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Establish a Service-Based Costing Model

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

    • 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.

    Our Advice

    Critical Insight

    • 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.
    • Service-based costing is not for everyone. It requires clearly defined goals and commitment to be successful.
    • 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.
    • Nobody trusts a “black box.” Be transparent with results.

    Impact and Result

    • 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.

    Establish a Service-Based Costing Model Research & Tools

    1. Make the case

    Recognize the importance of service-based costing.

    2. Assess service-based costing need and maturity

    Use the Service Based Costing Maturity Model to recognize your current level of capability as well as where you need to be to meet the needs of your organization.

    3. Establish a Level 1 service-based costing model

    Use Level 1 to help you get results quickly without having to transform all of IT to a service-based delivery model.

    4. Establish a Level 2 service-based costing model

    Enhance your Level 1 capability by evolving from categories of services to individual services to reach a level of service cost accuracy sufficient for benchmarking against industry.

    5. Establish a Level 3 service-based costing model

    Once you are fully committed to service-based costing, it is time to bring in sophisticated software and skills to take your service-based costing to the next level.

    6. Document and maintain the service-based costing model

    Maintain the service-based costing model over time to reflect both changes in cost structures and in the nature of the business; follow a proper change management process and keep the documentation up to date.

    7. Use service-based costing to drive business value

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


    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 guided implementation 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

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

    About Info-Tech

    Info-Tech Research Group is the world’s fastest-growing information technology research and advisory company, proudly serving over 30,000 IT professionals.

    We produce unbiased and highly relevant research to help CIOs and IT leaders make strategic, timely, and well-informed decisions. We partner closely with IT teams to provide everything they need, from actionable tools to analyst guidance, ensuring they deliver measurable results for their organizations.

    What Is a Blueprint?

    A blueprint is designed to be a roadmap, containing a methodology and the tools and templates you need to solve your IT problems.

    Each blueprint can be accompanied by a Guided Implementation that provides you access to our world-class analysts to help you get through the project.

    Need Extra Help?
    Speak With An Analyst

    Get the help you need in this 1-phase advisory process. You'll receive 5 touchpoints with our researchers, all included in your membership.

    • Call 1: Assess 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 and the needs of your organization.

    • Call 2: 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 transforming all of IT to a service-based delivery model.

    • Call 3: Establish a Level 2 service-based costing model

      Be fulsome: Enhance your Level 1 capability by evolving from categories of services to individual services and accounting for service-to-service consumption.

    • Call 4: 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.

    • Call 5: Use service-based costing to drive business value

      Show management how to drive value from service-based costing: enhance business decision making, increase service use accountability, and improve cost forecasting.

    Authors

    David Yackness

    Josh Mendelssohn

    Contributors

    • Robert Mischianti, Vice President Product Development, Nicus Software
    • Paul Lewis, Chief Technology Officer, Hitachi Data Systems
    • Michael Davison, Converged Infrastructure Specialist, Hitachi Data Systems
    • Jeff Yoder, Vice President, Strategic Partnerships, Global Marketing Strategies, ComSci by Upland
    • Chris Pick, CMO, Apptio, and President, Technology Business Management Council

    Search Code: 58881
    Last Revised: September 5, 2014

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