section.

Translate costs into value with service-based costing (SBC)

Defining Service-Based Costing

• Service-based costing looks at the output provided by a service and traces the costs incurred to produce a single unit of output. E.g. The cost to manage a single desktop computer.
• SBC incorporates all costs necessary to produce that service, including:
  • Direct costs
  • Shared costs
  • Overhead
• The total expenditure towards IT is accounted for in the total cost of all IT services delivered.

IT Departments Incur Costs…

• Hardware
• Software
• Third-Party Services
• Labor
• Resources
• Property
• Administration

…To Deliver Valuable Services

• Business-facing IT Services
  • Help Desk Service
  • Email Service
  • Etc.
• Internal IT Services
  • Network Service
  • Virtualization Service
  • Etc.

Service-based costing provides these benefits

Transparency

• Expenditures on IT resources can be directly linked to IT service delivery and business value, and IT investments can be targeted at specific service enhancements.

Comparability

• Cost to deliver services via internal resources is directly comparable to and can be benchmarked against service delivery via alternative sourcing options, such as outsourcing or cloud services.

Accountability for Consumption

• Business units recognize the impact of their consumption and can adjust their usage patterns to make more efficient use of IT services.

Budget Credibility

• Forecasting budget is closely tied to expected service demand and known service costs.

Clarity

• CFOs are able to identify how IT expenditures in the general ledger map to IT services delivered.

Cost Optimization

• Costs are decreased through reducing cost drivers and improving service processes.

Cost Attribution

• IT service costs can be fairly distributed among IT users, supporting chargeback or showback.

Push through the challenges of SBC

SBC has many benefits, but they don’t come easily.

Methodologies are Protected and Proprietary

The organizations that do SBC well – frequently commercial banks and insurance conglomerates – consider their SBC methodology a competitive advantage and guard it carefully. Additionally, developers of IT financial management software view their models as proprietary intellectual property. Consequently, there is little public information on SBC methodology.

Agreement on Service Definitions is Required

Having a well-defined service catalog is necessary for advanced SBC. Without clear service definitions, it is hard to allocate costs appropriately. However, building a service catalog is a difficult task: it is both expensive and time consuming.

Data Must be Available

Cost allocations can be simple, but accurate cost allocations need to be data driven. This means organizations must meter consumption of key IT resources. For example, if the amount of storage used by an application is unknown, then costing the storage used by that application will be difficult.

Allocation is Complex

In order to do SBC properly, shared costs and overhead must be allocated according to consumption. In order to do this, costs must be traced and disseminated appropriately across and in proportion to the services that consume them.

"Outside of the government space, no one shares anything. Banks and insurance companies do this better than anyone and do not share it." - Robert Mischianti, Vice President Product Development, Nicus Software

Differences between SBC and traditional costing

Traditional Costing

How Costs are Calculated:

• Direct costs: Are easier to trace and therefore added where the cost is incurred.
• Shared costs: Are often allocated based on an arbitrary proxy; e.g. total direct cost, business unit revenue, # of users.
• Overhead costs: Are usually allocated similarly to shared costs.

Benefits:

• Relatively simple to calculate.

Weaknesses:

• May be very inaccurate.
• May be unfair in business unit chargeback.
• May lead to misdirected decision making.

Service-Based Costing

How Costs are Calculated:

• Direct costs: Are allocated to the service that consumes them.
• Shared costs: Are allocated to the service that consumes them, in proportion to the consumption.
• Overhead costs: Allocated as closely as possible to actual consumption; otherwise a service-oriented proxy for consumption is used.

Benefits:

• More accurate service costing.
• More informed decision making.
• More transparent chargeback.

Weaknesses:

• Requires more and higher quality data.
• Requires more effort and resources.

Info-Tech Insight

The difference between SBC and traditional costing is exaggerated as overhead and shared costs increase in proportion to total costs.

Do SBC right, but don’t over do it

SBC done right brings transparency to IT service costing. But SBC done wrong brings mistrust, resentment, and resistance that can permeate throughout the organization.

Doing SBC Right

• Keep the Trust: Having the right model will generate credibility with internal customers. As changes to costing occur, customers will trust that the changes are fair. Any sense of unfairness will destroy trust.
• Be Accurate: Ensure that the model is applied accurately and deliberately. An error in one place will breed assumptions of others.
• Keep it Simple: IT cost transparency is often the key driver for SBC. Ironically, the more accurate the model, the more complex the model. Don’t make it more complicated than it needs to be so that it can be easily understood by all stakeholders.
• Recognize “Stickiness”: Once a cost is made public, clients will hold it to be true. Changes to this cost will be difficult to implement and may require justification.
• Collect Only the Data You Need: More data yields better accuracy; but data collection costs time and effort. Keep data collection to the minimum necessary.

Info-Tech Insight

It is tempting, therefore, to say “do it right or don’t do it at all.” However, SBC can be right-sized for your organization; the key is to assess your maturity and capabilities and design your service-based costing approach accordingly.

Case Study: SBC Can Drive Business Value

US-Based Fortune 500 Company

Employee Count: 50,000+

Situation

• The organization incurred significant IT costs, including project and service costs.
• Overall IT costs were distributed to business units based on headcount.
• The simplistic approach did not reflect actual usage; it was selected in order to minimize effort spent on chargeback.
• Business units with low usage felt unfairly treated and spent significant time refuting charges.
• Costly retroactive adjustments became commonplace.

Action

• Implemented a service-based costing process designed to:
  • Separate the IT project costs from service costs.
  • Identify the variable rates and fixed costs of IT services.
  • A chargeback model was developed based on the new system, promoting business unit accountability for IT consumption.
  • A financial management platform was implemented to manage IT finances.

Result

• Able to assess service competitiveness and evaluate outsourcing and other alternatives.
• Improved relationships and communication between IT and business units.
• Reduced disagreement with business units; business units bought in to the new model.

What this project will do for you

1. Make a Go or No-Go Decision

• Help you decide if SBC is appropriate for your organization – SBC requires effort and is not for everyone!

2. Assess Maturity

• Identify your current level of SBC maturity and determine the right level of service for your organization.

3. Guide SBC Analysis

• Provide a path to guide the progress of your organization to your desired level of maturity.

4. Ensure SBC Documentation

• Encourage continual documentation of the SBC process, to help keep decisions transparent and understood.

5. Drive Value with SBC

• Illustrate how to use SBC to drive value in your organization.

Section 1: Summary

Key Messages

• It is critical to know why you are embarking on service-based costing before you start.
• This is a very difficult journey that requires a significant commitment.
• If you do not have a specific rationale to know your service costs, you should not undertake service-based costing.

What You Achieved in this Section

• Recognized the flaws in traditional costing.
• Defined the opportunities service-based costing can afford.
• Clarity regarding the challenges of service-based costing.

Deliverables Created

• None for this section.

Section 2: Assess Your Maturity and Need

Sections:

Make the Case

Assess Your Maturity and Need

• What's in this Section:
  • Balancing Effort and Benefit
  • SBC Maturity Model
  • Assess Current State
  • Metrics

Establish a Level 1 SBC Model

Establish a Level 2 SBC Model

Establish a Level 3 SBC Model

Document and Maintain Your SBC Model

Use SBC to Drive Business Value

Section 2: Assess Your Maturity and Need

Insight

• Service-based costing is not for everyone.
• Don’t embark on improving your service-based costing capability if your capability is already sufficient to meet the needs of the organization.
• The Info-Tech Service-Based Costing Maturity Model can help you determine where you are today and where you need to arrive in the future; do only what you need!

What You Will Achieve in this Section

• Clarity regarding the Info-Tech Service-Based Costing Maturity Model and the capabilities required to achieve each level.
• Certainty regarding your current Service-Based Costing capability.
• A decision regarding your target level of Service-Based Costing maturity.
• Defined metrics to track your progress.

Deliverables

• A target Service-Based Costing maturity level.
• Specific Service-Based Costing progress metrics.

Strike a balance between SBC quality and effort

Perfect SBC is too expensive

• The analysis requires complex IT financial management software that pulls and analyzes data from other business systems to get a multi-layered view of cost allocation.
• Takes several years to complete.
• Needs dedicated, skilled IT financial resources.

Be pragmatic to determine your value point for quality vs. effort

• Step 1: Define the benefits and outcomes.
• Step 2: Determine the target state and align with the Info-Tech Maturity Model.
• Step 3: Ascertain your current level of SBC maturity.
• Step 4: Follow the Info-Tech process to improve your SBC capability.
• Step 5: Track your progress.

Step 1: Define the benefits and outcomes that your SBC initiative must achieve

Improving your SBC is a difficult journey. Depending on the level of capability that you are trying to achieve, this project could take weeks, months, or even years.

Target Benefits

• Improve transparency of costs.
• Accurate allocation of costs to services.
• Traceability of detailed costs to specific services.
• Understanding how purchases will change cost structure of services.

Target Outcomes

• Make the case for outsourcing or insourcing.
• Implement chargeback or showback.
• Accurate service costs.
• Fairness of allocation of costs.
• Completeness of service-based costing.

Info-Tech Insight

Are these benefits and outcomes important to your business? If not, stop now – SBC is not for you! If these benefits and outcomes are important to your business, be prepared to invest the required time and effort.

The Info-Tech Service-Based Costing Maturity Model

Step 2: Determine the target state and align with the Info-Tech Maturity Model

Deciding how mature you wish your organization to become is a balancing act between cost and clarity. The more mature you wish the organization to be, the more of an investment that will be required. Use the table below to choose a target level of maturity for your organization.

*Time to implement for a typical small to mid-sized organization

Step 3: Ascertain your current level of SBC maturity

Refer back to the Info-Tech SBC maturity model.

• Review each level of the maturity model and compare your organization against the maturity level descriptions.
• Select the level of maturity that is fully met by your organization; all the requirements must be met to achieve a level.
• Additionally, organizations should have the following capabilities at each level of maturity.

Info-Tech Insight

Most organizations are at the Level 0 or Level 1 stage of maturity.

Step 4: Follow the Info-Tech process to improve your SBC capability.

Follow this blueprint to move along the maturity curve.

This blueprint can help your organization move from a Level 0 to Level 1 and from Level 1 to Level 2 in the SBC Maturity Model. In order to move from Level 2 to Level 3, service-based IT financial management software is required.

Step 5: Track your progress

As the project progresses:

1. Your SBC maturity should improve.
2. Your accuracy scores should increase and ease of use scores should decrease.
3. Your coverage of services and IT spend should increase.

Guided Implementation: Assess Your SBC Maturity

Prior to the Guided Implementation

• Determine and document your goals and reasons for implementing SBC.
• Set a target SBC maturity level according to the Info-Tech SBC maturity model.
• Assess your current level of SBC maturity.

During the Guided Implementation

An Info-Tech Consulting Analysts with discuss with you:

• The alignment of your goals for SBC with your desired state of SBC maturity, and comment on the practicality of achieving those goals.
• Your current state of SBC maturity, any potential gaps that may exist with your self-assessed level, and how to address them.
• How to prepare to move from your current level of SBC maturity to the desired level.
• Metrics to measure your progress.

Value & Outcome

At the conclusion of the Guided Implementation call, you will have:

• Realistic goals of how SBC can help you.
• Verified current state SBC maturity level.
• Vision of the final state of SBC maturity to be obtained.
• Clearly defined next steps.

Arrange a call now:

Email GuidedImplementations@InfoTech.com or call 1-888-670-8889 and ask for the Guided Implementation Coordinator to book a Guided Implementation in your organization.

Section 2: Summary

Key Messages

• Service-based costing is not for everyone.
• Don’t embark on improving your service-based costing capability if your capability is already sufficient to meet the needs of the organization.
• Balance the effort required to improve with the level of need for the organization.

What You Achieved in this Section

• Clarity regarding the Info-Tech Service-Based Costing Maturity Model and the capabilities required to achieve each level.
• Certainty regarding your current Service-Based Costing capability.
• A decision regarding your target level of Service-Based Costing maturity.
• Defined metrics to track your progress.

Deliverables Created

• A target Service-Based Costing maturity level.
• Specific Service-Based Costing progress metrics.

Section 3: Establish a Level 1 Service-Based Costing Model

Sections:

Make the Case

Assess Your SBC Need and Maturity

Establish a Level 1 SBC Model

• What's in this Section:
  • Define Service Categories
  • Define Allocation Methodology
  • Allocate to Service Categories

Establish a Level 2 SBC Model

Establish a Level 3 SBC Model

Document and Maintain Your SBC Model

Use SBC to Drive Business Value

Section 3: Establish a Level 1 SBC Model

Insight

• Perfect SBC is not necessary to gain business value from an SBC undertaking.
• Business value and decision making can be enhanced even with a small increase in service-based costing maturity.
• Even Level 1 SBC maturity can help to focus your attention on the categories of services that consume the greatest amount of IT spend.
• Level 1 SBC can simplify the service-based costing analysis to minimize the amount and complexity of data collection.

What You Will Achieve in this Section

• Basic understanding of service-based costing will be achieved.
• Service categories will be defined.
• Allocation methodology will be developed.
• Service category costs will be identified.
• Level 2 maturity preparedness.

Deliverables

• Service-based costs for key service categories.

Before you begin, get the right people in the room

Establishing Level 1 service-based costing can be managed by a small, skilled project team.

Role: IT Finance Leader

Skillset

• Strong leadership skills
• Financial acumen
• Budgeting
• Financial reporting
• Strong relationship with CIO and CFO

Responsibilities

The IT finance leader is the lead of the SBC initiative. They are a liaison between the team and the executive sponsors. Additionally, they will lend their acumen to identify cost drivers and help make decisions about allocation methods.

Role: Technical Lead

Skillset

• Strong understanding of the cost model platform
• Understanding of the general ledger
• Basic financial accounting skills
• Basic cost accounting skills
• Basic understanding services

Responsibilities

Responsible for building, updating, documenting, and maintaining the SBC model. Strong technical skills in the modeling software of choice are required. Info-Tech’s Service-Based Cost Model Tool is created in Excel for your convenience, but any software platform may be used.

Other employees should also be available for consult:

• Finance executives – to advise about allocation methodology and financial modeling.
• IT service owners – to assist in defining service categories and to provide service cost and consumption data.

Use the IT costing pyramid to decompose high-level cost pools into smaller, targeted cost pools

A general ledger is the highest level cost pool and captures all costs in the IT organization.

Cost Pool

• A set of costs incurred when an activity is performed.

The goal of service-based costing is to determine the values of cost pools at the IT service level.

How cost allocation works

Cost Allocation

• For SBC purposes, cost allocation is defined as “moving costs from one cost pool to another.”
• For Level 1 service-based costing, we are using allocation to break down general ledger cost pools into cost pools at the service category level. See the below example.

Total amount allocated to service categories equals the general ledger cost pool. Therefore, every dollar has been allocated.

Approach service-based costing from top or bottom

There are two approaches to determine the costs of a service: top down and bottom up.

Top down

Start with the general ledger and allocate costs down until IT service costs are identified.

Bottom up

Start with configuration items, and allocate costs up until IT service costs are identified.

"The next step is dissecting the GL into cost pools. What is the cost of compute? What is the cost of labor? Is this useful? Absolutely; it helps you understand if you’re competitive" - Chris Pick, CMO, Apptio, and President, Technology business Management Council

Keep Level 1 service-based costing simple by using the top-down approach

Level 1 SBC covers top-down allocation to service categories only.

The complete top-down approach to SBC

Level 1 Service-Based Costing:

• Step 1: Allocate General Ledger to Service Categories

Not Addressed in Level 1 Service-Based Costing:

• Step 2: Allocate Service Category Cost Pool to IT Services
• Step 3: Account for Service-to-Service Consumption

For Level 1, doing step 1 is enough

This allows for simplification of the service-based costing process:

• Service definitions are not required, so construction of service catalog can be deferred.
• Data for SBC allocation is generally more available at the service category level.
• Fewer calculations are required since there are fewer service categories than services.
• Ignoring consumption of services by other services simplifies the analysis
• The final output of this step clarifies IT expenditures by service category. These service category cost pools are very useful; they can be used to improve cost transparency, for understanding key spending areas, and for making decisions regarding IT spending. Additionally, they are a fundamental building block of future service-based costing.

Execute these activities to accomplish Level 1 SBC maturity

Complete these four activities for level 1 SBC.

Step 1: Allocate General Ledger to Service Categories

• Activity 1: Define Service Categories
  • Use Info-Tech’s sample categorization or your own.
• Activity 2: Input General Ledger
  • Obtain current general ledger from finance.
• Activity 3: Define Allocation Methodology
  • Select an appropriate allocation method for every line item.
• Activity 4: Input Data to Allocate Cost Pools
  • Gather data from the appropriate systems of record.

Step 2: Allocate Service Category Cost Pool to IT Services

Step 3: Account for Service-to-Service Consumption

Activity 1: Define service categories

Services

• A set of processes that results in a positive business outcome.

IT Services

• A set of processes for which the IT department is accountable that results in a positive business outcome. For example: Application development service.
• An IT Service is a type of Service.
• An IT Service belongs to a single IT Service Category.

IT Service Category

• A set of related IT services.
• For example: Application services.
• Most IT organizations have between 5 and 20 IT Service Categories.
• Info-Tech provides a sample IT Service Category list on next page.

Define service categories or select from Info-Tech’s sample list

Category 1: Application Services

• Application Design
• Application Development
• Application Integration
• Etc.

Category 2: Computing Services

• Desktop / Laptop Provisioning
• Printing Service
• Service Desk
• Etc.

Category 3: Communication and Collaboration Services

• Instant Messaging
• Email Service
• Telecom Service
• Etc.

Category 4: Hosting Services

• Application Hosting
• Database as a Service
• Virtual Servers
• Etc.

Category 5: Mobility Services

• BYOD Management
• Mobile Phone Provision
• Etc.

Category 6: Network Services

• Basic Connectivity
• Remote Connectivity
• Mobile Connectivity * not under mobility
• Etc.

Category 7: Professional Services

• Enterprise Architecture
• Project Management
• Consulting
• Etc.

Category 8: Security Services

• Identity and Access Management
• Security Management and Monitoring
• Etc.

Category 9: Specialty and Miscellaneous Services

• Services that do not fit in another category or are unique to one area of the organization.

Use Info-Tech’s Service-Based Costing Model Tool throughout this blueprint to build your model

This blueprint will continually reference the Service-Based Cost Model Tool, so having it open in tandem with this storyboard will be helpful.

Purpose

• Identify the cost of service categories.
• Identify the cost of certain services.

Level 1 Participants

• The CIO
• A single IT Finance employee

Steps

• Define service categories.
• Input general ledger information.
• Define allocation methodology.
• Allocate to service categories.

Use Info-Tech’s Service-Based Cost Model Tool now.

Define your service categories

On the Define Service Category tab of the Service-Based Cost Model Tool, input all required elements.

IT Service Category Name

• Required field
• Use Info-Tech’s categorization or customize

Service Category Identifier (SCID)

• Editing not required, but can be replaced with a service category identifier already established in your organization.

Service Category Description

• Define/describe the service category or list services that fit under the service category in the description field or a separate document.
• Non-mandatory field.

Use the Define Service Categories tab on Info-Tech’s Service-Based Cost Model Tool.

Activity 2: Confirm the IT department’s general ledger

Obtain the General Ledger

• Obtain the IT sub-ledger of the general ledger from Finance personnel.
• Your direct reports may already have budget-cost variance reports from Finance that can be compiled to provide equivalent information, if the GL is unavailable.

Confirm Recency

• IT departments change quickly; avoid using out-of-date data.
• General ledger should be no more than one year old; six months-to-date is preferable.

Confirm Comprehensiveness

• Capital expenditures should be excluded, but depreciation should be included. Operating expense charts that do not include depreciation should be avoided or updated.
• It is beneficial to have notes available on specific expense accounts. Extraordinary, non-recurring expenses will be excluded, so having the information to identify those amounts is essential.

Info-Tech Insight

When you receive the general ledger, make sure it includes depreciation as part of the operating costs. It is a recurring expense, and failure to account for it will result in understating service or service category costs.

Enter the general ledger data

The general ledger data is input in the Account, Sub Account, and Amount columns.

For now, ignore the allocation method information in the Allocation Method, Cost Driver, and Cost Driver Unit columns – this will be discussed later.

General Ledger Identifier (GLID)

• Editing not required, but can be replaced with the general ledger account numbers used throughout your organization.

Account

• Required field
• The major account the expense belongs under – for example, “hardware.”

Sub-Account

• Required field
• The account component that will be allocated to service categories - For example, “server maintenance expense.”
• Remember: Exclude capital expenditures, but include depreciation.
• Remember: Exclude non-recurring items.

Use the General Ledger tab on Info-Tech’s Service-Based Cost Model Tool.

Activity 3: define allocation methodology – appropriate allocation method differs depending on the type of cost

Direct Costs

Allocation Required: No

Attribution Accuracy: High

• Are incurred entirely to support this, and only this, service category.
• They are not derived from allocation.
• Characterized by a high degree of accuracy.

Shared Costs

Allocation Required: Yes

Attribution Accuracy: Mid

• Are incurred to support this and other service categories.
• Allocation is required.
• Accuracy dependent on allocation methodology.

Overhead Costs

Allocation Required: Yes

Attribution Accuracy: Low

• Are incurred to support this and all other service categories.
• Allocation is required.
• Characterized by a low degree of accuracy.

Allocate your direct costs using the known dollar value

Direct Cost Attribution

• They are not derived from allocation methods.
• Cost attribution is characterized by a high degree of accuracy.
• These costs are directly traceable, so assign the exact dollar value used by each service category.

Data Will Be Required to Trace Direct Costs

• Mine data from a payroll or accounting system.
• Finance may have detailed breakdowns.
• If dollar value can’t be traced, treat as indirect cost.

Direct Costs in Service-Based Cost Model Tool

• If a general ledger account is directly attributable to service categories, select “Direct” from the Allocation Method column drop-down on the General Ledger tab.
• Then, input the dollar value consumed by each service category on the Allocate to Service Categories Tab - where input required is “Dollar ($)” only.

Use the General Ledger tab in Info-Tech’s Service-Based Cost Model Tool.

Allocate each shared and overhead cost using allocation methods

Shared Attribution

• Shared Cost: A cost that is incurred as a result of multiple IT services and must be allocated appropriately across those services.
• Allocation equation is required.
• Accuracy of cost attribution is dependent on allocation methodology.

Examples of Shared Costs

• Depreciation expenses for equipment that is shared between multiple service categories.
• Maintenance expenses for hardware that is shared between multiple services categories.
• Application expenses for applications used by IT employees working in multiple services.

Overhead Cost Attribution

• Overhead Cost: A cost that is incurred by the entire IT department and must be allocated across all services.
• Allocation equation is required.
• Cost attribution is characterized by a low degree of accuracy.

Examples of Overhead Costs

• CIO and other cross-functional IT executive salaries.
• Rent expense.
• Other expenses that can not be meaningfully allocated will be treated as overhead costs.

Data Requirements

• Significant data collection will be needed to allocate indirect and overhead costs. The amount and type of data needed is dependant on the allocation method used.
• Allocation methods are outlined next.

Select appropriate allocation methods for indirect and overhead costs

There are five different allocation methods:

• Even Spread Allocation
  • Allocates expenses evenly across all relevant cost pools.
  • For example, $100K of a server expense is allocated equally across 5 service categories at $20K each.
• Cost Rate Allocation
  • Allocates expenses proportionately based on the known costs of a service.
  • For example, Service 1 has known costs of $1M and service 2 has known costs of $2M. The $100K server expense is allocated 33% to service 1 and 66% to service 2.
• Assigned Percentage Allocation
  • Allocates expenses according to a predetermined, predefined, or standardized percentage.
  • For example, $100K of a server expense is allocated at 30% to service 1 and 70% to service 2.
• Single-Driver Activity-Based Costing (ABC) Allocation
  • Allocates expenses based on consumption of a single cost driver.
  • $20K of a $100K server expense is allocated to a service that consumed 1/5 of virtual servers.
• Multi-Driver ABC Allocation
  • Allocates expenses based on the consumption of multiple cost drivers.
  • A server expense is allocated based on consumption of compute, storage, and network resources.

(See appendix for additional information on allocation methods )

Recognize the inherent limitations caused by the complexity of your IT environment

Consider This Example

A CIO wants to allocate server maintenance expense to service categories:

• They spent $50,000 on server maintenance.
• They determine that application services category uses 3 servers, computing services category uses 7, and no other service category used servers.
• They have a total of 10 servers.

Perfect? No, but perfect is not easy…

• The costs are also affected by server type, specific server costs, colocation (applications that share servers), and capacity utilization.
• But accounting for all of the relevant factors is difficult: not only will it cost money to track all that data, but also it will require an enormous amount of expertise to create an allocation model that captures everything.
• While number of servers used is a poor method, the virtual server count may be sufficiently accurate.

Info-Tech Insight

Perfect allocation is a legend. Accepting that perfection is an expense you can’t afford is essential.

Create an allocation model that balances accuracy and cost of data collection

Optimizing Allocation Value-to-Effort Ratio:

• The amount of effort you should put into allocating costs should be proportionate to the importance of the cost and to the allocation effort required. Therefore, the most accurate allocations occur when the cost is highly important and allocation is low effort.

The importance of a cost is determined by:

• Magnitude: the cost represents a significant portion of the IT budget or is nominally large.
• Variability: the cost tends to fluctuate significantly based on the output of specific service components.
• Subject to Controversy: business units often dispute the allocation of the cost, necessitating a more granular breakdown.

The effort of allocation is determined by:

• Fragmentation: the number of components that affect the expense.
• Data Availability: how available data is on components that affect the expense. Is the data already tracked? Do investments need to be made to start tracking?

Info-Tech Insight

Make the cost of data collection as small as possible. Wherever possible, avoid multi-driver ABC allocations that necessitate tracking additional data.

Use the Info-Tech Allocation Decision Tree to select an appropriate allocation method for indirect and overhead costs

Specify your allocation methods

The general ledger input process occurs in the Allocation Method, Cost Driver, and Cost Driver Unit columns.

Allocation Method

• Required Field.
• Direct costs: select “Direct.”
• Indirect/Overhead costs: select allocation method.

Cost Driver

• Required Field for Single Driver ABC Allocation only.
• Input cost driver. For example, number of employees may be the cost driver for telephony expense.

Cost Driver Unit

• Required Field for Single Driver ABC Allocation only.
• Input cost driver unit.
• Ex: Server maintenance was allocated based on virtual memory use. Gigabytes was the cost driver unit.
• Ex: telephony expense was allocated based on number of employees. The cost driver unit was “count of users.”

See Appendix for more information.

Use the General Ledger tab on Info-Tech’s Service-Based Cost Model Tool.

Activity 4: Input data to allocate general ledger to service categories

The allocate to service category input process occurs on the Allocate to Service Category tab.

Data Required by Allocation Method

• For each general ledger expense, Input Required column identifies the input required. For each service, input the corresponding data:
  • If the general ledger account is being allocated as a direct expense, then the row will take dollar ($) values as inputs.
  • If the general ledger account is being allocated using even spread or cost rate allocation, then the row will auto-fill with “N/A” and no input is required.
  • If the general ledger account is being allocated using an ABC single driver allocation, then the row will take cost driver consumption as an input. For example, the number of virtual servers used.
  • If the general ledger account is being allocated using an ABC multi-driver allocation or manual percentage, then the row will take % allocated as an input. Make sure percentages add to 100%.
• Significant data collection will be needed to fill in the table. Request consumption data from direct reports or service owners.

Use the Allocate to Services tab on Info-Tech’s Service-Based Cost Model Tool.

Congratulations! You have achieved SBC Level 1

Step 1: Allocate General Ledger to Service Categories

• Activity 1: Define Service Categories
• Activity 2: Input General Ledger
• Activity 3: Define Allocation Methodology
• Activity 4: Input Data to Allocate Cost Pools

Pay attention to:

• Service categories that have a total expense significantly higher than others.
• GL accounts that significantly increase all service categories.

Next steps:

• Get to Level 2 Service-Based Costing to capitalize on even more SBC benefits.
• Refer to Section 6, Leverage SBC to Drive Business Value.

Progress:

• Basic understanding of service-based costing.
• Service category costs are known with reasonable accuracy.

You can now view your service category costs using the Service-Based Costing Model Tool! Go to the Service Category Output tab.

Use the Service Category Output tab on Info-Tech’s Service-Based Cost Model Tool.

How to interpret results

Below is a sample output of your Service Category Output Tab

The lines in the Sub-Account column correspond to general ledger line items.

Given this company’s $10M IT budget, the hardware storage expense is extremely high for both application services and computing services.

The boldfaced line at the bottom contains the total costs of service categories.

The total costs of the Application Services category is $1,015,826.40

Read the Report Summary to validate that your allocation methodology can meet your needs – Report Summary tab

Open the Validity Report tab.

Info-Tech Accuracy Score

Analyzes the accuracy of the Service-Based Costing Model. Determined by cost allocation methodology. As maturity increases, accuracy increases: greater accuracy needed for chargeback and benchmarking. To Improve: Reduce low accuracy allocation methods such as even spread and cost rate allocation. For Level 1 Service-Based Costing, 5/10 is the maximum accuracy score; detailed services and service-service allocation are not accounted for.

Info-Tech Ease-Of-Use Score

Analyzes the complexity and need for data collection the Service-Based Costing requires. As maturity increases, ease-of-use decreases: capability to manage increased complexity grows. To Improve: Reduce multi-driver ABC allocations.

Satisfactory Level 1 Accuracy: 5/10

Satisfactory Level 1 Ease Of Use: 5/10

Use the Report Summary tab on Info-Tech’s Service-Based Cost Model Tool.

Guided Implementation: Establish a Level 1 Allocation Methodology

Prior to the Guided Implementation

• Read Section 3: Establish a Level 1 Service-Based Costing Model.
• Download the Service-Based Costing Model Tool.
• Obtain general ledger from Finance.
• Input general ledger into the Service-Based Cost Model Tool, General Ledger tab.
• Define allocation methodology on General Ledger tab.
• Complete tabs 1-5.

During the Guided Implementation

An Info-Tech Consulting Analyst will discuss with you:

• Allocation methods most appropriate for general ledger line items.
• Limitations cause by unavailability of data and best practices for maintaining accuracy.
• Organizational changes that can allow for better service-based costing – what data to start tracking.
• Ways to improve accuracy and ease-of-use scores.

Value & Outcome

At the conclusion of the Guided Implementation call, you will have:

• A comprehensive cost allocation methodology that can be used to identify service category costs.
• Knowledge of what data will be needed and where to get it.
• A list of data and metrics to begin tracking.
• Recommendations on how to improve accuracy and ease-of-use scores.

Arrange a call now:

Email GuidedImplementations@InfoTech.com or call 1-888-670-8889 and ask for the Guided Implementation Coordinator to book a Guided Implementation in your organization.

Section 3: Summary

Key Messages

• Business value and decision-making can be enhanced even with a small increase in service-based costing maturity.
• Level 1 maturity will identify which bundles of services consume the greatest amount of IT spend.
• Simplify the service-based costing analysis to minimize the amount and complexity of data collection.
• Allocating general ledger costs to service categories requires balance: create an allocation methodology that is accurate enough to be useful but does not burden the organization with significant data collection.

What You Achieved in this Section

• Basic understanding of service-based costing achieved.
• Service categories defined.
• Allocation methodology developed.
• Service category costs identified.
• Readiness to begin a Level 2 service-based costing initiative.

Deliverables Created

• Service-based costs for key service categories

Section 4: Establish a Level 2 Service-Based Costing Model

Sections:

Make the Case

Assess Your SBC Need and Maturity

Establish a Level 1 SBC Model

Establish a Level 2 SBC Model

• What's in this Section:
  • Define Services
  • Define Allocation Methodology
  • Allocate to Services
  • Account for Service-to-Service Consumption

Establish a Level 3 SBC Model

Document and Maintain Your SBC Model

Use SBC to Drive Business Value

Section 4: Establish a Level 2 SBC Model

Insight

• Level 2 SBC is accurate enough for many organizations; however, few have achieved it.
• Align your service catalog and costing with industry standards to enable benchmarking of your services.
• Understanding the makeup of your services and how they interact with one another is key to establishing an accurate costing.
• Simplifying assumptions can greatly reduce the effort involved and can often be used without introducing excessive error.

What You Will Achieve in this Section

• Deep understanding of service-based costing will be achieved.
• Services will be identified.
• Allocation methodology will be developed.
• Service-to-service consumption will be accounted for.
• Service costs will be identified.

Deliverables

• Service-based costs for key services.
• Fully configured service-based costing tool for ongoing management.

Before you begin, get the right people in the room

Establishing Level 2 service-based costs is a large effort that will require the coordination and participation of IT leaders and other staff.

Role

• IT Finance Leader

Skillset

• Strong leadership skills.
• Financial acumen.
• Budgeting.
• Financial reporting.
• Strong relationship with CIO and CFO.

Responsibilities

The IT finance leader is the lead of the SBC initiative. They are a liaison between the team and the executive sponsors. Additionally, they will lend their acumen to identify cost drivers and help make decisions about allocation methods.

Role

• Technical Lead

Skillset

• Strong understanding of the cost model platform.
• Understanding of the general ledger.
• Basic financial accounting skills.
• Basic cost accounting skills.
• Basic understanding services.

Responsibilities

Responsible for building, updating, documenting, and maintaining the SBC model. Strong technical skills in the modeling software of choice are required. Info-Tech’s Service-Based Costing Model Tool is written in Excel for your convenience, but any software platform may be used.

Team continued on next slide

Before you begin, get the right people in the room (continued)

Role

• Executive Sponsors (CIO and CFO)

Skillset

• Financial acumen. Managerial decision making.

Responsibilities

The success of the service-based costing initiative will be assisted by executive support. The sponsors are responsible for setting the goals, the project, and outlining expectations. Additionally, they can set the direction of the initiative to focus on specific services.

Role

• Business Analysts

Skillset

• Strong understanding of business processes.
• Strong understanding of IT processes.
• Strong understanding of financial expectations within the organization.

Responsibilities

Business analysts will drive the cost modeling initiative. Their understanding of processes will allow them to identify cost drivers, make appropriate allocations, and draw insights from the model.

Role

• IT Service Owners

Skillset

• Knowledge of the service outputs.
• Understanding of cost drivers for their service.

Responsibilities

Service owners will not be active team members, but they will be part of the initiative. Service owners should be interviewed to identify cost drivers and understand services. Additionally, they will need to provide costing data.

Approach service-based costing from top or bottom

There are two approaches to determine the costs of a service: top down and bottom up.

Top down

Start with the general ledger and allocate costs down until IT service costs are identified.

Bottom up

Start with configuration items, and allocate costs up until IT service costs are identified.

"A ton of people go down this process without the education. This is incredibly dangerous." - Robert Mischianti, Vice President Product Development, Nicus

For level 2 service-based costing, dive deeper into the top-down method

Level 2 SBC covers allocation to services and cross service-allocation.

The complete top-down approach to SBC

Level 1 Service-Based Costing

• Step 1: Allocate General Ledger to Service Categories

Level 2 Service-Based Costing

• Step 2: Allocate Service Category Cost Pool to IT Services
• Step 3: Account for Service-to-Service Consumption

For Level 2, deeper analysis is required

Allocating to services means dealing with more granular and challenging cost pools:

• Strong service definitions are required, so construction of service catalog is highly recommended.
• Data for SBC allocation must exist at the service level; significant data collection will likely be required, and in some instances, the unavailability of data can undermine efforts.
• Accounting for service-to-service consumption is the hardest part of service-based costing; the methodology used at this level has been simplified, but it is still challenging.
• The final output of this step is that your costs are broken down by IT service:
  • Can be used for benchmarking.
  • Can be used for decision making.
  • Can be used for chargeback or showback.
  • Can be used for budgeting.

Execute these activities to accomplish Level 2 SBC maturity

Complete these four activities for level 2 SBC.

Step 1: Allocate General Ledger to Service Categories

• Complete

Step 2: Allocate Service Category Cost Pool to IT Services

• Activity 1: Define Services
  • Construct an IT Service Catalog.
• Activity 2: Allocate Cost Pools to Services
  • Gather data from appropriate systems of record.

Step 3: Account for Service-to-Service Consumption

• Activity 3: Define Service-to-Service Allocation Methodology
  • Select an appropriate allocation method for every service.
• Activity 4: Input Data to Account for Service-to-Service Consumption
  • Gather data from the appropriate systems of record.

Activity 1: Define services

Services

• A set of processes that, executed together, result in a positive business outcome.

IT Services

• A set of processes for which the IT department is accountable that results in a positive business outcome. For example: Application development service.
• An IT Service is a type of Service.
• An IT Service belongs to a single IT Service Category.
• To reach level 2, IT services must be well defined – this means a Service Definition is required.

IT Service Definition

• A Service Definition must therefore capture the information about business outcomes, IT activities, service users, and general information:
  • General Information: Service name and service type.
  • Service Users: Service users and procedures for requesting service.
  • Business Outcomes: Deliverables that improve the service requestor’s state.
  • IT Activities: Steps in the processes that deliver the service including identification roles involved and supporting technologies used.

Construct an IT service catalog

Defining an IT service catalog is a significant undertaking; do it properly by following Info-Tech’s Design and Build a User-Facing Service Catalog blueprint.

Service Catalog Value

• Prerequisite for Level 2 and 3 Service-Based Costing and all associated value.
• Ensure your services are customer-focused – Higher client satisfaction.
• Customize service levels to meet different client needs – Provide the right level of service at an efficient cost.
• Increase process standardization – Increased IT efficiency.
  • Consider procuring software that will assist in developing and defining a service catalog.
  • Consider contracting a consulting firm to assist in developing a service catalog.

Ensure Service Definitions are Consistent with Common Industry Practices

• Service definitions may be standardized within a given industry.
• These definitions may be based on generally available frameworks such as ITIL.
• If you define your services substantively different than standard, you will undermine your ability to benchmark.
• Benchmarks will be unavailable for services that are not frequently defined.
• You need to ask “how important is benchmarking to us?”
• If benchmarking is important, define your services similarly to industry standards.

Inconsistent definitions make comparison impossible.

Organization A defines email service as including email provisioning and support. Determines email service costs $300.00/user.

Industry standard defines email service as excluding support. Support is an activity of help desk service. Benchmark indicates email service costs $275.00/user.

External services may be defined differently than internal services

If an IT department provides a service both internally and externally, then there are two possible scenarios.

The services are reasonably similar and should have very similar costs.

• The service-based costs should be evaluated together.
• Simply define one service, e.g. help desk service.
• This service would be defined in your service catalog.
• In the “Users” section, input both external users and internal users.

The services are different and may have different costs.

• The service-based costs should be evaluated separately.
• You would define two services, e.g. internal help desk service and external help desk service.
• Both services would be defined in your service catalog.
• The “Users” section of the internal service would only list internal users and vice versa.
• Service-based costing would be done separately for each service, though likely with many shared resources that will need to be untangled with allocation.

Info-Tech Insight

In both cases, services should be focused on the end client ordering the service and benefiting from the final output from the service, regardless as to whether the client is internal or external.

Case Study: Incomplete service category definition can cripple service-based costing

Oil and Gas Mining Company

Employee Count: 40,000+

Situation

• The organization believed that some IT services were uncompetitive, but had no way to confirm its suspicion.
• It had a low service-based costing maturity and wanted to improve transparency into IT costs.
• A service catalog had been started, but it was incomplete and of low quality.

Action

• They began a service-based costing effort to improve the understanding of their costs.
• The first steps taken by the organization were to purchase two software packages:
  • IT financial management platform focused on service-based costing and technology business management.
  • IT services catalog management.

Result

• They failed to properly use the new software to define their IT services catalog which resulted in poorly defined IT services.
• Two years after purchase, their IT service catalog was unfinished.
• This significantly delayed service-based costing effort; could not proceed without service catalog.
• They still do not understand costs at a service level.
• To date, achieved a negative return on investment on both software platforms.

Determine if an iterative approach or a full-scale rollout is best for your organization

Determining the true cost of a service can be a time consuming and expensive exercise. An iterative approach that looks at a smaller subset of services may be preferable.

Iterative Service-Based Costing

Select one or two services that you want to focus on. Focus on services that are:

• Particularly costly.
• Subject of controversy (business units believe them to be too expensive).
• Being considered for outsourcing or service elimination.
• Believed to compare poorly with industry benchmarks.
• Iterate: select another set of services and repeat.

This will help you:

• Determine that service-based costing is valuable to your organization.
• Build the SBC skills you need.

Full Scale Service-Based Costing

A full-scale service-based costing effort is recommended if:

• Your organization has SBC experience – is at least at Level 1: Basic SBC at the onset of this blueprint.
• Better budgeting, decision making, and chargeback is required for all IT services.

This will help you:

• Make better, holistic IT service decisions.
• Use benchmarks to assess the viability of IT services.
• Budget for next fiscal year.
• Build the skills needed for Level 3 SBC.

Info-Tech Insight

Iterative service-based costing is recommended if this is your first attempt at service-based costing.

Use Info-Tech’s Service-Based Cost Model Tool to input services and definitions

This activity occurs on the Define Services tab of the Service-Based Cost Model Tool.

Service Name

• Required field.
• List all IT Services that will be analyzed.
• Include an “other” services unless all services are analyzed.

Category Name

• Required field.
• Specify service category the service belongs to.
• Accuracy is important as it affects allocation.

Description

• Non-required field.
• If a well-defined service catalog exists, simply leaving the data in this column as the default (“see service catalog”) is perfectly acceptable.

Use the Define Services tab on Info-Tech’s Service-Based Cost Model Tool.

Activity 2: Allocate costs to IT services – recall that in level 1, general ledger cost pools were allocated to service categories

Recall: Cost Allocation at Level 1

• For SBC purposes, cost allocation is defined as “moving costs from one cost pool to another.”
• For level one service-based costing, we are using allocation to break down general ledger cost pools into cost pools at the service category level. See the below example.

Total amount allocated to service categories equals the general ledger cost pool. Therefore, every dollar has been allocated.

Level 2 builds off level 1 and allocates costs from service categories to specific IT services

Cost Allocation at Level 2

• Level 2 SBC breaks down service category cost pools into IT service cost pools. Consider this example, where the communication and collaboration service category cost pool is allocated to: Email, Instant Messaging, Telecommunications, and Collaboration Portal.

Total amount allocated to IT services equals the service category cost pool. Therefore, every dollar has been allocated.

Level 2 allocation methodology has been defined – costs will be allocated according to method on the General Ledger tab

Revisit your allocation methodology on the General Ledger tab to ensure it is still appropriate.

Maintain Consistency

• This same allocation method defined in level 1 will be used to allocate cost pools accounts to services.
• Consistency is important: cost drivers should remain constant. However, you may want to…

Redefine Methodology If:

• More resources are available for increased complexity.
• Data has become available that wasn’t available during completion of level 1.

Redefine Methodology By:

• Update the selected methods in the General Ledger tab and redo data entry on the Allocate to Services tab.
• There is much more data entry required to allocate costs to the IT service cost level, so be careful about adding complexity.

Use the General Ledger tab on Info-Tech’s Service-Based Cost Model Tool.

Use the Service-based Costing Model Tool to input the data needed to compute costs – Allocate to Services tab

Open the Allocate to Services Tab.

Data Required by Allocation Method

• For each general ledger expense, the Input Required column identifies the type of input required. For every service, input:
  • If the general ledger account is being allocated as a direct expense, then the row will take dollar ($) values as inputs.
  • If the general ledger account is being allocated using even spread or cost rate allocation, then the row will auto-fill with “N/A” and no input is required.
  • If the general ledger account is being allocated using an ABC single driver allocation, then the row will take cost driver consumption as an input. For example, the number of virtual servers used.
  • If the general ledger account is being allocated using an ABC multi-driver allocation or manual percentage, then the row will take % allocated as an input. Make sure percentages add to 100%.
• Significant data collection will be needed to fill in the table. Request consumption data from direct reports or service owners, aggregate, and then input.

Use the Allocate to Services tab on Info-Tech’s Service-Based Cost Model Tool.

Congratulations! You have now computed your costs at the service level

Step 2: Allocate Service Category Cost Pools to IT Services (Complete)

• Activity 1: Define Services (Complete)
• Activity 2: Allocate Service Category Cost Pools to Services (Complete)

Pay attention to:

• Services that have a total expense significantly higher than others.
• GL accounts that significantly increase all service costs.

Next steps:

• The data is not quite at the level it needs to be for decision making and building a chargeback model.
• To finish the journey to Level 2 Service-Based Costing, account for service-to-service consumption.

Progress:

• Service category costs are known with reasonable accuracy.
• Service costs are known with reasonable accuracy.

You can now view your service costs using the Service-Based Costing Model Tool! Go to the Cost of Services Base tab.

Use the Cost of Services Base tab on Info-Tech’s Service-Based Cost Model Tool.

Activity 3: Define service-to-service allocation methodology

Failing to account for internal IT consumption of IT services can have a major impact on the final cost of services.

Impact of Not Accounting for Service-to-Service Consumption

• Most IT services service both IT clients and clients within business units.
• For example, the IT employees who provide the Help Desk Service also have email accounts. Therefore, the Help Desk Service consumes the email service.
• Not accounting for internal consumption can:
  • Inflate the cost of IT services that are heavily consumed by other IT services.
  • Deflate the cost of IT services that heavily consume other IT services.
• In the case of implementing a chargeback or showback model, the effect of inaccuracy is amplified:
  • Some business unit consumers will be overburdened.
  • Business units will complain services are uncompetitive.
  • In the case of benchmarking, wrong decisions can be made based on inflated or deflated service costs.

Consider this Example

• An applications group supports Visio for eight marketing employees and twelve IT employees who work in the Web Development Service:
• The total cost of Visio is made up of:
  • Licensing → $6,000 per year.
  • Support → $7,000 per year.
  • Labor → $5,000 per year.
• The cost of the Visio Service appears to be $6,000 + $7,000 + $5,000 = $18,000.
• But, 12 out of 20 (60%) total users are part of another service, Web Development Service. So 60% of the cost, $10,800, must be allocated to the Web Development service.
• So, external (non-IT), Visio Service costs only $7,800.
• Without accounting for internal IT consumption, the unit cost of Visio per external user appears to be $2,250, a highly uncompetitive rate. Allocating internal costs brings external cost down to $975, a truer cost.

Understand the complexity of service-to-service allocation

Email Service

• Consumes Email Service (itself)
• Consumes Instant Messaging Service
• Consumes Telecommunications Service

Instant Messaging Service

• Consumes Instant Messaging Service (itself)
• Consumes Email Service
• Consumes Telecommunications Service

Telecom Service

• Consumes Telecommunications Service (itself)
• Consumes Email Service
• Consumes Instant Messaging Service

Three services results in nine possible relationships. Extrapolating this, 200 services, would result in 4,000 possible relationships. Significant effort is required to manage the complexity of service-to-service allocation.

Managing the complexity of service-to-service allocation – make simplifying assumptions

Email Service

• Consumes Telecommunications service

Instant Messaging Service

• Consumes Email Service
• Consumes Telecommunications Service
• Assumption: not consumed by IT services.

Telecommunications Service

• Consumes Email Service

Simplifying Assumption Number 1: Self-consumption is irrelevant.

Self-consumption adds a lot of complexity and often has a marginal affect on end results.

Simplifying Assumption Number 2: Services that are minimally consumed within IT are not consumed within IT at all.

This is equivalent to categorizing a service as “Exclusively Consumed by Business Units.” The categorization of IT services is discussed next.

Info-Tech Insight

Focus simplification on smaller cost pools that require significant data collection for allocation. This allows for the greatest reduction of effort while minimizing inaccuracy.

Categorize IT services based on their consumers

There are three types of IT services, and each is accounted for differently.

Exclusively Consumed by Business Units

• For these services, ignore service-to-service consumption completely.
• If there is an IT service that very minimally supports other IT services (<1% of costs), consider labelling it as “Exclusively Consumed by Business Units.”

Exclusively Consumed by Other IT Services

• These services must be 100% allocated to other IT Services, such that the final service cost is $0.00 and the IT service costs of the consumers will be inflated.
• These are often referred to as “internal support services.”

Consumed by Business Units and IT Services

• These services should be partially allocated to other IT services, such that the final cost of the IT service will be deflated and the IT service costs of the consumers will be inflated.
• These services will still have a positive final service cost that is equal to the percentage of the service consumed by business units.
• For example, if Email Service was known to cost $100,000 prior to accounting for internal consumption and 70% of email users were in business units (cost driver is number of users) then:Email Service cost after accounting for internal consumption = $100,000* 70% = $70,000.

Choose an accounting mechanism for internally consumed services

There are three different accounting mechanisms.

The Ignore Mechanism

• Internal IT consumption is ignored, and all costs are allocated directly to business units in the event of chargeback based on their consumption of cost drivers.
• Commonly referred to as “the direct method,” but the name has been changed to avoid namespace collision with “direct cost allocation.”
• Results in inflation of some service costs and deflation of others.
• However, this is the simplest method. It may make sense to select the Ignore Mechanism for small IT services (<2% budget) or services that were minimally consumed by IT.
• Equivalent to labelling the service as “Exclusively consumed by Business Units.”

The Step Down Mechanism

• Internal IT consumption is accounted for sequentially, ignoring the possibility of reciprocal services.
• Results in some inaccuracy, but is often a close approximation of perfect allocation.
• The Info-Tech Service-Based Cost Model Tool uses an additional mechanism for accounting for reciprocal services, but the calculation is still imperfect.
• The Step Down Mechanism is versatile; the sequential allocations can be done using any of the allocation methods used in level 1 SBC.
• Info-Tech Insight
  • The Info-Tech Service-Based Cost Model Tool uses the Step Down Mechanism.

The Reciprocal Mechanism

• A mathematically perfect method of accounting for internal use, including reciprocal services. Extremely complicated; involves simultaneously solving multiple linear equations.
• Mathematically perfect allocation.
• The Info-Tech Service-Based Cost Model Tool does not support the reciprocal allocation mechanism. Basic Microsoft Excel is not able to easily solve linear equations; an Excel add-in is required. Additionally, solving the equations would be extremely time consuming.
• This limitation is why investing in IT financial management software, which can handle reciprocal allocation, may be considered.

When using the step down method, select an appropriate allocation method

There are five different allocation methods:

Even Spread Allocation

• Allocates expenses evenly across all relevant cost pools.
• E.g. $100K of a Colocation Service is allocated equally across 50 other IT services.

Cost Rate Allocation

• Allocates expenses proportionately based on the known costs of a service.
• E.g. Service 1 has known costs of $1M and Service 2 has known costs of $2M. The $100K Colocation Service is allocated 33% to service 1 and 66% to service 2.

Assigned Percentage Allocation

• Allocates expenses according to a predetermined, predefined, or standardized percentage.
• E.g. 10% of $100K Help Desk is allocated to Email Service as determined by IT service owners.

Single-Driver ABC Allocation

• Allocates expenses based on consumption of a single cost driver.
• E.g. Part of Email Service is allocated to other services based on the number of email users the services have.

Multi-Driver ABC Allocation

• Allocates expenses based on the consumption of multiple cost drivers.
• E.g. Colocation Service is allocated based on compute and network used by other services.

Use Info-Tech’s Service-Based Cost Model Tool to define service-to-service allocation methodology

This activity occurs on the Define Cross-Service Allocation tab.

Service Type

• Required field.
• Indicate if “Exclusively consumed by business units,” “Exclusively consumed by other IT services,” or “ consumed by both business units and IT.”

Allocation Method

• Not Required if “Exclusively Consumed by Business Units” is selected.
• Otherwise, specify the chosen allocation method.

Cost Driver and Cost Driver Unit

• Required only if “Single Driver ABC Allocation” is selected.
• Cost driver is the thing that is most correlated with costs. For example, number of users for Email Service.
• Cost Driver Unit is the unit of measurement. For example, “count” is the measurement of number of users.

Use the Define Cross-Service Allocation tab on Info-Tech’s Service-Based Cost Model Tool.

Account for cross-service consumption

Open the Cross-Service Allocation Tab.

Data Required by Allocation Method

• If the service is Exclusively Consumed by Business Units, no input is required.
• If the service is being allocated using even spread or cost rate allocation, then the row will auto-fill with “N/A” and no input is required (for the most part):
  • However, specify the percentage (%) consumed by business units for services consumed by Both Business Units and IT.
• If the service is being allocated using an ABC single driver allocation, then the row will take cost driver consumption as an input.
  • Specify the cost driver consumption by business units for services Consumed by Both IT and Business Units.
• If the service category account is being allocated using an ABC multi-drive driver allocation or manual percentage, then the row will take percentage allocated as an input.
• Make sure percentages add to 100% for services Exclusively Consumed by IT and are less than 100% for services Consumed by Both Business Units and IT.

Use the Cross-Service Allocation tab on Info-Tech’s Service-Based Cost Model Tool.

Congratulations! You have now accounted for service-to-service consumption

Step 3: Account for Service-to-Service Consumption (Complete)

• Activity 3: Define Service-to-Service Allocation Methodology (Complete)
• Activity 4: Input Data to Account for Service-to-Service Consumption (Complete)

Pay attention to:

• Services that have a total expense significantly higher than others.
• GL accounts that significantly increase all service costs.

Next steps:

• Refer to Section 6, Use Service-Based Costing to Drive Business Value.
• For absolute confidence, you may want to get to Level 3, Accurate and Precise Service-Based Costing.

Progress:

• You now understand the mechanics of service-based costing and allocation.
• Your IT service category costs are known.
• Your IT service costs are known.
• You have accounted for service-to-service consumption.

You can now view your final service costs using the Service-Based Costing Model Tool! Go to the Final Cost of Services tab.

Use the Final Cost of Services tab on Info-Tech’s Service-Based Cost Model Tool.

Read the Report Summary to validate that your allocation methodology can meet your needs – Report Summary tab

Open the Report Summary tab.

Info-Tech Accuracy Score

• Analyzes the accuracy of the Service-Based Costing Model. Determined by cost allocation methodology.
• As maturity increases, accuracy increases: greater accuracy needed for chargeback and benchmarking.
• To Improve: Reduce low accuracy allocation methods such as even spread and cost rate allocation.
• For Level 2 SBC, 7 is the maximum accuracy.

Info-Tech Ease-Of-Use Score

• Analyzes the complexity and need for data collection the Service-Based Costing requires.
• As maturity increases, ease-of-use decreases: Capability to manage increased complexity grows.
• To Improve: Reduce multi-driver ABC allocations.

Satisfactory Level 1 Accuracy: 7/10

Satisfactory Level 1 Ease-Of-Use: 4/10

Use the Report Summary tab on Info-Tech’s Service-Based Cost Model Tool.

Guided Implementation: Establish a Level 2 Allocation Methodology

Prior to the Guided Implementation

• Read Section 4: Establish a Level 2 Service-Based Costing Model.
• Complete Establish a Level 1 Allocation Methodology Guided Implementation.
• Define service-to-service allocation methodology.

During the Guided Implementation

An Info-Tech Consulting Analyst will discuss with you:

• Allocation methods most appropriate for allocating general ledger line items to services.
• Limitations caused by unavailable data and best practices for maintaining accuracy.
• Allocation methods appropriate for accounting for service-to-service consumption.
• The journey towards level 3 Service-Based Costing.

Value & Outcome

At the conclusion of the Guided Implementation call, you will have:

• A comprehensive cost allocation methodology that can be used to identify service costs.
• Knowledge of what data will be needed and where to get it.
• A comprehensive cost allocation methodology that can be used to account for service-to-service consumption.
• Recommendations on how to improve accuracy and ease-of-use scores.

Arrange a call now:

Email GuidedImplementations@InfoTech.com or call 1-888-670-8889 and ask for the Guided Implementation Coordinator to book a Guided Implementation in your organization.

Section 4: Summary

Key Messages

• External services should be defined differently than internal services if service level or processes are different.
• Service definitions should be consistent with industry standards and benchmarks.
• The allocation methodology used to allocate the general ledger to service categories can be used to allocate cost pools to services. However, update the methodology if greater accuracy is needed or if new data has become available.
• Managing the complexity of service-to-service consumption requires simplifying assumptions: ignore self-consumption and limit the number of service-to-service allocations addressed.

What You Achieved in this Section

• Deep understanding of service-based costing achieved.
• Services defined.
• Allocation methodology developed.
• Service-to-service consumption accounted for.
• Service costs identified.

Deliverables Created

• Service-based costs for key services.
• Fully-configured service-based costing tool for ongoing management.

Section 5: Establish a Level 3 Service-Based Costing Model

Sections:

Make the Case

Assess Your SBC Need and Maturity

Establish a Level 1 SBC Model

Establish a Level 2 SBC Model

Establish a Level 3 SBC Model

• What's in this Section:
  • Build a project team
  • Understand the methodology
  • Build capabilities

Document and Maintain Your SBC Model

Use SBC to Drive Business Value

Section 5: Establish a Level 3 SBC Model

Insight

• Bring in extra help if you want a truly accurate SBC.
• Level 3 SBC is a large and complex effort; you need the right combination of skills, experience, and knowledge, some of which may require sourcing externally, both from a service perspective and a finance perspective.
• Full service-orientation is critical and a pre-requisite for accurate costing.
• Think both top down from the General Ledger and bottom up from the Configuration Items and reconcile finances through Services; automated data collection and analysis will help.

What You Will Achieve in this Section

• Project team will be assembled.
• The level 3 SBC methodology will be understood.
• Next steps and best practices for level 3 SBC will be explained.
• Capabilities for SBC will be built.

Deliverables

• None for this section.

Recognize the scope of level 3 service-based costing and understand what this blueprint delivers

Establishing perfectly precise and accurate service-based costing is an enormous effort. This blueprint can help, but getting all the way there will require additional tools and work.

Required for Achieving Level 3 SBC

• Multi-year effort.
• IT financial management or technology business management software (~$150,000 annual).
• Dedicated team of IT finance employees.
  • A technical expert should own the IT financial management or technology business management solution.
  • IT finance team will help define solutions, allocation methodologies, and interpret reports to make recommendations.
• High maturity required. Level 2 service-based costing has been achieved and a satisfactory accuracy score has been obtained.
• Data collection for cost drivers is ingrained in IT and business processes.
• IT systems that automate data collection exist and can be integrated with IT financial management or technology business management solution.

Limitations of the Blueprint

The blueprint does not:

• Provide a step-by-step walkthrough of the Level 3: Service-Based Costing process.
• Provide assistance establishing a configuration management database, which is a prerequisite for Level 3: Service-Based Costing.
• Provide an Excel-based tool; Excel is not the right tool for this job.

The blueprint does:

• Provide a high-level overview of the Level 3: Service-Based Costing process.
• Provide best practices for level 3 SBC.
• Provide next steps and recommendations – especially pertaining to IT financial management software procurement and changing processes to prepare for Level 3 Service-Based Costing.

Before you begin, get the right people in the room

Establishing Level 3 service-based costs is a very large effort that will require the coordination and participation of IT leaders and a dedicated IT Finance team, a procurement team, and an implementation team.

Role

• IT Finance Leader

Skillset

• Strong leadership skills.
• Financial acumen.
• Budgeting.
• Financial reporting.
• Strong relationship with CIO and CFO.

Responsibilities

The IT finance leader is the lead of the SBC initiative. They are a liaison between the team and the executive sponsors. Additionally, they will lend their acumen to identify cost drivers and help make decisions about allocation methods.

Roles

• Technical Lead – (may be provided by vendor if large multi-year engagement).

Skillset

• Strong understanding of the platform (IT financial management).
• Understanding of the General Ledger.
• Basic financial accounting skills.
• Basic cost accounting skills.
• Vendor relations.

Responsibilities

Responsible for updating and maintaining the procured software. Will work closely with the vendor. Will be required to enter data into the system at regular intervals – though much of the data entry is automated.

Before you begin, get the right people in the room (continued)

Role

• Executive Sponsors (CIO and CFO)

Skillset

• Financial acumen.
• Managerial decision making.

Responsibilities

The success of the service-based costing initiative will be assisted by executive support. The sponsors are responsible for setting the goals, the project, and obtaining funds for procurement of a solution.

Role

• Business Analysts

Skillset

• Strong understanding of business processes.
• Strong understanding of IT processes.
• Strong understanding of financial expectations within the organization.

Responsibilities

Business analyst’s understanding of processes will allow them to identify cost drivers, make appropriate allocations, and draw insights from the model.

Role

• IT Service Owners

Skillset

• Understanding of cost drivers for their service.

Responsibilities

Service owners will not be active team members, but they will be part of the initiative. Service owners should be interviewed to identify cost drivers. Additionally, they will need to provide costing data.

Before you begin, get the right people in the room (continued)

Role

• IT Finance Team

Skillset

• Financial accounting acumen.
• Managerial accounting acumen.
• Understanding of activity-based costing.

Responsibilities

Responsible for making complex decisions about allocation methodology. Will perform “what-if” to make recommendations based off of IT financial management reports.

Role

• Procurement Team

Skillset

• Vendor selection.
• Requirements gathering.
• Vendor relations.
• Contract negotiation.

Responsibilities

Procurement team will be responsible for assembling system requirements, creating an RFP, and evaluating and selecting an IT financial management solution vendor.

Role

• Implementation Team

Skillset

• Systems integration.
• Configuration.
• Support.

Responsibilities

Implementation team will be responsible for deploying and supporting the IT financial management system. Significant integration with existing systems will be required.

Recall: approach service-based costing from top or bottom

There are two approaches to determine the costs of a service: top down and bottom up.

Top down

Start with the general ledger and allocate costs down until IT service costs are identified.

Bottom up

Start with configuration items, and allocate costs up until IT service costs are identified.

For level 3 service-based costing, use the bottom-up approach

Level 2 SBC covers allocation to services and cross-service allocation.

The complete bottom-up approach to SBC

Addressed in Level 3 Service-Based Costing:

• Step 1: Allocate Configuration Items to IT Systems
• Step 2: Allocate IT Systems to IT Services
• Step 3: Account for Service-to-Service Consumption and General Ledger Reconciliation

For Level 3, complex analysis is required

Costs are broken down to the configuration item level (see ITIL configuration item), so construction of a configuration management database (CMDB) is recommended.

Data for SBC allocation must exist at the configuration item level; significant data collection will certainly be required – in doses large enough that it is best handled by IT financial management software that can integrate with and pull data from existing systems.

Accounting for service-to-service consumption is the hardest part of service-based costing; the methodology used at this level is highly granular and complex, modeling these relationships with mathematical perfection.

The final output of this step is that your costs are broken down by IT service with a high degree of accuracy.

Can be used for benchmarking, decision making, budgeting, chargeback, and showback with absolute confidence.

The process at Level 3: accurate and precise service-based costing

The Level 3 SBC process can be broken down into seven activities.

Step 1: Allocate Configuration Items to IT Systems

• Activity 1: Identify the IT Systems That Are Components of IT Services
  • Configuration item identification – greatly expedited by a configuration management database (CMDB).
• Activity 2: Identify the Configuration Items That Are Components of IT Systems
  • Configuration item identification – greatly expedited by a configuration management database (CMDB).
• Activity 3: Identify the Costs of the Configuration Items
  • Configuration item identification – greatly expedited by a configuration management database (CMDB).
• Activity 4: Allocate Configuration Item Costs to IT Systems
  • Allocation methodology – defined by team or software solution.

Step 2: Allocate IT Systems to IT Services

• Activity 5: Allocate IT System Costs to IT Services
  • Allocation methodology – defined by team or software solution.

Step 3: Account for Service-to-Service Consumption and Reconcile with General Ledger

• Activity 6: Account for Service-to-Service Consumption
  • Reconciliation with general ledger uses a top-down approach.
• Activity 7: Reconcile with the General Ledger
  • Reconciliation with general ledger uses a top-down approach.

Understand the level 3 service-based costing components

The basic principle of level 3 service-based costing is that a larger component is the sum of its smaller components.

Layer 1: IT Services

• A sequence of activities performed by the IT department that results in a positive business outcome. For example, Email Service.
• An IT service is delivered via one or more IT systems.

Layer 2: IT Systems

• A collection of configuration items that are used to deliver IT Services. For example, Microsoft Exchange.
• An IT System is composed of one or more configuration items. Many configuration items are shared between multiple IT Systems.

Layer 3: Configuration Items

• For SBC purposes, a configuration item is broadly defined as any IT asset that is uniquely identifiable.
• Can vary widely in size and complexity: a disk and a data center are both configuration items.

Understand the level 3 service-based costing components (continued)

Configuration items can be broken down into smaller and smaller parts.

Layer 3: Primary Configuration Items

• Primary configuration item: any IT asset that is uniquely identifiable and a component of an IT system. For example, a data center.
• These are the building blocks of IT Systems.
• A primary configuration item is made up of one or more secondary configuration items.

Layer 4: Secondary Configuration Items

• Any IT asset that is uniquely identifiable and a component of a primary IT system. For example, Server Rack A.
• A primary configuration item is made up of one or more secondary configuration items.

Layer 5: Tertiary Configuration Items

• Any IT asset that is uniquely identifiable and a component of a secondary IT system. For Example, Linux Server A.
• In many instances, smaller components can still be identified.
• This blueprint only breaks down components as far as primary configuration items.

Activity 1: Identify the IT systems that are used by IT services

Consider the below example:

• IT Service: Email Service - This IT service is composed of two IT systems: Microsoft Outlook and Microsoft Exchange.
  • IT System: Microsoft Windows Server - Microsoft Windows Server is used to deliver the Email Service.
  • IT System: Microsoft Exchange - Microsoft Exchange is used to deliver the Email Service.

Note: Some IT systems will be used by multiple IT services.

How to Identify the IT Systems

Option 1: Use a Service Catalog – a well-defined service catalog will document the IT systems that IT services use.

Option 2: Ask Service Owners – service owners will generally be able to identify the IT systems used.

Info-Tech Insight

Some IT systems will be difficult to identify. Beware of legacy IT systems that are still used by a small number of employees. There will still be costs associated with these systems that must be identified; in fact, some legacy systems can be extremely expensive to support!

Activity 2: Identify the configuration items that are components of IT systems

Activity 2: Identify the configuration items that are components of IT systems

• IT System: Microsoft Exchange
  • MS Exchange is housed on a virtual server, Virtual Server 1.
  • A copy of all emails are stored on a local server in Data Center 1.
• Configuration Item: Virtual Server 1
  • Virtual Server 1 supports the Microsoft Exchange IT System.
• Configuration Item: Data Center 1
  • Data Center 1 supports the Microsoft Exchange IT System.

Note: Many configuration items will be used by multiple IT systems.

How to Identify the Configuration Items:

Option 1: Use a configuration management database (CMDB) – a well-defined CMDB will document the configuration items that IT systems use.

Identifying configuration items is a challenging task. In the absence of a CMDB, ask service-owners, power users, and employees managing data centers.

Be prepared to invest time, money, and brain power in configuration item identification.

Activity 3: Identify the cost of configuration items

Identify configuration items costs one at a time.

Configuration Item: Data Center 1

Direct Costs: $500,000.00

Indirect Costs: $400,000.00

Overhead Costs: $200,000.00

Total Cost: $1,100,000.00

The Process for Costing Configuration Items

Costing configuration items is a three-step process:

1) Identify and input your direct costs.

• Common direct costs include direct labor and directly consumed equipment and materials.

2) Identify and allocate your indirect costs.

• Common indirect costs include shared labor, shared equipment expenses, and shared consumption of smaller configuration items.
• Indirect costs will be allocated based on the account-to-service allocation methods discussed in Level 1 and Level 2.

3) Identify and allocate overhead costs.

• Common overhead costs include IT executive salaries and rent expenses.
• Overhead costs will be allocated based on the account-to-service allocation methods discussed in Level 1 and Level 2.

Recall that there are five primary allocation methods used for indirect and overhead cost allocation:

1. Even Spread Allocation
2. Cost Rate Allocation
3. Manual Assignment Allocation
4. Single-Driver ABC Allocation
5. Multi-Driver ABC Allocation

Allocation methods can be combined.

Activity 4: Allocate configuration item costs to IT systems

Allocate configuration items using the allocation methods used in level 1 and level 2, but try to make the majority of costs directly attributable. For activity-based allocations, consumption of cost drivers is used to derive the allocation percentages.

Activity 5: Allocate IT system costs to IT services

Not all IT systems will be entirely attributable to one IT service. There will be IT systems that are used by multiple services and must be allocated using the methods discussed in levels 1 and 2.

Activity 6: Account for service-to-service consumption

Recall there are three accounting mechanisms. For level 3, use the reciprocal mechanism.

The Ignore Mechanism

• Internal IT consumption is ignored, and all costs are allocated directly to business units in the event of chargeback based on their consumption of cost drivers.
• Commonly referred to as “the direct method,” but the name has been changed to avoid namespace collision with “direct cost allocation.”
• Results in inflation of some service costs and deflation of others.
• However, this is the simplest method. It may make sense to select the Ignore Mechanism for small IT services (<2% budget) or services that were minimally consumed by IT.
• Equivalent to labelling the service as “Exclusively consumed by Business Units.”
• Not appropriate for level 3.

The Step Down Mechanism

• Internal IT consumption is accounted for sequentially, ignoring the possibility of reciprocal services.
• The Step Down Mechanism is versatile; the sequential allocations can be done using any of the allocation methods used in level 1 SBC.
• Results in some inaccuracy, but is often a close approximation of perfect allocation.
• The step down method is not accurate enough for level 3 SBC; for level 3 SBC, accounting for reciprocal relationships is with mathematical precision is important.

The Reciprocal Mechanism

• A mathematically precise method of accounting for internal use, including reciprocal services. Extremely complicated; involves simultaneously solving multiple linear equations.
• Mathematically precise allocation.
• This is the preferred accounting mechanism for level 3 SBC.
• IT financial management or business technology management software can handle the complexity of these calculations.
• Identifying allocation relationships still relies on allocation methods discussed in levels 1 and 2, with greater emphasis on multi-driver ABC allocation.

Activity 7: Reconcile with the general ledger

Disparities between total service costs and total operating expenses on the general ledger will occur. Use top-down allocation to reconcile.

Step 1: Allocate Unaccounted for Balance of General Ledger to Service Categories

• Explained in Level 1 Service-Based Costing

Step 2: Allocate Unaccounted for Balance of Service Category Cost Pool to IT Services

• Explained in Level 2 Service-Based Costing

Step 3: Account for Service-to-Service Consumption

• Explained in Level 2 Service-Based Costing

The Process of Reconciliation

For Level 3: Service-Based Costing, disparities between the general ledger and service-based costs should be minimized due to a high degree of accuracy.

However, disparities can and will occur.

For example: The total server maintenance expense derived from summing the server maintenance expense of all services is $99,400.00, but the general ledger says that $100,000.00 were spent. How to reconcile?

Top-down allocation:

General Ledger

1) Allocate Unaccounted for Balance of General Ledger Accounts to Service Categories.

2) Allocate Unaccounted for Balance of Service Category Accounts to Services.

3) Account for Service Consumption of Other Service (again - Total service costs).

Follow slides x through x in Section 4: Establish a Level 2 Service-Based Costing Model to recap how this is done.

Level 3 service-based costing will require enhancing your capabilities

Focus on improving people, process, and technology

People

Establishing a Level 1 and Level 2 SBC model will have allowed employees to build the skills they need. However, Level 3 SBC is extremely complex and challenging. Consider bringing in full-time help – perhaps an FTE with service-based costing experience or an external consultant.

Process

Process change will be necessary for Level 3 Service-Based Costing. Specifically, adapt processes to focus on collecting data. For example, if networking consumed by a specific server is not measured, it may need to be to allocate costs at the configuration item level.

Technology

Procure an IT financial management software suite. The magnitude of data collection, synthesis, and modeling required to allocate accurately is just too big to handle without one. At a certain level of complexity, financial analysts and a big spreadsheet just won’t be enough.

Build SBC capabilities: people

There are two key ways to develop the people skills needed for level 3 SBC.

People

Establishing a Level 1 and Level 2 SBC model will have allowed employees to build the skills they need. However, Level 3 SBC is extremely complex and challenging. Consider bringing in full-time help – perhaps an FTE with service-based costing experience or an external consultant.

Develop SBC Skills

• Some skill development will have occurred through completion of Levels 1 and 2 SBC.
• However, the Level 3 SBC team will be larger. Make sure new members are educated about SBC.
• Have all team members read this blueprint.
• Consider formal training; courses are available.
• Book an Info-Tech Service-Based Costing Workshop; we can help get your project team up to speed.

Grow Resource Pool

• Hire an FTE who has managed an SBC initiative in the past.
• Hire a consulting firm to manage the SBC initiative and develop the allocation model.
• If procuring financial management software for SBC, the vendors will likely have resources that can help.
• Use Info-Tech consulting; we have a team that specializes in SBC. They can help.

Build SBC capabilities: process

There are three steps to building the data collection needed for level 3 SBC into organizational processes.

Process

Process change will be necessary for Level 3 Service-Based Costing. Specifically, adapt processes to focus on collecting data. For example, if networking consumed by a specific server is not measured, it may need to be to allocate costs at the configuration item level.

Step 1: Audit Processes

• Audit processes to determine where additional data collection is needed.
• Level 1 and Level 2 models will provide insight: Examine even spread, cost rate, and manual assignment allocations where more data was needed for activity-based allocation.

Step 2: Determine Capability

• Determine if data collection is possible.
• Is collecting data reasonably inexpensive and easy?
• Data collection is not feasible if it will significantly increase cycle time.
• Wherever possible, use automated data collection.

Step 3: Implement Change

• Make it part of the process to collect data. Even in the case of automated data collection – such as automated logging – a process will have to be established for monitoring and validating data.
• Note that IT financial management platforms will often collect automatically through integration with existing systems.

Build SBC capabilities: technology

Consider procurement of an IT financial management or a business technology management solution.

Technology

Procure an IT financial management software suite. The magnitude of data collection, synthesis, and modeling required to allocate accurately is just too big to handle without one. At a certain level of complexity, financial analysts, and a big spreadsheet just won’t be enough.

Benefits

• Cost model methodology: Provides suggested models to handle allocation and cost attribution. Highly customizable.
• Data collection assistance: Integrate with existing systems to automate this function.
• Reporting and analytics: Analyzes costing trends and identifies patterns.

Cost

Price Range: $20,000 - $300,000

• Pricing varies depending on the selected vendor, the size of the organization, and the number of users.

Vendors

• Apptio
• ComSci
• Nicus
• others

Guided Implementation: Establish a Level 3 Service-Based Costing Model

Prior to the Guided Implementation

• Complete Section 5: Establish a Level 3 Service-Based Costing Model.
• Reassess your SBC maturity.
• Research IT financial management vendors and explore requirements.

During the Guided Implementation

An Info-Tech Consulting Analyst will discuss with you:

• The journey towards Level 3 SBC.
• The data available to drive Level 3 allocations.
• Building data collection into processes.
• IT financial management vendor selection.
• IT financial management requirements.
• Building people skills required for Level 3 SBC.

Value & Outcome

At the conclusion of the Guided Implementation call, you will have:

• An understanding of what level SBC requires.
• A plan to build data collection into processes.
• A plan to build people skills required for Level 3 SBC.
• A basic list of IT financial management requirements.

Arrange a call now:

Email GuidedImplementations@InfoTech.com or call 1-888-670-8889 and ask for the Guided Implementation Coordinator to book a Guided Implementation in your organization.

Section 5: Summary

Key Messages

• Level 3 SBC is a large effort: assembling a strong project team and building SBC capabilities are required for success.
• The Level 3 SBC process is both top down and bottom up. First, the bottom-up approach must be used to allocate configuration items to IT services. Next, the top-down approach must be used for general ledger reconciliation.
• Develop staff skills through formal training, hiring experienced SBC personnel, and leveraging consulting firms.
• Build data collection into processes to enable more accurate allocation.
• Procure an IT financial management solution to manage the great complexity and data demands of Level 3 SBC.

What You Achieved in this Section

• Project team assembled.
• The Level 3 SBC methodology understood.
• Next steps and best practices for Level 3 SBC explained.
• Capabilities for SBC built.

Deliverables Created

• None for this section.

Section 6: Document and Maintain Your Service-Based Costing Model

Sections:

Make the Case

Assess Your SBC Need and Maturity

Establish a Level 1 SBC Model

Establish a Level 2 SBC Model

Establish a Level 3 SBC Model

Document and Maintain Your SBC Model

• What's in this Section:
  • Document the SBC Model
  • Institute Change Management
  • Prepare for Change

Use SBC to Drive Business Value

Section 6: Document and maintain your SBC model

Insight

• Nobody trusts a “black box.”
• Documenting your SBC model will help to bring transparency, authority, and acceptance of your model.
• Keep it current! And keep a written history of all of your SBC decisions and the rationale behind them.
• Communicate all changes early and simply; nobody likes surprises on their IT bill.

What You Will Achieve in this Section

• Service-based costing model will be documented.
• Change management process will be established.

Deliverables

• Service-Based Costing Model Documentation Template.
• Service-Based Costing Model Change Request Form.

Don’t let the service-based costing model become a “black box”

The service-based costing model is complex and has a large number of moving parts. Help others understand by using clear documentation and communication.

• Documenting the methods used to allocate general ledger costs is essential for ensuring that the process remains consistent.
• Articulating the rationale behind a chosen allocation method is also important; as the business changes, allocation methods may become obsolete, and stewards need to be able to identify a lack of fit.
• There will be a number of users of the model within IT and across the organization. Make sure all authorized users can access the current version of the model and all its supporting documentation:
  • Finance IT – Individuals responsible for developing chargeback model.
  • IT – Individuals responsible for assessing service viability and outsourcing decisions.
  • IT – Individuals responsible for budgeting.

What to Document

• Service category definitions
• Service definitions
• General ledger version, date, and information
• Allocation methods used for each allocation
• Rationale behind allocation method choice
• Data source(s) and transformations for activity-based allocations
• Financial and service data availability, accuracy, limitations, and constraints

Use Info-Tech’s Service-Based Costing Model Documentation Template to document your service-based costing model

Open the Service-Based Costing Model Documentation Template Costing Model Documentation Template.

Document Required Information

• Allocation Methods
• Data Sources
• Etc. - Detailed in template.

Make the Template Available

• Store the documentation template in an access-controlled location. Consider using a collaboration platform, such as SharePoint.
• Notify all relevant employees outlining access protocols to the reference guide and model.

Maintain Documentation

• As the Service-Based Costing Model changes, the documentation must be updated.
• Change management is key.

Use Info-Tech’s Service-Based Costing Documentation Template.

Establish a change management process to ensure service-based costing evolves smoothly

There are two phases to managing changes to the model.

Implement Change

• As the business evolves, there will be significant changes that necessitate changing a component of the model.
  • Consider this case: an insignificant cost was allocated via even spread method. The cost increases, necessitating more accurate allocation.
• When a change is made, it is critical to follow proper change management protocol, including review, approval, and documentation of the change. Include:
  • What the change was
  • Why it was made
  • Who approved the change

Communicate Change

• Make sure you inform all necessary users of the model:
  • The CIO will use the model to make spend optimization decisions and to communicate expenditures with finance.
  • IT managers and service owners will use the model to optimize their expenditures.
  • Financial analysts will use the model to understand how competitively IT is delivering services.
  • Business department heads will use the model to rationalize chargeback and showback.

Info-Tech Insight

While costs and allocation methodology will change, the basic allocation structure should not be radically altered. Significant changes to allocation structures could cause a loss of faith in the integrity of the SBC. Make sure the rationale behind the changes are communicated clearly.

Govern changes to the SBC model to manage its evolution

Open Info-Tech’s Change Management: Request for Change Form.

How the Tool is Used

• Use formal change management procedures to handle all changes to the model.
• The request should be handled so that consistency and traceability is maintained across the model over its evolution.

Apply Governance

• Ensure that all changes are assessed and approved through the proper governing entity.
• Track the implementation of the change through to completion.

Document the Change

• Ensure consistency between the model and documentation by updating both simultaneously when the change is implemented.

Use your own change request template or use Info-Tech’s Request for Change Form as a baseline.

Don’t let your service-based cost model become outdated

Your costs will change over time. Re-evaluate your service-based costs and allocations on an annual basis – or sooner, if these events occur:

Significant Growth

• If the organization experiences rapid growth, the demand for IT services will grow rapidly. This means the proportion of fixed costs as a percentage of the whole will decrease leading to a decrease in unit costs.

Outsourcing a Service

• The cost of delivering a service in-house does not approximate outsourcing costs. Furthermore, simply changing your unit costs to what the third party bills per unit is undercounting. You still need to allocate costs that are associated with managing the third party.

Eliminating a Service

• If a service is eliminated, the overhead and indirect costs that were previously allocated to the service must still be accounted for. This means they will be allocated to other services if they are not eliminated, increasing unit costs elsewhere.

Significant Service Modification

• Service modifications, such as automating a process that was previously done by a person (labor), can affect costing. Re-evaluate if service modification will affect cost to serve.

Section 6: Summary

Key Messages

• Service-based costing models are highly complex. Documentation must be maintained and made available to all users.
• A change management procedure is required for updating the service-based costing model. Maintain consistency between the model and the documentation.
• Re-evaluate your service-based costing annually or in the event of significant growth, outsourcing, service elimination, or service modification.

What You Achieved in this Section

• Service-based costing model documented.
• Change management process established.

Deliverables Created

• Service-Based Costing Model Documentation Template.
• Service-Based Costing Model Change Request Form.

Section 7: Use Service-Based Costing to Drive Business Value

Sections:

Make the Case

Assess Your SBC Need and Maturity

Establish a Level 1 SBC Model

Establish a Level 2 SBC Model

Establish a Level 3 SBC Model

Document and Maintain Your SBC Model

Use SBC to Drive Business Value

• What's in this Section:
  • Use SBC for business accountability
  • Use SBC for decision making
  • Use SBC for budgeting
  • Use SBC to reduce your costs

Section 7: Use Service-Based Costing to Drive Business Value

Insight

• Many IT consumers are unaware of the costs they incur; exposing the cost can reduce unnecessary consumption.
• Understanding service utilization can help with capacity optimization; you’ll have the right balance of cost and flexibility.
• Knowing services costs allows better planning and budgeting; you can boil it down to unit cost X utilization.
• Properly costed IT services can be compared against industry and alternative delivery methods; there may be a less expensive way to provide users the services they rely on.
• Outsourcing can improve the overall efficiency of your IT department, allowing you to focus on delivering services that provide competitive and outsourcing commodities.

What You Will Achieve in this Section

• Business unit accountability will be established using SBC.
• Benchmarks will be obtained and validated.
• Business decision making using SBC will occur.
• Best practices for budgeting with SBC will be established.

Deliverables

• Service-Based Costing Presentation

7.1 Use service-based costing to increase business unit accountability

Exposing Costs To Promote Accountability

• Business units need to know how much their use of IT resources costs the organization before they can become responsible consumers.
• This means that you need to expose the costs of your IT services to business units.

Info-Tech Insight

When communicating IT costs to business units, emphasize that they are not being asked to reduce their consumption; the goal of IT is to help business units achieve their objectives. However, they also need to consume wisely and appropriately.

• In the absence of chargeback and showback IT can:
  • Provide business users with examples of when they should use a given service.
  • Provide them with examples of when they should not use a given service.
  • Provide them with alternatives to meet their needs.
  • For example, before calling the help desk, clients should check company FAQs and common solutions stored in a knowledge management platform to find answers to their questions.

Use Unit Rates to Show Competitiveness

• Exposing IT costs also provides an opportunity to demonstrate competitiveness; apples-to-apples comparisons require service unit rates.
• Benchmarks can be used to demonstrate the competitiveness of IT services. Industry benchmarks are generally presented in the form of a unit rate.

Unit Rate

• A unit rate is the cost to produce a single unit of a service output. It is usually the average cost per unit that is used (although in some cases the marginal cost per unit may be more relevant).
  • For example, the unit rate for Email Service might be expressed in cost per email user. To calculate this you take: Email Service Cost / Number of Email Users
  • Some services will cost more than the benchmark. For these services, emphasize service quality differences, complementary services, or other factors that affect your costs or provide extra value.
  • The use of benchmarks is assessed in more detail in Section 7.2: Use SBC to make better decisions.

Use Info-Tech’s Service-Based Costing Presentation template to expose relevant findings

Open Info-Tech’s Service-Based Costing Presentation Template.

Purpose

• Expose key service costs.
• Demonstrate current competitiveness.
• Create accountability and awareness.

Who to Include

• Managers from major business units
• CFO
• Other finance executives
• Service owners

Steps

1. Input Cost of Service as a total.
2. Input Unit Rate.
3. Input Benchmarked Rate.
4. Input Key Insights – This field can be used to explain variance from benchmarks.

Use Info-Tech’s Service-Based Costing Presentation.

Prepare for the next step in business unit accountability: chargeback or showback

Use Service-Based Costing as the Foundation

• Service-Based Costing is the foundation for building a chargeback or showback model. Creating such a model, however, necessitates an additional layer of allocation:
• It is necessary to allocate service costs to business units based on their consumption.

Cost Pools

General ledger

• Service-Based Costing General ledger cost pools have been allocated to services.

Services

• Service-Based Costing General ledger cost pools have been allocated to services.

Business Units

• Chargeback/Showback Service cost pools need to be allocated to business units.

Determine which model is right for you: chargeback or showback

Showback Model

• Business units are presented with the cost of their IT consumption.
• Improves business unit accountability –business units are able to identify how much their consumption is costing the organization.
• Motivates responsible consumption – can reduce unnecessary consumption of an expensive service.
• Does not provide a vehicle for cost recovery; IT remains a cost center to the business.

Chargeback Model

• Business units pay for IT consumption.
• Improves business unit accountability.
• Motivates responsible consumption.
• Cost recovery – IT becomes a break-even center since business units will effectively pay for the IT services that they use.

Info-Tech Insight

Do not implement a chargeback model based on Level 1 service-based costing as the accuracy is too low and costing model too unsophisticated to be durable over time. Chargeback models are “sticky” and difficult to change once made public. Avoid implementing chargeback until Level 2 SBC is achieved.

7.2 Use service-based costing to make better decisions

Business decisions derived from SBC primarily drive cost reduction. There are three methods for identifying cost reduction candidates:

Method 1: Benchmarking

If a service is significantly more costly than benchmarked prices, it may be a target for cost reduction – via service streamlining or outsourcing.

Method 2: Outliers

If benchmarks are unavailable, focus on IT Services that seem to consume a disproportionate amount of resources.

For example, a service that is used by only 1% of business users may be consuming 5% of the IT budget. If the service is not absolutely necessary for the business users, it is likely a candidate for service elimination.

Method 3: Perceived Low Value

When you expose your costs to business units, ask business units if they would be willing to pay that amount for the service.

This can occur without actual showback or chargeback.

If business units say “no,” the “business unit market” has determined the cost of the service is greater than its value to the business.

Info-Tech Insight

When making big decisions, use all three methods in concert. Often, a service cost that is above industry benchmarks will be discovered. If the service is a core offering, don’t jump the gun; compare the cost to serve against other services and investigate perceived value.

Obtain benchmark data to compare your costs

Obtaining valid, industry-specific benchmarks isn’t easy. Use these data sources to obtain them.

Data Source 1: Use Info-Tech’s Measure IT

• Info-Tech’s MeasureIT is a custom benchmarking initiative with more than 12,000 data points!
• The Budget Metrics and Benchmarking Tool shows an overview of capital and operating expenditures and spend in specific areas as a percentage of sales.
• The Staffing Metrics and Benchmarking Tool shows direct labor time spend on services.
• MeasureIT will not provide you with everything you need for granular service-based costing breakdowns, but it is an excellent starting place.
• Does not provide a vehicle of cost recovery; IT is still a loss center.

Data Source 2: Consulting firms

• Often, consulting firms and industry research houses compile benchmarks.
• Reach out to firms you have a relationship with and ask if they can help.

Data Source 3: IT Financial Management Solutions

• IT financial management solutions, such as Nicus, Apptio, and ComSci, provide benchmarks.
• While it is certainly not worth procuring a solution for the benchmarks alone, if you are procuring a solution, make sure you take advantage of the benchmarks.

Validate benchmarks to ensure reliability

If the benchmarks are going to drive decisions, then you need to dig deeper. Make sure your benchmarks are valid.

Organization Using Benchmark – Sample Facts

Industry: Auto Manufacturing – Last Fiscal Year Revenue: $100,000,000

Benchmark Checklist:

• Benchmarks should meet all five (5) criteria
• The data is less than two years old. Things change quickly in IT; the effect of increasing cloud-based services has drastically changed service costs.
• The data has an N count above 200. Low N counts make data statistically insignificant. If no N count is provided, assume invalidity.
• Benchmark source is impartial. Make sure the source is unbiased.
• Benchmark is applicable to the same industry as the organization using the benchmark.
• Benchmark is applicable to organizations of a similar size.

Benchmark Example

• Benchmark: Cost per ticket for help desk: $50.46
• Data dated April 2014.✓
• N Count: 312 ✓
• Source: Help desk solution vendor X
• Industry: Pharmaceuticals X
• Revenue: $10M–$50M X
• Benchmark is invalid

Do not jump to conclusions; your IT department is not a statistic

Caution

An organization finds that managed internet costs $800 per user per year, and a valid benchmark indicates that $700 per user per year is the average. This does not necessarily imply inefficiency. Certain factors can explain variance.

Service-Level Explains Benchmark Variance:

• Providing a higher service-level will result in higher costs.

Sourcing Strategy Explains Benchmark Variance:

• Dealing with premium suppliers, whether they are software, hardware, or services vendors, will result in higher costs.

Geography Can Explain Benchmark Variance:

• Operating in a high GDP per capita country with high minimum wages and an educated workforce will result in higher costs.

Other Factors Can Explain Benchmark Variance:

• Additional security costs, recent merger, and temporary inefficiencies caused by technology changes are other reasons costs may be higher.

7.3 Using service-based costing for budgeting

There are two ways that SBC can be useful for budgeting

Use Service-Based Costing for Cost Projection

• The simple method is to use unit rates to approximate cost increases:
  • If your Email Service costs $100,000, and you have 400 users, then it costs $250 per user.
• Then, if 100 new users will be supported next year, your costs will increase by $25,000.
• This generally provides a better approximation than “increase it by about 5%.”
• However, some additional work is required to leverage service-based costing for projecting costs with the highest degree of accuracy.
• Stratify your service level costs into “fixed,” “variable,” and “stepped” portions.
  • Fixed: Remain constant.
  • Variable: Increase directly as a cost driver increases.
  • Stepped: Remain constant up to a point, but increase after a threshold is reached.
• You can then use this information to project costs.

Use Service-Based Costing to Defend the Budget

• Often, CIOs face downward budgetary pressure.
• “I think this can be reduced by 10%” – CFO.
• Use benchmarks to defend your budget:
  • If unit rates are comparable to industry benchmarks, then this demonstrates that your budget projection is reasonable.
  • Benchmarks can also be used to validate a budget increase; if unit rates are significantly below industry benchmarks, then perhaps spending more is justified.
  • Benchmarks are especially useful for defending line items often not understood by business units – virtualization expenses, for example.
• Note that just because your benchmarks are above industry averages doesn’t mean benchmarks can’t be used. Emphasize the factors that account for your costs being higher – geography, service level, etc.

Use SBC to reduce your costs

Capacity Management

Having the right amount of capacity is critical for service and cost efficiency. Overprovisioning and over specification is common practice in IT due to the propensity for risk aversion. Plan to have enough capacity to meet expected demand, but don’t buy excess capacity or you will end up with unnecessary waste.

Outsourcing

If a service you are providing costs more than it does if you were to buy it from a service provider, ensure that there is good justification to do so, i.e. the service provides a competitive advantage. If you’re paying more to keep a commodity service internal, it’s time to consider outsourcing.

Elimination

Services that are used infrequently, by few people, are easily substitutable, or provide little value are prime candidates for elimination. Don’t fall into the trap of providing a service just because it’s always been there. However, some costs of a service are already committed to and need to be reallocated to other services when a service is retired.

Reduce costs through increased capacity utilization

Effect of Unused Capacity:

• Low capacity utilization inflates your cost to serve as a unit rate.
• There are fixed expenses that are incurred whether or not you use all available capacity. These expenses are allocated to services.
• Increasing your utilized capacity by serving more customers without procuring more assets, will spread the fixed costs over more service delivery units.

What to Do:

• As demand increases, additional capacity will be needed. However:
  • Stop buying to meet peak demand.
  • Instead, buy for the expected level of demand (with a small buffer).
  • Consider using cloud services to manage unexpected overages.
    • This requires that a contract and load shifting strategy be in place with a cloud vendor if a sudden spike in demand occurs.

Info-Tech Insight

Capacity utilization only drives service cost reduction up to a point. Often, when extremely high capacity utilization is reached, costs will increase due to inefficiencies managing the capacity. An insufficient buffer drives costs up.

Case Study: Increasing IT capacity utilization

US Healthcare Provider

Employee Count: 10,000+

The last straw: Capacity utilization below 20% of key IT assets

Situation

• Changing regulations forces a US healthcare provider to alter its operations in order to provide a higher standard of care and increase documentation of doctor-patient interaction.
• The changes resulted in operational inefficiencies and higher costs of care.
• These costs were passed on to patients, and patients began to seek care at less expensive healthcare providers.

Solution

• A full service-based costing analysis uncovered the true costs of all services, including IT functions.
• The costing model also captured the true capacity utilizations of IT resources by accounting for how those resources were used across all services; some key assets were found to be below 20% utilization.

Result

• The results allowed them to identify underutilized resources, minimize unused resources, and redeploy excess capacity to reduce bottlenecks, resulting in:
  • A 40% reduction in application development cycle time.
  • $10 million cost savings in improved IT infrastructure management.
  • Improved relationships and collaboration between IT and business units.

Reduce costs through outsourcing if certain criteria are met

If outsourcing is cheaper, then it must be considered. However:

Don’t Sacrifice Competitive Advantage

• A mortgage lender might be able to outsource loan request filing. But if internal IT has proprietary methods that achieve better results, then it may not be a good idea.

Don’t Sacrifice Service Level

• If an organization has a low data entry error rate, which is essential to the business, then the third party must match the level of service.

Don’t Sacrifice Security

• Do you deal with sensitive financial information? If so, maybe the third party doesn’t adhere to sufficient security standards. Check to make sure they meet necessary requirements and regulations.

Don’t Sacrifice Flexibility

• Outsourcing can be inflexible. Contracts may have punitive exit clauses that make it difficult to end the business relationship.

Info-Tech Insight

People may resist outsourcing, and for good reason; it isn’t easy. However, outsourcing can drive enormous value. Recognize that outsourcing can improve the overall efficiency of your IT department, allowing you to focus on delivering services that provide your business with competitive advantage.

Case Study: Lack of cost transparency leads IT outsourcing in banking

Situation

• In the late 1990s, banks were investing heavily into IT infrastructure and systems. However, how this investment transformed into business value was unclear and there was suspicion that funding was being used inefficiently.
• As a result of IT departments’ inability to meter IT usage, show full service costs, and allocate costs to business, significant parts of IT were outsourced.

Deutsche Bank Solution

• Deutsche Bank launched a cost transparency project to evaluate the cost of IT services. The initiative focused on costing the activities performed at computer centers in continental Europe. The findings resulted in the outsourcing of computer center management to IBM and allowed Deutsche Bank to have transparent rate-based costs for the IT services they needed.

Deutsche Bank Result

• Deutsche Bank was able to pass on rate-based charges to business units directly.
• Increased service level: the e-business and on-demand technology provided by IBM was more flexible than Deutsche Bank’s internal offering.
• Deutsche Bank expects to realize $1 billion in cost savings over the first ten years of the agreement.

ABN AMRO Solution

• ABN AMRO launched an analysis of their IT services. They concluded that 1) costs were very high, 2) there was poor transparency of how costs were allocated to business services, and 3) IT services represented certain risks to the business. ABN AMBRO negotiated an outsourcing contract with Electronic Data Systems (EDS) to provide technology services and application development.

ABN AMRO Result

• Transparency of IT spend and business value improved.
• Performance metrics became more available.
• Cost savings increased.
• IT governance improved.

Reduce costs through service elimination

Eliminating a service completely is one way to reduce costs. Beware, not all costs can be eliminated.

Not All Costs Are Eliminated

• Just because an IT-provided application is eliminated, does not mean the fixed costs that were attributed to it are eliminated.
• This means these costs need to be allocated elsewhere. They are not truly eliminated.
• The result: the cost of other services increases.
• In the event of chargeback, business units will resent the change.
• Make sure you analyze what costs can actually be cut and how the remaining costs will affect the costs of other services.
• This type of what-if analysis is essential to decision making.

Example

• A small IT shop at a consumer packaged goods company was supporting both Box and Dropbox for file sharing.
• They decide to stop supporting Box.
• An IT manager previously had 30% of his salary allocated to Box. The manager is still employed.
• 15% of rent expense was previously allocated to Box.
• The expenses need to be allocated elsewhere. The cost of other services will increase by the proportion of 30% of the manager’s salary and 15% of the rent expense that is allocated to them.
• However, the organization still benefits from cost reduction.
  • For example, direct labor employees who supported Box can be reduced.

Info-Tech Insight

Service elimination can increase the proportion of costs that are not directly attributable. This may result in a new allocation methodology; a cost that was insignificant enough to be allocated via cost rate allocation may now require ABC allocation.

Use Info-Tech’s Service-Based Cost Model Tool for “what-if” analysis for service elimination and outsourcing decisions

• Save a new copy of the Service-Based Cost Model Tool and name it: “ScenarioName_Scenario_SBC_Projection.”

What to do

• Estimate the cost savings that would be derived from service elimination.
• Identify the proportion of costs that are “fixed” for every general ledger account on the service tab (For example, Email Service Cost tab).
• Reduce the general ledger accounts on the General Ledger tab by the variable portion (total cost – variable cost = new general ledger cost).
• For activity-based costs, reduce the total consumption of cost drivers based on estimates. Allocations will adjust automatically to ensure 100% cost allocation.
• For other indirect and overhead costs, increase the % allocated to other services so that 100% of costs are allocated.
• This will give you your new service-based costs.

Use Info-Tech’s Service-Based Cost Model Tool.

Guided Implementation: Maximize SBC Value Creation

Prior to the Guided Implementation

• Review the goals that you defined in section 1. Have you achieved them? Are you on track?
• Create the messages that you want to communicate to the business – service costs, awareness, etc. – to help drive accountability.
• Obtain benchmarks and compare against your costs.
• Define an approach as to how you will use SBC to inform business decisions.
• Define an approach for incorporating SBC into the budgeting process.

During the Guided Implementation

An Info-Tech Consulting Analyst will discuss with you:

• Progress towards goals and how to improve achievement.
• How to encourage behavioral changes from the business to drive accountability for IT consumption.
• The comparability of benchmarks and how to use them to communicate progress to the business.
• Review upcoming business decisions informed by SBC.
• Plan to incorporate SBC into budgeting.

Value & Outcome

At the conclusion of the Guided Implementation call, you will have:

• Status of progress to goals.
• Direction on how to encourage business behavioral change.
• A validated comparison of costs against benchmarks.
• Guidance on incorporating SBC into business decision making, planning, and budgeting.

Arrange a call now:

Email GuidedImplementations@InfoTech.com or call 1-888-670-8889 and ask for the Guided Implementation Coordinator to book a Guided Implementation in your organization.

Section 7: Summary

Key Messages

• When exposing costs, the goal is not to get business units to reduce consumption; the goal is to reduce unnecessary consumption.
• Do not implement a chargeback model based on Level 1 service-based costing. Business units will resist pricing changes. Prices will change significantly as maturity increases and service-to-service consumption is accounted for.
• Capacity utilization only drives service cost reduction up to a point. Often, extremely high capacity creates inefficiencies managing the capacity. An insufficient “buffer” drives costs up.
• Outsourcing can improve the overall efficiency of your IT department, allowing you to focus on delivering services that you have a comparative advantage in.

What You Will Achieve in this Section

• Business unit accountability will be established using SBC.
• Benchmarks will be obtained and validated.
• Business decision making using SBC will occur.
• Best practices for budgeting with SBC will be established.

Deliverables Created

• Service-Based Costing Presentation

Blueprint complete: Track your progress

After reaching your target level of SBC:

1. Your SBC maturity should improve.
2. Your accuracy scores should increase and ease of use scores should decrease.
3. Your coverage of services and IT spend should increase.

Appendix 1: Allocation Methods

Sections:

Allocation Methods

• What's in this Section:
  • Allocation methods explained

Contributors

Bibliography

Select an appropriate allocation method for each indirect and overhead cost

Method 1: Even Spread Allocation

Strengths:

• Easy implementation

Weaknesses:

• Fails to distribute costs based on actual use.
• Ease-of-Use Score: how easy the allocation method is to execute – determined by need for data. Ten is the easiest to use.
• Accuracy Score: how accurate the allocation method is. Ten is the most accurate.

Info-Tech Ease-of-Use Score: 9/10

Info-Tech Accuracy Score: 1/10

Method 2: Cost Rate Allocation

Strengths:

• Easy implementation.
• Individual IT service cost as a percentage of total IT service cost remains constant, which is desirable in some circumstances.
• Can provide satisfactory accuracy in some circumstances.

Weaknesses:

• Fails to distribute costs based on actual use.

Info-Tech Ease-of-Use Score: 8/10

Info-Tech Accuracy Score: 3/10

Method 3: Assigned Percentage Allocation

Strengths:

• Leverage internal knowledge to produce an accurate allocation.
• High degree of flexibility.

Weaknesses:

• Expertise and knowledge required may not exist.
• Allocation often viewed as unfair.
• Low confidence in numbers can undermine use of model.

Info-Tech Ease-of-Use Score: 8/10

Info-Tech Accuracy Score: 4/10

Select an appropriate allocation method for each indirect and overhead cost (continued)

Method 4: Single-Driver Activity-Based Allocation

Strengths:

• Accurate allocation of costs.
• Creates cost reduction transparency.

Weaknesses:

• Data may be unavailable.
• Data may be expensive to collect.
• Selected cost driver may not be sole driver of expense.

Info-Tech Ease-of-Use Score: 4/10

Info-Tech Accuracy Score: 8/10

Method 5: Multi-Driver Activity-Based Allocation

Strengths:

• High degree of accuracy.
• Highly defensible.

Weaknesses:

• High complexity.
• Enormous data collection.
• Potential for allocation “infinite loops.”

Info-Tech Ease-of-Use Score: 2/10

Info-Tech Accuracy Score: 9/10

Combining Allocation Methods

Combining allocations methods may allow for higher accuracy, but can increase complexity.

For example, a portion of server expense may be known to be the result of a server breakdown that is directly used by application services only.

The organization may chose to treat the known portion as a direct cost and attribute the dollar value of the maintenance expense for that server.

Then, the remaining allocation expense can be allocated using one of these five methods.

While these combinations may be practical at times, they can also add a lot of complexity to your model. Use sparingly.

Data entry by allocation method and cost driver identification

Direct Costs

• No input required in Cost Driver or Cost Driver Unit columns.

Even Spread and Cost Rate Allocation

• No input required in Cost Driver or Cost Driver Unit columns.

Manual Percentage Allocation

• No input required in Cost Driver or Cost Driver Unit columns.

Single-Driver ABC Allocation

• Specify the cost driver in Cost Driver column.
• Specify the cost driver unit in Cost Driver Unit column.

Multi-Driver ABC Allocation

• No input required in Cost Driver or Cost Driver Unit columns.
• Document your allocation equation in the Service-Based Cost Model Documentation Template.

Identifying Cost Drivers

Cost driver: Anything that changes the cost of an activity. For single driver ABC, you will be focusing on the single factor that is most responsible for a change in cost.

For example: A CIO wants to allocate software virtualization expense between two service categories: application services and hosting services.

Cost Driver: Virtual Servers

Cost Driver Unit: Number

If application services uses 100 virtual servers, hosting services uses 200 virtual servers, and no other service category uses virtual servers:

66.6% of the expense would be allocated to hosting services and 33.3% of the expense would be allocated to application services.

Use the General Ledger tab on Info-Tech’s Service-Based Cost Model Tool.

Appendix 2: Contributors

Sections:

• Allocation Methods
• Contributors
  • What's in this Section:
    • Our thanks to the contributors
• Bibliography

Our thanks to the following contributors

Michael Davison, Converged Infrastructure Specialist – Hitachi Data Systems

Paul Lewis, Chief Technology Officer – Hitachi Data Systems

Robert Mischianti, Vice President of Product Development – Nicus Software

Chris Pick, Chief Marketing Officer – Apptio

Jeff Yoder, Vice President, Strategic Partnerships, Global Marketing Operations – ComSci by Upland

Appendix 3: Bibliography

Sections:

• Allocation Methods
• Contributors
• Bibliography
  • What's in this Section:
    • Bibliography

Bibliography

Automating IT Cost Transparency. Apptio, Web. 28 May 2014.

Meyer, N. D. "Service-based Costing." FullCost/NDMA. Web. 28 May 2014.

Ryan, Robert, and Tim Raducha-Grace. “IT Financial Management: The Business of IT." The IBM Press. Web. 17 May 2014.

“Technology Business Management." Automating IT Cost Transparency. Apptio, Web. 28 May 2014.

"The IT Financial Management Challenge: Where Is the ROI?" VMWare. Web. 14 May 2014.

"The Step-Down Allocation Method in Cost Accounting." For Dummies. Web. 28 May 2014.

"What Service-Based Costing Really Means." CIO. 30 Sep. 2007. Web. 28 May 2014.

Workshop: Establish a Service-Based Cost Model

Not knowing your costs is an expense you can’t afford.

Workshop objectives

This Workshop has these main objectives:

• Improve understanding of service-based costing (SBC) and SBC value.
• Right size your SBC approach.
• Increase SBC maturity through capability building.
• Demonstrate a methodology that will drive a deep understanding of service costs and empowered decision-making.

This workshop will help understand how to:

• Understand the SBC process.
• Assess your service-based costing maturity and need.
• Identify and define a target service category.
• Identify and define a target service.
• Develop an allocation methodology.
• Identify a service category cost.
• Identify a service cost.
• Use SBC to drive business value.

Overview of two-day workshop

This two-day workshop will cover the following activities

• Define SBC.
• Discuss benefits of SBC for your organization.
• Select metrics to measure SBC success.
• Measure SBC maturity and need.
• Discuss SBC process and concepts.
• Target and define one service category.
• Target and define one service.
• Discuss the need for data and data availability.
• Develop an allocation methodology.
• Document an allocation methodology.
• Determine service category costs.
• Determine service costs.
• Discuss using SBC to drive business decisions and walkthrough an example.
• Measure SBC accuracy and ease-of-use.
• Discuss next steps.

Workshop deliverables

• List of metrics to measure SBC success.
• Baseline measurements of SBC maturity and need.
• Service category definition.
• Service definition.
• Allocation methodology developed – cost model.
• Allocation methodology documented – documentation template.
• Service category and service cost breakdown – cost model.
• SBC management presentation.
• “What-if” scenario cost breakdown – cost model.

Our understanding of the problem

This Research Is Designed For:

• CIO with IT budgets <$20M, all industries
• IT Finance Head

This Research Will Help You:

• Define the relevance of service-based costing to your organization.
• Identify your current service-based costing needs and level of maturity.
• Improve your service-based costing capability.
• Determine the cost of your IT services.
• Use costing information to drive business value.

This Research Will Also Assist:

• CFO
• IT Financial Analyst

This Research Will Help Them:

• Recognize how IT investments are deployed to support business services.
• Allocate IT costs fairly across IT services.

Executive Summary

Situation

• While IT departments provide valuable services to their organizations, it is frequently unclear how much these services cost. CIO’s often find themselves in a position where they cannot articulate exactly how much it costs to deliver a given service in order to justify the service’s value.

Complication

• IT capital and operational costs are captured in accounting ledgers using financial constructs that lend themselves well to financial reporting, but obscure the true cost to deliver each IT service.
• Translating accounting ledgers to IT service costs is a difficult process that may sometimes appear arbitrary.
• The data required for detailed service-based costing is often unavailable.

Resolution

• Use a method of determining the full cost of services that provides a reasonable level of accuracy without overburdening staff with excessive analysis and investigation.
• Optimize the balance between analytical effort and accuracy of service costing by understanding your service cost accuracy needs and matching them to an appropriate level of service based costing capability.
• Develop the right level of service based costing capability by applying the methods in this blueprint.

Info-Tech Insight

1. Service-based costing is not for everyone.It requires clearly defined goals and commitment to be successful.
2. You don’t have to be perfect to gain value from service-based costing.Imperfect analysis can still point you in the right direction for improvement.
3. Nobody trusts a “black box.”Be transparent with results.

Key Insights

Don’t begin without purpose

• Know how you intend to make use of your service-based costing results before your begin; if there is no clear purpose, it will be a waste of time.
• Service-based costing is complex, difficult, and lengthy.
• Service-based costing requires a serious commitment in order to do it right.
• Service-based costing is useful to achieve certain objectives, but is not a panacea for all costing woes.

Service-based costing (SBC) is not for everyone

• Do only what you need. If your capability is already sufficient to meet the needs of the organization, don’t embark on improving your service-based costing capability.
• The Info-Tech Service-Based Costing Maturity Model can help you determine where you are today and where you need to arrive in the future; do only what you need!

Everybody can benefit from basic SBC

• Business value and decision-making can be enhanced even with a small increase in service-based costing maturity.
• Even Level 1 SBC maturity can help to focus your attention on the categories of services that consume the greatest amount of IT spend.
• Level 1 SBC can simplify the service-based costing analysis to minimize the amount and complexity of data collection.

Key Insights (cont.)

Level 2 SBC is accurate enough for many organizations; however, few have achieved it

• Align your service catalog with common industry practices to enable benchmarking of your service costs.
• Understanding the makeup of your services and how they interact with one another is key to establishing an accurate costing.
• Simplifying assumptions can greatly reduce the effort involved and can often be used without introducing excessive error.

Bring in extra help if you want a truly accurate SBC

• Level 3 SBC is a large and complex effort; you need the right combination of skills, experience, and knowledge, some of which may require sourcing externally, both from a service perspective and a finance perspective.
• Full service-orientation is critical and a pre-requisite for accurate costing.
• Think both top down from the general ledger and bottom up from the configuration items, and reconcile finances through services; automated data collection and analysis will help.

Nobody trusts a “black box”

• Documenting your SBC model will help to bring transparency, authority, and acceptance of your model.
• Keep it current! And keep a written history of all of your SBC decisions and the rationale behind them.
• Communicate all changes early and simply; nobody likes surprises on their IT bill.

Key Insights (cont.)

Understanding true service costs can improve business efficiency

• Many IT consumers are unaware of the costs they incur; exposing the cost can reduce unnecessary consumption.
• Understanding service utilization can help with capacity optimization; you’ll have the right balance of cost and flexibility.
• Knowing services costs allows better planning and budgeting; you can boil it down to unit cost * utilization.
• Properly costed IT services can be compared against industry benchmarks and alternative delivery methods; there may be a less expensive way to deliver the services users rely upon.
• Outsourcing can improve the overall efficiency of you IT department, allowing you to focus on delivering services that provide a competitive and outsourcing commodities.

Module 1: Make the Case

Sections:

• Make the Case
  • What's in this Section:
    • Define Service-Based Costing (SBC)
    • Benefits of SBC
    • Risks of SBC
• Assess Your SBC Need and Maturity
• Target Service Category and Service
• Develop an Allocation Methodology
• Determine Costs
• Use SBC to Drive Business Value

Section 1: Make The Case

Insight

• Don’t begin without a purpose.
• Know how you intend to make use of your service-based costing results before your begin; if there is no clear purpose, it will be a waste of time.
• Service-based costing is complex, difficult, and lengthy.
• Service-based costing requires a serious commitment in order to do it right.
• Service-based costing is useful to achieve certain objectives, but is not a panacea for all costing woes.

What You Will Achieve in this Section

• The flaws in traditional costing methods will be recognized.
• The opportunities service-based costing can afford will be defined.
• The challenges of service-based costing will be explained.

Deliverables

• None for this section.

Translate costs into value with service-based costing (SBC)

Defining Service Based Costing

• Service-based costing looks at the output provided by a service and traces the costs incurred to produce a single unit of output. E.g. The cost to manage a single desktop computer.
• SBC incorporates all costs necessary to produce that service, including:
  • Direct costs
  • Shared costs
  • Overhead
• The total expenditure towards IT is accounted for in the total cost of all IT services delivered.

IT Departments Incur Costs…

• Hardware
• Software
• Third-Party Services
• Labor
• Resources
• Property
• Administration

…To Deliver Valuable Services

• Business-facing IT services
  • Help Desk Service
  • Email Service
  • Etc.
• Internal IT services
  • Network Service
  • Virtualization Service
  • Etc.

Service-based costing provides these benefits

Transparency

• Expenditures on IT resources can be directly linked to IT service delivery and business value, and IT investments can be targeted at specific service enhancements.

Comparability

• Cost to deliver services via internal resources is directly comparable to and can be benchmarked against service delivery via alternative sourcing options, such as outsourcing or cloud services.

Accountability for Consumption

• Business units recognize the impact of their consumption and can adjust their usage patterns to make more efficient use of IT services.

Budget Credibility

• Forecasting budget is closely tied to expected service demand and known service costs.

Clarity

• CFOs are able to identify how IT expenditures in GL map to IT services delivered.

Cost Optimization

• Costs are decreased through reducing cost drivers and improving service processes.

Cost Attribution

• IT service costs can be fairly distributed among IT users, supporting chargeback or showback.

Push through the challenges of SBC

SBC has many benefits, but they don’t come easily.

Methodologies are Protected and Proprietary

The organizations that do SBC well – frequently commercial banks and insurance conglomerates – consider their SBC methodology a competitive advantage and guard it carefully. Additionally, developers of IT financial management software view their models as proprietary intellectual property. Consequently, there is little public information on SBC methodology.

Agreement on Service Definitions is Required

Having a well-defined service catalog is necessary for advanced SBC. Without clear service definitions, it is hard to allocate costs appropriately. However, building a service catalog is a difficult task; it is both expensive and time consuming.

Data Must be Available

Cost allocations can be simple, but accurate cost allocations need to be data driven. This means organizations must meter consumption of key IT resources. For example, if the amount of storage used by an application is unknown, then costing the storage used by that application will be difficult.

Allocation is Complex

In order to do SBC properly, shared costs and overhead must be allocated according to consumption. In order to do this, costs must be traced and disseminated appropriately across and in proportion to the services that consume them.

Differences between SBC and traditional costing

Traditional Costing

How Costs are Calculated:

• Direct costs: Are easier to trace and therefore added where the cost is incurred.
• Shared costs: Are often allocated based on an arbitrary proxy; e.g. total direct cost, business unit revenue, # of users.
• Overhead costs: Are usually allocated similarly to shared costs.

Benefits:

• Relatively simple to calculate.

Weaknesses:

• May be very inaccurate.
• May be unfair in business unit chargeback.
• May lead to misdirected decision making.

Service-Based Costing

How Costs are Calculated:

• Direct costs: Are allocated to the service that consumes them.
• Shared costs: Are allocated to the service that consumes them, in proportion to the consumption.
• Overhead costs: Allocated as closely as possible to actual consumption; otherwise a service-oriented proxy for consumption is used.

Benefits:

• More accurate service costing.
• More informed decision making.
• More transparent chargeback.

Weaknesses:

• Requires more and higher quality data.
• Requires more effort and resources.

Info-Tech Insight

The difference between SBC and traditional costing is exaggerated as overhead and shared costs increase in proportion to total costs.

Case Study: SBC Can Drive Business Value

US-Based Fortune 500 Company

Employee Count: 50,000+

Situation

• The organization incurred significant IT costs, including project and service costs.
• Overall IT costs were distributed to business units based on headcount.
• The simplistic approach did not reflect actual usage; it was selected in order to minimize effort spent on chargeback.
• Business units with low usage felt unfairly treated and spent significant time refuting charges.
• Costly retroactive adjustments became commonplace.

Action

• Implemented a service-based costing process designed to:
  • Separate the IT project costs from service costs.
  • Identify the variable rates and fixed costs of IT services.
  • A chargeback model was developed based on the new system, promoting business unit accountability for IT consumption.
  • A financial management platform was implemented to manage IT finances.

Result

• Able to assess service competitiveness and evaluate outsourcing and other alternatives.
• Improved relationships and communication between IT and business units.
• Reduced disagreement with business units; business units bought in to the new model.

What this workshop will do for you

1. Make a Go or No-Go Decision

• Help you decide if SBC is appropriate for your organization – SBC requires effort and is not for everyone!

2. Assess Maturity

• Identify your current level of SBC maturity and determine the right level of service for your organization.

3. Guide SBC Analysis

• Provide a path to guide the progress of your organization to your desired level of maturity.

4. Ensure SBC Documentation

• Encourage continual documentation of the SBC process, to help keep decisions transparent and understood.

5. Drive Value with SBC

• Illustrate how to use SBC to drive value in your organization.

Exercise: Describe how IT costing is done in your organization

Objective: Define how IT costing is currently done in your organization and how well it accomplishes the goals of being accurate and transparent.

Questions:

1. How do you do IT costing today?
2. How accurate are your costs?
3. Do your stakeholders feel that IT costs are transparent and clearly linked to business objectives?
4. Do you need more IT cost transparency at this time? Why?
5. What have you done in the past to improve cost transparency?
6. What do you hope to achieve with service-based costing?

Section 1: Summary

Key Messages

• It is critical to know why you are embarking on a service-based costing before you start.
• This is a very difficult journey that requires a significant commitment.
• If you do not have a specific rationale to know your service costs, you should not undertake service-based costing.

What You Achieved in this Section

• Recognized the flaws in traditional.
• Defined the opportunities service-based costing can afford.
• Clarity regarding the challenges of service-based costing.

Deliverables Created

• None for this section.

Section 2: Assess Your SBC Maturity and Need

Sections:

Make the Case

Assess Your SBC Need and Maturity

• What's in this Section:
  • Balancing Effort and Benefit
  • SBC Maturity Model
  • Assess Current State
  • Metrics

Target Service Category and Service

Develop an Allocation Methodology

Determine Costs

Use SBC to Drive Business Value

Section 2: Assess Your Maturity and Need

Insight

• Service-based costing is not for everyone.
• Don’t embark on improving your service-based costing capability if your capability is already sufficient to meet the needs of the organization.
• The Info-Tech Service-Based Costing Maturity Model can help you determine where you are today and where you need to arrive in the future; do only what you need!

What You Will Achieve in this Section

• Clarity regarding the Info-Tech Service-Based Costing Maturity Model and the capabilities required to achieve each level.
• Certainty regarding your current Service-Based Costing capability.
• A decision regarding your target level of Service-Based Costing maturity.
• Defined metrics to track your progress.

Deliverables

• A target Service-Based Costing maturity level.
• Specific Service-Based Costing progress metrics.

The Info-Tech Service-Based Costing Maturity Model

Determine the target state and align with the Info-Tech Maturity Model

*Time to implement for a typical small to mid-sized organization

Exercise: Identify target maturity

What you will need:

• Whiteboard
• Markers
• Sticky notes

Objective: Identify your organization’s target state of maturity.

Instructions:

1. Identify the key benefits that the organization would like to achieve and write them on sticky notes.
2. Arrange the benefits in order of importance.
3. Determine the level of maturity that would achieve the most important benefits.
4. Discuss if that level of maturity makes sense as a target for the organization and decide on a target level of maturity.

Ascertain your current level of SBC maturity

Exercise: Identify current maturity level

What you will need:

• Whiteboard
• Markers

Objective: Identify your organization’s current SBC maturity level.

Instructions:

1. Use the maturity descriptions from earlier slides as guidance for identifying your current maturity level.
2. Each person place a dot beside the maturity level that they believe the organization is at.
3. Open forum discussion: discuss the key reasons why the organization is at each maturity level.

Exercise: Being practical in deciding attainable benefits

What you will need:

• Whiteboard
• Markers
• Sticky notes

Objective: Identify your organization’s current SBC maturity level.

Instructions:

1. Return to the benefits identified earlier as “most important” and place them on the whiteboard.
2. Write a blocker that could prevent achievement of each maturity level on red sticky notes.
3. Open discussion: as a team, brainstorm actions that could be taken to mitigate blockers. Write these on blue sticky notes.
4. Rationalize the set of benefits and confirm the set that seem achievable. Set these as the target outcomes from the project.

Track your progress

As the project progresses:

1. Your SBC maturity should improve.
2. Your accuracy scores should increase and ease of use scores should decrease.
3. Your coverage of services and IT spend should increase.

Section 2: Summary

Key Messages

• Service-based costing is not for everyone.
• Don’t embark on improving your service-based costing capability if your capability is already sufficient to meet the needs of the organization.
• Balance the effort required to improve with the level of need for the organization.

What You Achieved in this Section

• Clarity regarding the Info-Tech Service-Based Costing Maturity Model and the capabilities required to achieve each level.
• Certainty regarding your current Service-Based Costing capability.
• A decision regarding your target level of Service-Based Costing maturity.
• Defined metrics to track your progress.

Deliverables Created

• A target Service-Based Costing maturity level.
• Specific Service-Based Costing progress metrics.

Section 3: Target Service Category and Service

Sections:

Make the Case

Assess Your SBC Need and Maturity

Target Service Category and Service

• What's in this Section
  • Target service category
  • Define service category
  • Target service
  • Define service

Develop an Allocation Methodology

Determine Costs

Use SBC to Drive Business Value

Section 3: Target service category and service

Insight

• In order to determine the cost of a service category, a comprehensive list of all services within that category is required.
• However, defining a complete service catalog is overkill unless a full-scale service-based costing initiative is planned.
• A service definition should include a high-level SLA, service users, service owners, and a description of the value delivery process.
• Align your service catalog with common industry practices to enable benchmarking of your service costs.
• Understanding the makeup of your services and how they interact with one another is key to establishing accurate costing.

What You Will Achieve in this Section

• Service category will be targeted.
• Service category will be defined.
• Service will be targeted.
• Service will be defined.

Deliverables

• A clear definition of the targeted service category.
• A clear definition of the targeted service.

Target service categories

Services

• A set of processes that results in a positive business outcome.

IT Services

• A set of processes for which the IT department is accountable that results in a positive business outcome. For example: Application development service.
• An IT Service is a type of Service.
• An IT Service belongs to a single IT Service Category.

IT Service Category

• A set of related IT services.
• For example: Application services.
• Most IT organizations have between 5 to 20 IT Service Categories.
• Info-Tech provides a sample IT Service Category list on next page.

Define service categories or select from Info-Tech’s sample list

Category 1: Application Services

• Application Design
• Application Development
• Application Integration
• Etc.

Category 2: Computing Services

• Desktop / Laptop Provisioning
• Printing Service
• Service Desk
• Etc.

Category 3: Communication and Collaboration Services

• Instant Messaging
• Email Service
• Telecom Service
• Etc.

Category 4: Hosting Services

• Application Hosting
• Database as a Service
• Virtual Servers
• Etc.

Category 5: Mobility Services

• BYOD Management
• Mobile Phone Provision
• Etc.

Category 6: Network Services

• Basic Connectivity
• Remote Connectivity
• Mobile Connectivity * not under mobility
• Etc.

Category 7: Professional Services

• Enterprise Architecture
• Project Management
• Consulting
• Etc.

Category 8: Security Services

• Identity and Access Management
• Security Management and Monitoring
• Etc.

Category 9: Specialty and Miscellaneous Services

• Services that do not fit in another category or are unique to one area of the organization.

Exercise: Target a service category

What you will need

• Whiteboard
• Markers
• Sticky notes

Objective: Identify a service category for analysis.

Instructions:

1. Write down the most important IT service categories to your organization.
2. Write three IT cost transparency concerns that correspond to each service category (or most specifically) on red sticky notes.
3. Place sticky notes on whiteboard next to corresponding service category.
4. Open discussion: come to consensus regarding which service category and associated challenges should be addressed in this workshop.
5. Note the remaining service categories to be addressed later by the team after the workshop has completed.

Exercise: Describe the targeted service category in detail

What you will need

• Whiteboard
• Markers

Objective: Identify the services within the targeted service category.

Instructions:

1. As a group, brainstorm IT services that are part of the targeted service category.
2. Open discussion: identify any services that may better belong under another service category.
3. Open discussion: modify and come to consensus on service list.

Activity 1: Target service

Services

• A set of processes that executed together result in a positive business outcome.

IT Services

• A set of processes for which the IT department is accountable that results in a positive business outcome. For example: Application development service.
• An IT Service is a type of Service.
• An IT Service belongs to a single IT Service Category.
• To reach level 2, IT services must be well defined – this means a Service Definition is required.

IT Service Definition

• A Service Definition must therefore capture the information about business outcomes, IT activities, service users, and general information:
  • General Information: service name and service type.
  • Service Users: service users and procedures for requesting service.
  • Business Outcomes: deliverables that improve the services requestor’s state.
  • IT Activities: steps in the processes that deliver the service including identification roles involved and supporting technologies used.

Construct an IT service catalog

Defining an IT service catalog is a significant undertaking; do it properly by following Info-Tech’s Build a User-Facing Service Catalogue blueprint.

Service Catalog Value

• Prerequisite for Level 2 and 3 Service-Based Costing and all associated value.
• Ensure your services are customer-focused – Higher client satisfaction.
• Customize service levels to meet different client needs – Provide the right level of service at an efficient cost.
• Increase process standardization – Increased IT efficiency.
  • Consider procuring software that will assist in developing and defining a service catalog.
  • Consider contracting a consulting firm to assist in developing a service catalog.

Ensure Service Definitions are Consistent with Common Industry Practices

• Service definitions may be standardized within a given industry.
• These definitions may be based on generally available frameworks such as ITIL.
• If you define your services substantively different than standard, you will undermine your ability to benchmark.
• Benchmarks will be unavailable for services that are not frequently defined.
• You need to ask “how important is benchmarking to us?”
• If benchmarking is important, define your services similarly to industry standards.

Inconsistent definitions make comparison impossible.

Organization A defines email service as including email provisioning and support. Determines email service costs $300.00/user.

Industry standard defines email service as excluding support. Support is an activity of help desk service. Benchmark indicates email service costs $275.00/user.

External services may be defined differently than internal services

If an IT department provides a service both internally and externally, then there are two possible scenarios.

The services are reasonably similar and should have very similar costs.

• The service-based costs should be evaluated together.
• Simply define one service, e.g. help desk service.
• This service would be defined in your service catalog.
• In the “Users” section, input both external users and internal users.

The services are different and may have different costs.

• The service-based costs should be evaluated separately.
• You would define two services, e.g. internal help desk service and external help desk service.
• Both services would be defined in your service catalog.
• The “Users” section of the internal service would only list internal users and vice versa.
• Service-based costing would be done separately for each service, though likely with many shared resources that will need to be untangled with allocation.

Info-Tech Insight

In both cases, services should be focused on the end client ordering the service and benefiting from the final output from the service, regardless as to whether the client is internal or external.

Case Study: Incomplete service category definition can cripple service-based costing

Oil and Gas Mining Company

Employee Count: 40,000+

Situation

• The organization believed that some IT services were uncompetitive, but had no way to confirm its suspicion.
• It had a low service-based costing maturity and wanted to improve transparency into IT costs.
• A service catalog had been started, but it was incomplete and of low quality.

Action

• They began a service-based costing effort to improve the understanding of their costs.
• The first steps taken by the organization were to purchase two software packages:
  • IT financial management platform focused on service-based costing and technology business management.
  • IT services catalog management.

Result

• They failed to properly use the new software to define their IT services catalog which resulted in poorly defined IT services.
• Two years after purchase, their IT service catalog was unfinished.
• This significantly delayed service-based costing effort; could not proceed without service catalog.
• They still do not understand costs at a service level.
• To date, achieved a negative return on investment on both software platforms.

Exercise: Target a service

What you will need

• Whiteboard
• Markers
• Sticky notes

Objective: Identify the IT service your service-based costing analysis will focus on.

Instructions:

1. Review the services included within the selected service category.
2. Using red sticky notes, write several IT cost transparency concerns that correspond to each of the services within the service category.
3. Place sticky notes on whiteboard next to corresponding service.
4. Open discussion: identify benefits of addressing each service.
5. Open discussion: come to consensus on a service to analyze for the remainder of the workshop.

Exercise: Describe the service in detail

What you will need

• Whiteboard
• Markers

Objective: Describe the service chosen for analysis.

Questions:

1. Recap: what is the service name and category?
2. What are the key service outputs? Who is accountable for them?
3. Who are the authorized clients?
4. What are the service delivery processes?
5. Who executes the service delivery processes?
6. What is the SLA at a high level?

Section 3: Summary

Key Messages

• In order to determine the cost of a service category, a comprehensive list of all services within that category is required.
• However, defining a complete service catalog is overkill unless a full-scale service-based costing initiative is planned.
• A service definition should include a high-level SLA, service users, service owners, and a description of the value delivery process.
• Align your service catalog with common industry practices to enable benchmarking of your service costs.
• Understanding the makeup of your services and how they interact with one another is key to establishing accurate costing.

What You Achieved in this Section

• Service category targeted.
• Service category defined.
• Service targeted.
• Service defined.

Deliverables Created

• A clear definition of the targeted service category.
• A clear definition of the targeted service.

Module 4: Develop an Allocation Methodology

Sections:

Make the Case

Assess Your SBC Need and Maturity

Target Service Category and Service

Develop an Allocation Methodology

• What's in this Section:
  • Understand the Allocation Process
  • Define Allocation Methodology
  • Document Allocation Methodology

Determine Costs

Use SBC to Drive Business Value

Section 4: Develop an allocation methodology

Insight

• Use a top-down approach to simplify SBC analysis and minimize the amount and complexity of data collection.
• Do only what you need. Avoid complex allocation methods that necessitate tracking additional data unless the additional accuracy provided is absolutely critical.
• Documenting your SBC model will help to bring transparency, authority, and acceptance of your model.
• Keep it current! And keep a written history of all of your SBC decisions and the rationale behind them.
• Communicate all changes early and simply; nobody likes surprises on their IT bill.

What You Will Achieve in this Section

• Allocation process will be understood.
• Allocation methodology will be defined.
• Allocation Methodology will be documented.

Deliverables

• Cost model with defined allocation methodology.
• Documentation template outlining allocation methodology and rationale.

Approach service-based costing from top or bottom

There are two approaches to determine the costs of a service: top down and bottom up.

Top down

Start with the general ledger and allocate costs down until IT service costs are identified.

Bottom up

Start with configuration items, and allocate costs up until IT service costs are identified.

Use the top-down method

Level 2 SBC covers allocation to services and cross service-allocation

Top top-down approach to SBC

Step 1: Allocate General Ledger to Service Categories

• Covered in this workshop – For one service and one service category

Step 2: Allocate Service Category Cost Pool to IT Services

• Covered in this workshop – For one service and one service category

Step 3: Account for Service-to-Service Consumption

• Not covered in this workshop

First, allocate from general ledger costs to the service category

Recall: Cost Allocation at Level 1

• For SBC purposes, cost allocation is defined as “moving costs from one cost pool to another.”
• For level one service-based costing, we are using allocation to break down general ledger cost pools into cost pools at the service category level. See the below example.

Total amount allocated to service categories equals the general ledger cost pool. Therefore, every dollar has been allocated.

Second, allocate service category costs to the service

Cost Allocation at Step 2

• Second, we use allocation to break down service category cost pools into service cost pools.
• Consider this example, where the communication and collaboration service category cost pool is allocated to: Email, Instant Messaging, Telecommunications, and Collaboration Portal.

Total amount allocated to IT services equals the service category cost pool. Therefore, every dollar has been allocated.

The allocation process starts with the general ledger

Obtain the General Ledger

• Obtain the IT sub-ledger of the General Ledger from Finance personnel.
• Your direct reports may already have budget-cost variance reports from Finance that can be compiled to provide equivalent information, if the GL is unavailable.

Confirm Recency

• IT departments change quickly; avoid using out-of-date data.
• General ledger should be no more than one year old; six months-to-date is preferable.

Confirm Comprehensiveness

• Capital expenditures should be excluded, but depreciation should be included. Operating expense charts that do not include depreciation should be avoided or updated.
• It is beneficial to have notes available on specific expense accounts. Extraordinary, non-recurring expenses will be excluded, so having the information to identify those amounts is essential.

Info-Tech Insight

When you receive the general ledger, make sure it includes depreciation as part of the operating costs. It is a recurring expense, and failure to account for it will result in understating service or service category costs.

Determine what type of cost each general ledger line item is: this will determine the allocation method used

Direct Costs

Allocation Required: No

Attribution Accuracy: High

• Are incurred entirely to support this, and only this, service category.
• They are not derived from allocation.
• Characterized by a high degree of accuracy.

Shared Costs

Allocation Required: Yes

Attribution Accuracy: Mid

• Are incurred to support this and other service categories.
• Allocation is required.
• Accuracy dependent on allocation methodology.

Overhead Costs

Allocation Required: Yes

Attribution Accuracy: Low

• Are incurred to support this and all other service categories.
• Allocation is required.
• Characterized by a low degree of accuracy.

Select appropriate allocation methods for indirect and overhead costs

There are five different allocation methods:

Even Spread Allocation

• Allocates expenses evenly across all relevant cost pools.
• For example, $100K of a server expense is allocated equally across 5 service categories at $20K each.

Cost Rate Allocation

• Allocates expenses proportionately based on the known costs of a service.
• For example, Service 1 has known costs of $1M and service 2 has known costs of $2M. The $100K server expense is allocated 33% to service 1 and 66% to service 2.

Assigned Percentage Allocation

• Allocates expenses according to a predetermined, predefined, or standardized percentage.
• For example, $100K of a server expense is allocated at 30% to service 1 and 70% to service 2.

Single-Driver Activity-Based Costing (ABC) Allocation

• Allocates expenses based on consumption of a single cost driver.
• $20K of a $100K server expense is allocated to a service that consumed 1/5 of virtual servers.

Multi-Driver ABC Allocation

• Allocates expenses based on the consumption of multiple cost drivers.
• A server expense is allocated based on consumption of compute, storage, and network resources.

*See appendix for additional information on allocation methods.

Select an appropriate allocation method for each indirect and overhead cost

Method 1: Even Spread Allocation

Strengths:

• Easy implementation

Weaknesses:

• Fails to distribute costs based on actual use.
• Ease-of-Use Score: how easy the allocation method is to execute – determined by need for data. Ten is the easiest to use.
• Accuracy Score: how accurate the allocation method is. Ten is the most accurate.

Info-Tech Ease-of-Use Score: 9/10

Info-Tech Accuracy Score: 1/10

Method 2: Cost Rate Allocation

Strengths:

• Easy implementation.
• Individual IT service cost as a percentage of total IT service cost remains constant, which is desirable in some circumstances.
• Can provide satisfactory accuracy in some circumstances.

Weaknesses:

• Fails to distribute costs based on actual use.

Info-Tech Ease-of-Use Score: 8/10

Info-Tech Accuracy Score: 3/10

Method 3: Assigned Percentage Allocation

Strengths:

• Leverage internal knowledge to produce an accurate allocation.
• High degree of flexibility.

Weaknesses:

• Expertise and knowledge required may not exist.
• Allocation often viewed as unfair.
• Low confidence in numbers can undermine use of model.

Info-Tech Ease-of-Use Score: 8/10

Info-Tech Accuracy Score: 4/10

Select an appropriate allocation method for each indirect and overhead cost (continued)

Method 4: Single-Driver Activity-Based Allocation

Strengths:

• Accurate allocation of costs.
• Creates cost reduction transparency.

Weaknesses:

• Data may be unavailable.
• Data may be expensive to collect.
• Selected cost driver may not be sole driver of expense.

Info-Tech Ease-of-Use Score: 4/10

Info-Tech Accuracy Score: 8/10

Method 5: Multi-Driver Activity-Based Allocation

Strengths:

• High degree of accuracy.
• Highly defensible.

Weaknesses:

• High complexity.
• Enormous data collection.
• Potential for allocation “infinite loops.”

Info-Tech Ease-of-Use Score: 2/10

Info-Tech Accuracy Score: 9/10

Combining Allocation Methods

Combining allocations methods may allow for higher accuracy, but can increase complexity.

For example, a portion of server expense may be known to be the result of a server breakdown that is directly used by application services only.

The organization may chose to treat the known portion as a direct cost and attribute the dollar value of the maintenance expense for that server.

Then, the remaining allocation expense can be allocated using one of these five methods.

While these combinations may be practical at times, they can also add a lot of complexity to your model. Use sparingly.

Use the Info-Tech Allocation Decision Tree to select an appropriate allocation method for indirect and overhead costs

Exercise: Define your allocation methodology

What you will need

• Projector
• Info-Tech’s Service-Based Cost Model Tool

Objective: Define an appropriate allocation methodology for a subset of general ledger line items.

Instructions:

1. Select five general ledger items that we will focus are analysis on.

For each general ledger item:

2. Specify importance.
3. Brainstorm cost drivers, and discuss data availability.
4. Brainstorm other factors that may affect allocation decision.
5. Use the decision tree to select an allocation method.

Don’t let the service-based costing model become a “black box”

The service-based costing model is complex and has a large number of moving parts. Help others understand by using clear documentation and communication.

• Documenting the methods used to allocate general ledger costs is essential for ensuring that the process remains consistent.
• Articulating the rationale behind a chosen allocation method is also important; as the business changes, allocation methods may become obsolete, and stewards need to be able to identify a lack of fit.
• There will be a number of users of the model within IT and across the organization. Make sure all authorized users can access the current version of the model and all its supporting documentation:
  • Finance
  • IT – Individuals responsible for developing chargeback model.
  • IT – Individuals responsible for assessing service viability and outsourcing decisions.
  • IT – Individuals responsible for budgeting.

What to Document

• Service category definitions
• Service definitions
• General ledger version, date, and information
• Allocation methods used for each allocation Rationale behind allocation method choice
• Data source(s) and transformations for activity-based allocations
• Financial and service data availability, accuracy, limitations, and constraints

Establish a change management process to ensure service-based costing evolves smoothly

There are two phases to managing changes to the model.

Implement Change

• As the business evolves, there will be significant changes that necessitate changing a component of the model.
  • Consider this case: an insignificant cost was allocated via even spread method. The cost increases, necessitating more accurate allocation.
• When a change is made, it is critical to follow proper change management protocol, including review, approval, and documentation of the change. Include:
  • What the change was
  • Why it was made
  • Who approved the change

Communicate Change

• Make sure you inform all necessary users of the model:
  • The CIO will use the model to make spend optimization decisions and to communicate expenditures with finance.
  • IT managers and service owners will use the model to optimize their expenditures.
  • Financial analysts will use the model to understand how competitively IT is delivering services.
  • Business department heads will use the model to rationalize chargeback and showback.

Info-Tech Insight

While costs and allocation methodology will change, the basic allocation structure should not be radically altered. Significant changes to allocation structures could cause a loss of faith in the integrity of the SBC. Make sure the rationale behind the changes are communicated clearly.

Don’t let your service-based cost model become outdated

Your costs will change over time. Re-evaluate your service-based costs and allocations on an annual basis – or sooner, if these events occur:

Significant Growth

• If the organization experiences rapid growth, the demand for IT services will grow rapidly. This means the proportion of fixed costs as a percentage of the whole will decrease leading to a decrease in unit costs.

Outsourcing a Service

• The cost of delivering a service in-house does not approximate outsourcing costs. Furthermore, simply changing your unit costs to what the third party bills per unit is undercounting. You still need to allocate costs that are associated with managing the third party.

Eliminating a Service

• If a service is eliminated, the overhead and indirect costs that were previously allocated to the service must still be accounted for. This means they will be allocated to other services if they are not eliminated, increasing unit costs elsewhere.

Significant Service Modification

• Service modifications, such as automating a process that was previously done by a person (labor), can affect costing. Re-evaluate if service modification will affect cost to serve.

Exercise: Document your service-based costing model

What you will need

• Projector
• Info-Tech’s Service-Based Cost Model Documentation Template

Objective: Document your allocation methodology and rationale.

Instructions:

1. For each general ledger item, record the required data into the Service-Based Costing Model Documentation Template.

Section 4: Summary

Key Messages

• Use a top-down approach to simplify SBC analysis and minimize the amount and complexity of data collection.
• Do only what you need. Avoid complex allocation methods that necessitate tracking additional data unless the additional accuracy provided is absolutely critical.
• Documenting your SBC model will help to bring transparency, authority, and acceptance of your model.
• Keep it current! And keep a written history of all of your SBC decisions and the rationale behind them.
• Communicate all changes early and simply; nobody likes surprises on their IT bill.

What You Achieved in this Section

• Allocation process will be understood.
• Allocation methodology will be defined.
• Allocation methodology will be documented.

Deliverables Created

• Cost model with defined allocation methodology.
• Documentation template outlining allocation methodology and rationale.

Section 5: Determine Costs

Sections:

Make the Case

Make the Case

Assess Your SBC Need and Maturity

Target Service Category and Service

Develop an Allocation Methodology

Determine Costs

• What's in this Section:
  • Determine service category costs
  • Determine service costs
  • Ensure cost model meets needs

Use SBC to Drive Business Value

Section 5: Determine costs

Insight

• Determining service category costs can help to focus your attention on the categories of services that consume the greatest amount of IT spend.
• Determining service costs allows you to identify exactly how much is being spent on each service, providing a snapshot of IT competitiveness and strong insight into cost drivers.

What You Will Achieve in this Section

• Determine service category costs.
• Determine service costs.
• Ensure cost model meets needs.

Deliverables

• A breakdown of targeted service category costs.
• A breakdown of targeted service costs.
• A report on cost model accuracy and ease-of-use.

Exercise: Identify service category costs

What you will need

• Projector
• Info-Tech’s Service-Based Cost Model Tool

Objective: Identify the cost of your targeted IT service category.

Instructions:

1. For each general ledger item, input the required data into the Service-Based Cost Model Tool on the Allocate to Service Categories tab.
   • For direct costs, input the dollar value of the expense incurred by the service category.
   • For multi-driver ABC allocations and manually assigned percentages, input the percentage of the expense allocated to the service category.
   • For single-driver ABC allocations, input the cost driver consumption by the service category.

How to interpret results

Below is a sample output of your Service Category Output Tab

The lines in the Sub-Account column correspond to general ledger line items.

Given this company’s $10M IT budget, the hardware storage expense is extremely high for both application services and computing services.

The boldfaced line at the bottom contains the total costs of service categories.

The total costs of the Application Services category is $1,015,826.40

Exercise: Identify service costs

What you will need

• Projector
• Info-Tech’s Service-Based Cost Model Tool

Objective: Identify the cost of your targeted IT service.

Instructions:

1. For each general ledger item, input the required data into the Service-Based Cost Model Tool on the Allocate to Services tab.
   • For direct costs, input the dollar value of the expense incurred by the service.
   • For multi-driver ABC allocations and manually assigned percentages, input the percentage of the expense allocated to the service.
   • For single-driver ABC allocations, input the cost driver consumption by the service.

How to interpret results

Below is a sample output of your Cost of Services Base tab.

The Application Development column lines correspond to general ledger line itms.

• This company spent $2,500 on servers for Application Development.

The boldfaced line at the bottom contains the total costs of service categories.

• The total costs of the Call Recording Service is $271,611.10

Congratulations! You now know your costs

Step 1: Allocate General Ledger to Service Categories (Complete)

Step 2: Allocate Service Category Cost Pool to IT Services (Complete)

Step 3: Account for Service-to-Service Consumption

You can now view your service category costs using the Service-Based Costing Model Tool! Go to the Service Category Output and Cost of Services Base tabs.

Pay attention to:

• Services and service categories that have total expenses significantly higher than others.
• GL accounts that significantly increase all service categories and services.

Next steps:

• Leverage SBC to drive business value.
• Consider a future model that accounts for service-to-service consumption.

Progress:

• Service category costs are known.
• Service costs are known.

Use the Service Category Output and Cost of Services Base tabs on Info-Tech’s Service-Based Cost Model Tool.

Exercise: Ensure your cost model can meet your needs

What you will need

• Projector
• Info-Tech’s Service-Based Cost Model Tool

Objective: Ensure the model is accurate enough and easy to use enough to meet your needs.

Instructions:

1. View the Report Summary tab of the Service-Based Cost Model Tool.
2. Open discussion: how can accuracy be improved?
3. Open discussion: how can ease-of-use be maintained?
4. Open discussion: any changes that are expected in the near future?

Section 5: Summary

Key Messages

• Determining service category costs can help to focus your attention on the categories of services that consume the greatest amount of IT spend.
• Determining service costs allows you to identify exactly how much is being spent on each service, providing a snapshot of IT competitiveness and strong insight into cost drivers.

What You Achieved in this Section

• Determine service category costs.
• Determine service costs.
• Ensure cost model meets needs.

Deliverables Created

• A breakdown of targeted service category costs.
• A breakdown of targeted service costs.
• A report on cost model accuracy and ease-of-use.

Section 7: Use Service-Based Costing to Drive Business Value

Sections

Make the Case

Assess Your SBC Need and Maturity

Target Service Category and Service

Develop an Allocation Methodology

Determine Costs

Use SBC to Drive Business Value

• What's in this Section:
  • Use SBC for business accountability
  • Use SBC for decision making
  • Use SBC for budgeting
  • Use SBC to reduce your costs

Section 7: Use service-based costing to drive business value

Insight

• Many IT consumers are unaware of the costs they incur; exposing the cost can reduce unnecessary consumption.
• Understanding service utilization can help with capacity optimization; you’ll have the right balance of cost and flexibility.
• Knowing services costs allows better planning and budgeting; you can boil it down to unit cost X utilization.
• Properly costed IT services can be compared against industry and alternative delivery methods; there may be a less expensive way to provide users the services they rely upon.
• Outsourcing can improve the overall efficiency of you IT department, allowing you to focus on delivering services that provide a competitive and outsourcing commodities.

What You Will Achieve in this Section

• Business unit accountability will be established using SBC.
• Benchmarks will be obtained and validated.
• Business decision making using SBC will occur.
• Best practices for budgeting with SBC will be established.

Deliverables

• Service-Based Costing Presentation

Use service-based costing to increase business unit accountability

Exposing Costs To Promote Accountability

• Business units need to know how much their use of IT resources costs the organization before they can become responsible consumers.
• This means that you need to expose the costs of your IT services to business units.

Info-Tech Insight

When communicating IT costs to business units, emphasize that they are not being asked to reduce their consumption; the goal of IT is to help business units achieve their objectives. However, they also need to consume wisely and appropriately.

• In the absence of chargeback and showback IT can:
  • Provide business users with examples of when they should use a given service.
  • Provide them with examples of when they should not use a given service.
  • Provide them with alternatives to meet their needs. For example, before calling the help desk, clients should check company FAQs and common solutions stored in a knowledge management platform to find answers to their questions.

Use Unit Rates to Show Competitiveness

• Exposing IT costs also provides an opportunity to demonstrate competitiveness; apples-to-apples comparisons require service unit rates.
• Benchmarks can be used to demonstrate the competitiveness of IT services. Industry benchmarks are generally presented in the form of a unit rate.

Unit Rate

• A unit rate is the cost to produce a single unit of a service output. It is usually the average cost per unit that is used (although in some cases the marginal cost per unit may be more relevant).
  • For example, the unit rate for Email Service might be expressed in cost per email user. To calculate this you take:
    • Email Service Cost / Number of Email Users
  • Some services will cost more than the benchmark. For these services, emphasize service quality differences, complementary services, or other factors that affect your costs or provide extra value.
  • The use of benchmarks is assessed in more detail in Section 7.2: Use SBC to make better decisions.

Prepare for the next step in business unit accountability: chargeback or showback

Use Service-Based Costing as the Foundation

• Service-Based Costing is the foundation for building a chargeback or showback model. Creating such a model, however, necessitates an additional layer of allocation:
• It is necessary to allocate service costs to business units based on their consumption.

Cost Pools

General ledger

• Service-Based Costing
  • General ledger cost pools have been allocated to services.

Services

• Service-Based Costing
  • General ledger cost pools have been allocated to services.

Business Units

• Chargeback/Showback
  • Service cost pools need to be allocated to business units.

Determine which model is right for you: chargeback or showback

Showback Model

• Business units are presented with the cost of their IT consumption.
• Improves business unit accountability –business units are able to identify how much their consumption is costing the organization.
• Motivates responsible consumption – can reduce unnecessary consumption of an expensive service.
• Does not provide a vehicle for cost recovery; IT remains a cost center to the business.

Chargeback Model

• Business units pay for IT consumption.
• Improves business unit accountability.
• Motivates responsible consumption.
• Cost recovery – IT becomes a break-even center since business units will effectively pay for the IT services that they use.

Info-Tech Insight

Do not implement a chargeback model based on Level 1 service-based costing as the accuracy is too low and costing model too unsophisticated to be durable over time. Chargeback models are “sticky” and difficult to change once made public. Avoid implementing chargeback until Level 2 SBC is achieved.

Use service-based costing to make better decisions

Business decisions derived from SBC primarily drive cost reduction. There are three methods for identifying cost reduction candidates:

Method 1: Benchmarking

If a service is significantly more costly than benchmarked prices, it may be a target for cost reduction – via service streamlining or outsourcing.

Method 2: Outliers

If benchmarks are unavailable, focus on IT Services that seem to consume a disproportionate amount of resources.

For example, a service that is used by only 1% of business users may be consuming 5% of the IT budget. If the service is not absolutely necessary for the business users, it is likely a candidate for service elimination.

Method 3: Perceived Low Value

When you expose your costs to business units, ask business units if they would be willing to pay that amount for the service.

This can occur without actual showback or chargeback.

If business units say “no,” the “business unit market” has determined the cost of the service is greater than its value to the business.

Info-Tech Insight

When making big decisions, use all three methods in concert. Often, a service cost that is above industry benchmarks will be discovered. If the service is a core offering, don’t jump the gun; compare the cost to serve against other services and investigate perceived value.

Obtain benchmark data to compare your costs

Obtaining valid, industry-specific benchmarks isn’t easy. Use these data sources to obtain them.

Data Source 1: Use Info-Tech’s Measure IT

• Info-Tech’s MeasureIT is a custom benchmarking initiative with more than 12,000 data points!
• The Budget Metrics and Benchmarking Tool shows an overview of capital and operating expenditures and spend in specific areas as a percentage of sales.
• The Staffing Metrics and Benchmarking Tool shows direct labor time spend on services.
• MeasureIT will not provide you with everything you need for granular service-based costing breakdowns, but it is an excellent starting place.
• Does not provide a vehicle of cost recovery; IT is still a loss center.

Data Source 2: Consulting firms

• Often, consulting firms and industry research houses compile benchmarks.
• Reach out to firms you have a relationship with and ask if they can help.

Data Source 3: IT Financial Management Solutions

• IT financial management solutions, such as Nicus, Apptio, and ComSci, provide benchmarks.
• While it is certainly not worth procuring a solution for the benchmarks alone, if you are procuring a solution, make sure you take advantage of the benchmarks.

Validate benchmarks to ensure reliability

If the benchmarks are going to drive decisions, then you need to dig deeper. Make sure your benchmarks are valid.

Organization Using Benchmark – Sample Facts

Industry: Auto Manufacturing - Last Fiscal Year Revenue: $100,000,000

Benchmark Checklist:

• Benchmarks should meet all five (5) criteria
• The data is less than two years old. Things change quickly in IT; the effect of increasing cloud-based services has drastically changed service costs.
• The data has an N count above 200. Low N counts make data statistically insignificant. If no N count is provided, assume invalidity.
• Benchmark source is impartial. Make sure the source is unbiased.
• Benchmark is applicable to the same industry as the organization using the benchmark.
• Benchmark is applicable to organizations of a similar size.

Benchmark Example

• Benchmark: Cost per ticket for help desk: $50.46
• Data dated April 2014.✓
• N Count: 312 ✓
• Source: Help desk solution vendor X
• Industry: Pharmaceuticals X
• Revenue: $10M–$50M X
• Benchmark is invalid

Do not jump to conclusions; your IT department is not a statistic

Caution

An organization finds that managed internet costs $800 per user per year, and a valid benchmark indicates that $700 per user per year is the average. This does not necessarily imply inefficiency. Certain factors can explain variance.

Service-Level Explains Benchmark Variance:

• Providing a higher service-level will result in higher costs.

Sourcing Strategy Explains Benchmark Variance:

• Dealing with premium suppliers, whether they are software, hardware, or services vendors, will result in higher costs.

Geography Can Explain Benchmark Variance:

• Operating in a high GDP per capita country with high minimum wages and an educated workforce will result in higher costs.

Other Factors Can Explain Benchmark Variance:

• Additional security costs, recent merger, and temporary inefficiencies caused by technology changes are other reasons costs may be higher.

Use service-based costing for budgeting

There are two ways that SBC can be useful for budgeting

Use Service-Based Costing for Cost Projection

• The simple method is to use unit rates to approximate cost increases: If your Email Service costs $100,000, and you have 400 users, then it costs $250 per user.
• Then, if 100 new users will be supported next year, your costs will increase by $25,000.
• This generally provides a better approximation than “increase it by about 5%.”
• However, some additional work is required to leverage service-based costing for projecting costs with the highest degree of accuracy.
• Stratify your service level costs into “fixed,” “variable,” and “stepped” portions.
  • Fixed: Remain constant.
  • Variable: Increase directly as a cost driver increases.
  • Stepped: Remain constant up to a point, but increase after a threshold is reached. You can then use this information to project costs.

Use Service-Based Costing to Defend the Budget

• Often, CIOs face downward budgetary pressure.
• “I think this can be reduced by 10%” – CFO.
• Use benchmarks to defend your budget:
  • If unit rates are comparable to industry benchmarks, then this demonstrates that your budget projection is reasonable.
  • Benchmarks can also be used to validate a budget increase; if unit rates are significantly below industry benchmarks, then perhaps spending more is justified.
  • Benchmarks are especially useful for defending line items often not understood by business units – virtualization expenses, for example.
• Note that just because your benchmarks are above industry averages doesn’t mean benchmarks can’t be used. Emphasize the factors that account for your costs being higher – geography, service level, etc.

Use SBC to reduce your costs

Capacity Management

Having the right amount of capacity is critical for service and cost efficiency. Overprovisioning and over specification is common practice in IT due to the propensity for risk aversion. Plan to have enough capacity to meet expected demand, but don’t buy excess capacity or you will end up with unnecessary waste.

Outsourcing

If a service you are providing costs more than it does if you were to buy it from a service provider, ensure that there is good justification to do so, i.e. the service provides a competitive advantage. If you’re paying more to keep a commodity service internal, it’s time to consider outsourcing.

Elimination

Services that are used infrequently, by few people, are easily substitutable, or provide little value are prime candidates for elimination. Don’t fall into the trap of providing a service just because it’s always been there. However, some costs of a service are already committed to and need to be reallocated to other services when a service is retired.

Reduce costs through increased capacity utilization

Effect of Unused Capacity:

• Low capacity utilization inflates your cost to serve as a unit rate.
• There are fixed expenses that are incurred whether or not you use all available capacity. These expenses are allocated to services.
• Increasing your utilized capacity by serving more customers without procuring more assets, will spread the fixed costs over more service delivery units.

What to Do:

• As demand increases, additional capacity will be needed. However:
  • Stop buying to meet peak demand.
  • Instead, buy for the expected level of demand (with a small buffer).
  • Consider using cloud services to manage unexpected overages.
    • This requires that a contract and load shifting strategy be in place with a cloud vendor if a sudden spike in demand occurs.

Info-Tech Insight

Capacity utilization only drives service cost reduction up to a point. Often, when extremely high capacity utilization is reached, costs will increase due to inefficiencies managing the capacity. An insufficient buffer drives costs up.

Case Study: Increasing IT capacity utilization

US Healthcare Provider

Employee Count: 10,000+

The last straw: Capacity utilization below 20% of key IT assets

Situation

• Changing regulations forces a US healthcare provider to alter its operations in order to provide a higher standard of care and increase documentation of doctor-patient interaction.
• The changes resulted in operational inefficiencies and higher costs of care.
• These costs were passed on to patients, and patients began to seek care at less expensive healthcare providers.

Solution

• A full service-based costing analysis uncovered the true costs of all services, including IT functions.
• The costing model also captured the true capacity utilizations of IT resources by accounting for how those resources were used across all services; some key assets were found to be below 20% utilization.

Result

• The results allowed them to identify underutilized resources, minimize unused resources, and redeploy excess capacity to reduce bottlenecks, resulting in:
  • A 40% reduction in application development cycle time.
  • $10 million cost savings in improved IT infrastructure management.
  • Improved relationships and collaboration between IT and business units.

Reduce costs through outsourcing if certain criteria are met

If outsourcing is cheaper, then it must be considered. However:

Don’t Sacrifice Competitive Advantage

• A mortgage lender might be able to outsource loan request filing. But if internal IT has proprietary methods that achieve better results, then it may not be a good idea.

Don’t Sacrifice Service Level

• If an organization has a low data entry error rate, which is essential to the business, then the third party must match the level of service.

Don’t Sacrifice Security

• Do you deal with sensitive financial information? If so, maybe the third party doesn’t adhere to sufficient security standards. Check to make sure they meet necessary requirements and regulations.

Don’t Sacrifice Flexibility

• Outsourcing can be inflexible. Contracts may have punitive exit clauses that make it difficult to end the business relationship.

Info-Tech Insight

People may resist outsourcing, and for good reason; it isn’t easy. However, outsourcing can drive enormous value. Recognize that outsourcing can improve the overall efficiency of your IT department, allowing you to focus on delivering services that provide your business with competitive advantage.

Case Study: Lack of cost transparency leads IT outsourcing in banking

Situation

• In the late 1990s, banks were investing heavily into IT infrastructure and systems. However, how this investment transformed into business value was unclear and there was suspicion that funding was being used inefficiently.
• As a result of IT departments’ inability to meter IT usage, show full service costs, and allocate costs to business, significant parts of IT were outsourced.

Deutsche Bank Solution

• Deutsche Bank launched a cost transparency project to evaluate the cost of IT services. The initiative focused on costing the activities performed at computer centers in continental Europe. The findings resulted in the outsourcing of computer center management to IBM and allowed Deutsche Bank to have transparent rate-based costs for the IT services they needed.

Deutsche Bank Result

• Deutsche Bank was able to pass on rate-based charges to business units directly.
• Increased service level: the e-business and on-demand technology provided by IBM was more flexible than Deutsche Bank’s internal offering.
• Deutsche Bank expects to realize $1 billion in cost savings over the first ten years of the agreement.

ABN AMRO Solution

• ABN AMRO launched an analysis of their IT services. They concluded that 1) costs were very high, 2) there was poor transparency of how costs were allocated to business services, and 3) IT services represented certain risks to the business. ABN AMBRO negotiated an outsourcing contract with Electronic Data Systems (EDS) to provide technology services and application development.

ABN AMRO Result

• Transparency of IT spend and business value improved.
• Performance metrics became more available.
• Cost savings increased.
• IT governance improved.

Reduce costs through service elimination

Eliminating a service completely is one way to reduce costs. Beware, not all costs can be eliminated.

Not All Costs Are Eliminated

• Just because an IT-provided application is eliminated, does not mean the fixed costs that were attributed to it are eliminated.
• This means these costs need to be allocated elsewhere. They are not truly eliminated.
• The result: the cost of other services increases.
• In the event of chargeback, business units will resent the change.
• Make sure you analyze what costs can actually be cut and how the remaining costs will affect the costs of other services.
• This type of what-if analysis is essential to decision making.

Example

• A small IT shop at a consumer packaged goods company was supporting both Box and Dropbox for file sharing.
• They decide to stop supporting Box.
• An IT manager previously had 30% of his salary allocated to Box. The manager is still employed.
• 15% of rent expense was previously allocated to Box.
• The expenses need to be allocated elsewhere. The cost of other services will increase by the proportion of 30% of the manager’s salary and 15% of the rent expense that is allocated to them.
• However, the organization still benefits from cost reduction.
  • For example, direct labor employees who supported Box can be reduced.

Info-Tech Insight

Service elimination can increase the proportion of costs that are not directly attributable. This may result in a new allocation methodology; a cost that was insignificant enough to be allocated via cost rate allocation may now require ABC allocation.

Exercise: Use SBC for decision making

What you will need

• Projector
• Info-Tech’s Service-Based Cost Model Tool

Objective: Demonstrate using the Service-Based Cost Model Tool for “what-if” analysis.

Instructions:

1. Open discussion: What is a possible cost saving scenario? Use the previous slides to identify one.
2. Reduce general ledger by the amount of savings.
3. Adjust allocation methodology.
4. View new cost of service category and cost of service.

Section 7: Summary

Key Messages

• When exposing costs, the goal is not to get business units to reduce consumption; the goal is to reduce unnecessary consumption.
• Do not implement a chargeback model based on Level 1 service-based costing. Business units will resist pricing changes. Prices will change significantly as maturity increases and service-to-service consumption is accounted for.
• Capacity utilization only drives service cost reduction up to a point. Often, extremely high capacity creates inefficiencies managing the capacity. An insufficient “buffer” drives costs up.
• Outsourcing can improve the overall efficiency of your IT department, allowing you to focus on delivering services that you have a comparative advantage in.

What You Will Achieve in this Section

• Business unit accountability will be established using SBC.
• Benchmarks will be obtained and validated.
• Business decision-making using SBC will occur.
• Best practices for budgeting with SBC will be established.

Deliverables Created

Workshop Summary: here’s what we accomplished in the last two days

• Defined SBC.
• Discussed benefits of SBC for your organization.
• Selected metrics to measure SBC success.
• Measured SBC maturity and need.
• Discussed SBC process and concepts.
• Targeted and defined one service category.
• Targeted and defined one service.
• Discussed the need for data and data availability.
• Developed an allocation methodology.
• Documented an allocation methodology.
• Determined service category costs.
• Determined service costs.
• Discussed using SBC to drive business decisions.
• Measured SBC accuracy and ease-of-use.
• Discussed next steps.