WHITE PAPER: IT FINANCIAL MANAGEMENT AND COST RECOVERY IT…

WHITE PAPER: IT FINANCIAL MANAGEMENT AND COST RECOVERY




IT Financial Management
and Cost Recovery
JULY 2008




Patricia Genetin
CA T EC H N I CA L SA L E S


David Messineo
CA S E RV I C E S
Table of Contents

Executive Summary                                                                             SECTION 4: CONCLUSIONS                                                            9

SECTION 1: CHALLENGE                                                              2           SECTION 5: ABOUT THE AUTHORS                                                      9
The Daunting Process of Implementing an IT
Financial Management and Cost Recovery
System
The Deceptive "Simplicity" of Total Cost of
Ownership
Internal IT Charges May Seem Uncontrollable
Establishing Meanings for Cost Drivers and
Units of Measure
Resources are Limited
Is IT Still a Cost Center?
The Good Governance Mandate

SECTION 2: OPPORTUNITY                                                            4
The Winning Formula: Driving Economical
Behavior
Simply and Fairly Charging for Services is
Possible
Building the Cost Recovery System

SECTION 3: BENEFITS                                                               8
Improving Economic Decisions with Cost
Recovery Processes
Simplify Cost Allocations
Improve Visibility into Cost Structures
Optimize Resource Management




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Executive Summary
Challenge
 Understanding IT costs and effectively applying IT chargeback and cost recovery methods
 tends to be daunting from both the practical and organizational standpoints. Many IT
 organizations lack the formal policies and procedures required to understand the true cost
 of an asset or service, and in many cases, are not given the budgets to do so due to limited
 resources. However, as good governance initiatives promote tighter financial responsibility
 and IT transforms into a customer-focused service provider, the need for better
 consideration of the factors driving technology decisions and formal cost recovery
 methodologies continues to grow.



Opportunity
 IT Financial Management processes make it possible to fairly allocate costs for IT services
 and gain information for assessing options, managing consumption and perceiving the true
 value of IT. Building awareness within the areas of portfolio, vendor and resource management
 results in opportunities for financial optimization and helps build cost recovery processes
 that help IT make cost-effective decisions. Pairing this awareness with formal recovery
 methodologies in a cost recovery platform enables governance and accountability, and
 provides a choice of options for insight into costs, contracts and usage, allowing an IT
 organization to gain an understanding of the factors needed to drive economical preferences.



Benefits
 Developing a concrete, comprehensive IT financial management process provides
 organizations with insight into how IT's service portfolio, vendor relations and resource
 allocations will influence the cost structure as a whole. Incorporating this knowledge into a
 formal cost recovery plan allows IT to play an integral role in improving financial management
 and fostering economical use of technology resources, helping the organization simplify
 cost allocations, improve visibility into cost structures and optimize resource management.
 Doing so provides a greater understanding of accumulated costs per service, the influence
 of third-party agreements on procurement plans and the best way to balance supply
 and demand.




                                                       IT FINANCIAL MANAGEMENT AND COST RECOVERY 1
                                     SECTION 1

                                     The Daunting Process of Implementing an IT Financial
                                     Management and Cost Recovery System
                                     The Deceptive "Simplicity" of Total Cost of Ownership
                                     Several years ago, the Gartner Group introduced the concept of total cost of ownership (TCO)
                                     to illustrate how an asset's contractual costs were not always representative of its true costs.
                                     Because a given asset could be configured in different ways -- and therefore carry different
                                     workloads -- the varying combinations led to the possibility of a wide range of potential costs.
                                     Many organizations supported this analysis and implemented procedures attempting to
                                     capture an asset's true cost in order to derive a clear view of TCO.

                                     Calculating return on investment (ROI), a related financial indicator, can be even more
                                     cumbersome when you consider that predicting returns often includes a large component of
                                     estimation. While ROI is a widely accepted standard and can be a very good indicator of the
                                     true value of a project, there's a tendency to ignore the costs required for changes beyond
                                     immediate implementation.

                                     Internal IT Charges May Seem Uncontrollable
                                     As infrastructure costs and environmental concerns continue to escalate, new policies and
                                     procedures are required for analysis and control, reuse and disposal and replacement and
                                     migration of technology. Meanwhile, executive management no longer assumes that all IT
                                     investments will result in a financial windfall and often forgo innovation and technological
                                     advancement opportunities in favor of IT's daily, core activities.

                                     Though management may consider IT costs to be uncontrollable, IT cost recovery is often
                                     avoided, as even an utterance of the word "chargeback" elicits thoughts of disputes and
                                     mistrust. Yet, without properly charging for IT resources and services, organizations won't
                                     receive the critical information they need to properly assess options, manage consumption or
                                     understand the business value of IT. Therefore, IT cost recovery is an imperative IT/business
                                     dialogue because it encourages conversation and provides visibility to the key drivers of cost
                                     and value.

                                     Establishing Meanings for Cost Drivers and Units of Measure
                                     Perhaps the most challenging issue IT must deal with when developing a cost recovery model
                                     is the process of identifying and establishing appropriate measures. Certainly, measures are
                                     necessary. But, what makes a measure appropriate? Consider the SMART acronym that's
                                     frequently used when setting objectives -- units of measure should be specific, measurable,
                                     relevant and timely.




2 IT FINANCIAL MANAGEMENT AND COST RECOVERY
Also consider that some measures have different meanings based on context. Varying
interpretations are driven by timing, roles, responsibilities, comparisons, inferences, perceived
alternatives and a myriad of other factors. IT must clarify contextual differences by:
· Identifying the factors that drive costs
· Establishing control over how metrics are identified and collected
· Defining specific policy and rules around the aggregation and presentation of metrics
· Explaining how measures are calculated and why

A primary reason that service level management has become a priority discipline for IT is
that service level agreements (SLAs) attempt to coordinate and confirm communication about
what's required from IT, and at what cost and quality. It's critical that IT understand the needs
of the business and the influence of the various service levels required to support those needs.
Likewise, the business must understand and rely on what IT can provide; measurements must
be specifically identified so they can be monitored to automatically raise alerts when
performance or availability degrades to warning levels.

Resources are Limited
IT is often instructed to do more with less, while continuing to adequately protect its assets
and improve service. If resources were unlimited, IT could certainly -- and constantly --
provide the highest level of service possible. However, funds are limited, making tradeoffs
an inherent part of the process.

Economists define cost in terms of opportunities that are sacrificed when a choice is made.
Conversely, benefits are sometimes quantified as costs avoided. When making tradeoff
decisions, it's critical for organizations to understand that IT exists to support business
objectives, and as such, optimal investment and operational decisions demand collaboration
between IT and the business it supports.

Is IT Still a Cost Center?
It's been generally accepted that IT operates as a cost center that makes only indirect
contributions to revenue. Even though management relies on IT as a strategic asset, the
historical focus was primarily on back-office efficiency gains. However, IT has become a crucial
mechanism through which an organization's activities with its customers, suppliers, partners
and other key resources are performed -- making it a direct contributor to revenue.

The discipline of IT Service Management (ITSM) helps transition IT from its technology-centric
cost center role to that of an internal, customer-centric service provider focused on managing
demand and encouraging a competitive attitude that drives business goals.




                                                        IT FINANCIAL MANAGEMENT AND COST RECOVERY 3
                                     The Good Governance Mandate
                                     Today, good governance initiatives, such as ITSM, are driving IT priorities by requiring
                                     the tighter responsibilities, proven controls and enhanced resource stewardship that force
                                     organizations to assess and improve their processes. These mandates allow IT to play
                                     an integral role in business transformation and best practice frameworks by promoting
                                     continuous improvement and building competitive advantage.

                                     But in order to provide the insight required to make the best choices and manage and control
                                     costs, IT must develop appropriate cost models with adequate levels of detail. When creating
                                     these methodologies, IT must consider the factors most relevant to sound economical
                                     behavior.


                                     SECTION 2

                                     The Winning Formula: Driving Economical Behavior
                                     Simply and Fairly Charging for Services is Possible
                                     Properly charging for services allows organizations to provide adequate information and
                                     accountability for assessing options, managing consumption and determining the true value
                                     provided by IT. IT financial management processes make it possible to simply and fairly charge
                                     for IT services.

                                     There are three primary domains where IT can look to gain knowledge and provide insight
                                     when creating cost-recovery models:
                                     · Portfolio Management
                                     · Vendor Management
                                     · Resource Management




4 IT FINANCIAL MANAGEMENT AND COST RECOVERY
FIGURE A                               A COMPREHENSIVE IT COST RECOVERY PLATFORM
A comprehensive IT cost recovery
platform provides insight into the        Good IT Governance requires IT/Business collaboration across these primary domains
influence service portfolios, vendor
relations and resource allocations        IT Domains
have on an organization's overall
cost structure.                               Portfolio                     Vendor                        Resource
                                              Management                    Management                    Management
                                              Approval and                  Negotiation and               Planning and
                                              Prioritization                Commitment                    Measurement

                                              Investment Amounts:           Contract Terms:               Service Volumes:
                                              · Projects                    · Leases, Purchases           · Request Fulfillment
                                              · Applications                · Warranties, SLAs            · Platform Availability
                                              · Inventories                 · Capacity Measures           · Application Access



                                          Key Financial Insight

                                                 Direct vs. Indirect           Fixed vs. Variable              Cost vs. Price




                                       PORTFOLIO MANAGEMENT PROVIDES INSIGHT INTO COSTS
                                       Portfolio Management offers a means to validate the rationale for cost recovery methods and
                                       policies, while supporting stakeholders' cost/benefit tradeoff decisions. Performing corporate
                                       budget preparation and expense analysis based on costs processed through the general ledger
                                       or accounts payable system provides valuable insight into planned expenditures.

                                       Service costs, another piece of the portfolio, are computed by recording general ledger and
                                       budget amounts as a baseline and distributing these costs up the hierarchy to arrive at an
                                       accumulated charge per service. For example, the cost to provide email service actually
                                       includes portions of hardware, software and labor costs. Redistributing these amounts to
                                       the proper areas helps organizations compute an aggregated cost of providing email.

                                       Consistent measures need to be used to determine the portions allocated to each business
                                       unit. Typically, accumulators and multiple rounds of allocations are performed to arrive at an
                                       aggregated service cost. These collected charges represent shared services such as operating
                                       system support or administrative overhead, which once computed, will be allocated to the next
                                       level in the business service hierarchy.

                                       To improve the reporting and analysis of portfolio allocations, cost elements need to be
                                       classified as:
                                       · Operational or capital
                                       · Direct or indirect
                                       · Fixed or variable




                                                                                              IT FINANCIAL MANAGEMENT AND COST RECOVERY 5
                                     Automated financial allocation rules and features within portfolio management tools simplify
                                     this process by helping distribute indirect costs to components or services. Additionally, a unit
                                     of measure such as counts of user ids, serial numbers or transactions should be identified for
                                     each cost type.

                                     And, what-if scenarios help IT facilitate the planning and design of models for distributing
                                     shared costs. Insight from these discussions can also help identify opportunities for cost
                                     optimization and influence operational initiatives and prioritizations.

                                     VENDOR MANAGEMENT PROVIDES INSIGHT INTO CONTRACTS
                                     Vendor management tools help IT assess procurement processes, improve their understanding
                                     of existing third-party agreements and discover opportunities for cost optimization.

                                     When vendor costs are fixed, IT should encourage usage to optimize the investment. But when
                                     costs are variable, IT should foster an understanding that expanding usage can lead to
                                     increased costs. Communication is critical for appropriately influencing business behavior -- as
                                     are the following questions:
                                     · Does IT pay for unlimited use software licenses but then encourage limits through policies
                                       that charge per use?
                                     · Are there prepaid maintenance or warranty agreements that the business doesn't take
                                       advantage of because they don't know they exist?
                                     · Are there various rate options available when setting up conference calls or webcasts that
                                       could influence user choices if cost factors were known?
                                     · How do the costs of printing options differ?

                                     Only by using a service catalog to quantify cost and service level options can organizations
                                     understand the financial impact of their choices. Armed with this information, management
                                     can implement vendor-related policies and procedures to appropriately control IT usage.

                                     RESOURCE MANAGEMENT PROVIDES INSIGHT INTO USAGE
                                     Resource Management ensures assets are identifiable, usage metrics are available and cost
                                     drivers are understood. Tools can help track owned resources and automatically discover
                                     hardware and software related to those resources within the IT environment. Likewise,
                                     time-tracking systems provide insight into labor costs, and automated reconciliation provides
                                     management with an efficient means of identifying discrepancies.

                                     The fundamental economic concepts of supply and demand influence the cost of resources,
                                     and must be considered as well. For example, when demand on IT increases, resource
                                     spending increases in order to provide the services needed to meet demand. Many
                                     organizations incrementally increase resource levels beyond demand, meaning they often
                                     plan for a capacity that won't be realized.

                                     To avoid this situation, it's important to account for the four areas of resource planning:
                                     · Planned demand
                                     · Unplanned demand
                                     · Planned capacity
                                     · Unplanned capacity


6 IT FINANCIAL MANAGEMENT AND COST RECOVERY
Financial management methods help IT estimate -- or plan -- demand and develop a budget
that accounts for new expenses. To protect against unplanned expenses, an estimate is often
added for additional demand and an extra level of capacity is built into budget estimates.

Models that define and account for customer demands should be implemented to provide
visibility into resource costs and enable proper management. As such, the business will pay
for the access to, rather than actual use of, resources, and become conscious of identifying real
needs, quantifying requirements and prioritizing by value. For example, instead of requesting
disk space, consumers will pay for the ability to access and store email for a specific number
of users, or instead of buying bandwidth, consumers will request system access with a
quantifiable response time.

Demand-focused charging or cost recovery models such as these shift the business
conversation to a discussion of value and facilitates a consensus about how IT resources
should be contributed. Responsibility for managing capacity, and its cost, is left appropriately
with IT specialists.

Building the Cost Recovery System
Understanding the distributions of costs and assets across the areas of portfolio, vendor and
resource management provides organizations with the information needed to achieve financial
optimization. Pairing this awareness with cost recovery processes grants IT the ability to
improve financial management and steer stakeholders toward cost-effective decisions.
IT cost recovery should be used as a key technique to encourage and provide an incentive
for the efficient, effective and economical use of technology resources.

A comprehensive cost recovery platform enables governance and accountability, and provides
a choice of options for insight into costs, contracts and usage, allowing IT to gain an
understanding of the factors needed to drive economical preferences.

Organizations should follow these practical steps for implementing a cost recovery and
chargeback methodology:
1.   Define and catalog IT services, including business-oriented descriptions, scope, service
     levels, measurements, owners, customers and users
2.   Determine the components that make up services, including people, hardware, operating
     systems and application software
3.   Identify the cost elements related to each service
     a. Review accounts payable listings to determine which costs may be assigned directly
        to services, and which are overhead or indirect costs
     b. Categorize direct and indirect costs by specific ownership accountability
     c. Review contracts and identify important terms and conditions
     d. Categorize costs as fixed or variable
4.   Determine how low-level services relate to higher-level offerings
     a. Analyze usage patterns
     b. Identify metrics as cost drivers
5.   Develop a chargeback strategy for each service offering and formulate a model that
     best drives economical behavior



                                                        IT FINANCIAL MANAGEMENT AND COST RECOVERY 7
                                     6.       Review operating and financial principles with corporate functions such as controlling,
                                              budgeting, procurement, tax and general accounting
                                              a. Determine how account coding structures assist in the automation of cost distributions
                                              b. Consider standards and naming conventions for use in verifying appropriate
                                                 identification of cost attributes such as fixed, variable, direct and indirect
                                     7.       Build awareness around adopting chargeback methodology
                                              a. Build business relationships and share IT/business objectives and strategies
                                              b. Educate and communicate
                                              c. Focus on policies and exception management
                                     8.       Gather appropriate approvals and ensure buy-in
                                     9.       Implement chargeback methodology, including baseline reporting and key performance
                                              indicators (KPIs)
                                     10. Measure and report on savings realized, then solicit feedback and provide continuous
                                         review for ongoing process improvement


                                     SECTION 3

                                     Improving Economic Decisions with Cost Recovery Processes
                                     Building and implementing comprehensive IT financial management processes provides a
                                     basis for understanding how IT's service portfolio, vendor relations and resource allocations
                                     will influence the organization's overall cost structure. When built into a formal cost recovery
                                     plan, knowledge in these three areas allows IT to play an integral role in improving financial
                                     management and fostering sound economical use of technology resources. Specifically, IT can
                                     help the organization it supports simplify cost allocations, improve visibility into cost structures
                                     and optimize resource management.

                                     Simplify Cost Allocations
                                     IT financial management and cost recovery processes provide insight into how IT service
                                     costs factor into an organization's overall service portfolio by recording budget amounts and
                                     determining accumulated costs per service. Using automated allocation rules, these tools help
                                     organizations better define cost elements and improve the distribution of service costs across
                                     the enterprise. Additionally, a strong understanding of service costs and allocation processes
                                     provides insight into the planning and design of future cost models and creates opportunities
                                     for ongoing financial optimization.

                                     Improve Visibility into Cost Structures
                                     By gaining knowledge into the influence third-party agreements have on procurement processes
                                     and the cost structure as a whole, organizations can improve their understanding of vendor
                                     relationships and discover opportunities for cost optimization. IT financial management and
                                     cost recovery methods clarify usage costs, helping IT determine if a particular third-party
                                     product has a fixed cost, or if expanding usage will lead to increased expenses.




8 IT FINANCIAL MANAGEMENT AND COST RECOVERY
                     Optimize Resource Management
                     IT financial management and cost recovery processes help define and account for customer
                     demand, allowing IT to prioritize demand by business value and increase the supply of
                     resources accordingly. An accurate view of the influence of supply and demand helps
                     organizations develop a demand-focused cost model that fosters a greater understanding
                     of the best methods of resource allocation and improves overall resource management.


                     SECTION 4

                     Conclusions
                     Organizations looking to establish IT cost recovery processes do so in order to understand the
                     true cost of a service or asset. However, many struggle to achieve this goal because of tight
                     budgetary constraints and a lack of insight into the steps that need to be taken along the way.
                     Gaining insight into the distributions of costs across portfolios, vendors and resources opens
                     the door to developing clear, comprehensive IT cost recovery processes. Using this knowledge
                     to build concrete IT financial management and cost recovery processes allows IT and the
                     organization it supports to better align economic planning and budgetary decisions with
                     business goals and simplify cost allocations, improve visibility into cost structure and optimize
                     resource management.


                     SECTION 5


                     About the Authors
Patricia Genetin     Patricia Genetin is a CPA and Principal Consultant in the sales organization at CA. She has
CA Technical Sales   more than 20 years of experience spanning IT development, accounting and audit and other
                     business operations and management activities. Patricia is currently focused on increasing IT
                     and business integration through practical solutions for IT Service Management. She holds an
                     ITIL Service Manager Certification.

David Messineo       David Messineo is an ITSM practitioner with more than 20 years experience developing and
CA Services          deploying enterprise-level software solutions focused on IT management. He is currently a
                     Practice Director at CA, where he focuses on establishing best practices for consistently
                     delivering large scale implementations. David holds both an ITIL Service Manager and
                     an eSCM Certification.




                                                                             IT FINANCIAL MANAGEMENT AND COST RECOVERY 9
CA (NSD: CA), one of the world's leading independent,
enterprise management software companies, unifies and
simplifies complex information technology (IT) management
across the enterprise for greater business results. With our
Enterprise IT Management vision, solutions and expertise,
we help customers effectively govern, manage and secure IT.




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