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Cutting capital projects and reducing headcount are the most popular means to reduce IT costs. CIOs often fall into this trap and experience a creeping operating cost structure in subsequent years after the cost cut. In my previous blog entry, I had explained this phenomenon in detail. In this one, I will attempt to identify a few types of projects that create “value” in the enterprise i.e. increase the potential for a better operating cost model for the future.
The CIOs goals are either to improve the efficiency of their businesses by achieving economies of scale or seek opportunities to provide their businesses with an advantage of a latent or a dormant revenue channel. These are categorized to provide the following two types of impact to the entire business.
1. Efficiency Impact
2. Opportunity Impact
Efficiency Impact
These projects aim to improve the efficiency of IT operations. As a result of improving operations there is a corresponding impact on the operational efficiency of the entire business. These must NEVER be interchangeably termed as “cost-reducing”. The reason is quite simple. “Improving Efficiency” is a tangible CIO goal NOT “Reducing Cost” which is an outcome of improving efficiency. As I mentioned in my previous blog entry, that there are exogenous and endogenous factors that are constraints to an operating model. The exogenous factors include power costs, real-estate costs and cost of telecommunications. Endogenous factors consist of hardware and software license costs and staff costs. The CIO is often in better control of endogenous factors than the exogenous factors. Increasing the efficiency of IT operations would imply using creative means to control these factors. The following fundamental goals serve as a good guideline:
• Converting Fixed Costs into Variable Costs
• Improve the Transaction Cost model
• Lock-down long-term negotiated rates on exogenous factors
Converting Fixed to Variable costs is specifically important when there are high fixed-cost items in the CIOs list of direct costs. Some of the key ones would be to embark on a strategy to transform an annual software license model into a “usage-based” model if the use of the software is dependent on the number of its users. Software-as-a-Service (SaaS) is ideally suited to address this problem. Another one would be to use more variable labor in IT than fixed. Variability in the usage of labor is easier when the IT organization has demarcated “value-added” activities from “commoditized tasks”. There is no “silver bullet” to determine what jobs comprise these. It depends on what is the perception of the rest of the company towards IT. In other words a sales force automation company may not consider “call-center outsourcing” as a commoditized task – where some others may not doubt that it is a commoditized task. On the other hand, help-desk support for internal staff is a commodity service. Application development is a debatable one for the CIO. It depends on the importance of “customized software” on the business. It is clear that payroll and accounts payables do not need to be customized software. With the thought of converting fixed into variable costs come the options of outsourcing and off-shoring or not. Again outsourcing and off-shoring are tools to attain the goals – not goals by themselves.
Improving the Transaction Cost model implies whether a CIO is cognizant of the cost burden on the company. Businesses often take on costs to provide better customer service or use it as a competitive advantage. However, it is equally important that businesses incurring these voluntarily at the cost of a creeping IT operation cost year after year. When retail banking went “Internet”, customers were happy that they could access there accounts 24hrs a day. However, banks cut down on the number of tellers and customer-service staff – reducing their transaction costs and passing the burden of accessing their accounts and performing personal banking to the customer. Hence, it is very important for CIOs to be constantly sensitive to these opportunities. A common example is “data feeds” that certain companies provide to their suppliers or vice-versa. Who incurs the cost of “data transformation”? The company with a higher share price or revenue dictates this…On a more serious note CIOs must be aware of this transaction cost and attempt to pass the burden or minimize it.
Locking down long-term power rates or real-estate leases is another area that has a significant impact on the operating cost model. CIOs must employ a strong Finance and Procurement group to constantly focus on leveraging the advantages of long-term rates. Telecommunication carriers are extremely competitive about their rates. It is up to the CIO to take advantage of this competitive market. Locking down long-term rates also provides the CIO the time to define a new strategy for subsequent years without worrying about macroeconomic factors such as price of crude oil or power company rate changes.
Opportunity Impact
Capital projects that have an “Opportunity Impact” take advantage of internal and external information to identify value propositions. For example a regulation from the government may impose a constraint for companies that need to implement it. However, some companies may be take the “first mover” advantage and recoup the investment for the risk they undertook by selling it as an offering to other companies. Example, when MiFID was introduced as a statute in Europe on 1st November, 2007, some companies took advantage of it prior to that by defining offerings that will not only help them meet the stipulations closely but would help others. They then bundled it as a service and sold it to other companies to recover the investment they made. The role of the CIO in these types of scenarios is to foresee these events and pay as much attention as possible to evaluate the magnitude of the return on such as investment in these types of initiatives. Hence, the CIO must look into short-term as well as long-term opportunities even if results in re-aligning with the business strategy or lead the business strategy in some aspects.
Another way to perceive an Opportunity impact is by trying to look into “capacity reselling”. Google and Amazon are selling storage and computing capacity to consumers not in the technology business for a “small” fee. However, the fee accumulated from there customers adds to new and recurring revenue channels. CIOs must think in terms of collective and shared resources outside their companies. They may set up consortiums to leverage “collective bargain” techniques to procure storage, bandwidth and computing capacity and may look for opportunities to resell the excess capacity. Companies owning large data centers must realize that procurement and re-selling capacity are linked inextricably, and must be considered in tandem. In other words, when large companies procure capacity such as storage infrastructure or power-efficient servers, they must consider potential customers who may buy their excess capacity. Re-selling capacity is better than ideal capacity “in anticipation” of being used. This has a direct impact on fixed cost and introduces unwanted overheads in the operating structure.
Some may draw an analogy between Opportunity impacts as “revenue” impacts and Efficiency impacts as “cost” impacts. There is an analogy and it is causal in nature. In other words cost reduction is a result of driving an Efficiency goal and potential revenue enhancement is an outcome of driving an Opportunity goal. It is not the other way around – where CIOs address the symptoms and not the cause of the problem.
Conclusion
CIOs must pursue the goals of enhancing the efficiencies of their IT organization or seek opportunities to create revenue or competitive advantages for their businesses. They must never try and address “cost reduction” or “revenue enhancements” directly as those are outcomes of the goals. In order to do so, that they must formulate their IT strategy on sound fundamentals. The following provide some basic guidelines around the thought process:
• Converting Fixed Costs into Variable Costs
• Improve the Transaction Cost model
• Lock-down long-term negotiated rates on exogenous factors
• Use of Collective Bargain
• Leveraging compulsory regulations to your advantage
CIOs are in the business of “creating value” as the CFO or any other executives. They have a different set of tools in their arsenal to achieve their goals. They must use these to pursue business goals based on strong fundamentals. As a CIO you must consider “Does my IT organization has Strong Fundamentals?”
Sumitro Sarkar has 20 years of experience in technology consulting and product strategy. He has served in management and leadership positions in big- five management consulting firms, financial information services and technology product companies. His areas of interest are redefining technology value propositions, resolving bleeding-edge technology myths, using technology to change the rules of business. He holds a BA in Economics and Mathematics (with honors) and an MBA from Delhi, India. He also holds an MBA from the Johnson Graduate School of Management at Cornell University. He also writes the “Is IT Worth It” blog.
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