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Redefining The IT
Value Proposition
Sumitro Sarkar

IT Cost Reduction - Reactive or Proactive?

by Sumitro Sarkar

Should the CIO be now called CFO-IT? IT cost reduction or “budget-management” (to put it in softer terms) is the most important aspect of the CIO’s job. It is perhaps the most critical key performance indicator for CIOs that are either in low-growth or highly competitive industry verticals.

IT Cost reduction is a double-edged sword. Either you save now or pay later or pay now and save later. This is analogous to say that a “short position on a call option” is the same as a “long position on a put option” wherein I should be able to hedge my bets and come out “breakeven” or have no losses. But the subtle interpretation to this is lies in the accurate interpretation of the “options theory” – which states that the profits for an investor is limited with a short position in a call option by the price of the of the option whereas in the long position in a call the profits are unlimited. A long position necessarily implies that you are “buying for sustainable upside” and short position implies you are “selling to reap short-term benefits”. So what has IT got to do with it? Well a lot!

IT cost reduction needs to be viewed in an analogous way i.e. identify the “correct cost reduction” areas and “use some of the money from the cost-reduction” to “invest” in “sustainable” areas to create a lower operating cost model for the future by creating IT assets that augment the total enterprise value of IT.

In order to do this, an analysis of the IT cost factors is imperative before embarking on a cost reduction initiative. This explicitly implies identifying in quantitative terms what comprises the “big-ticket” cost items in the CIO budget. Well we all do that – don’t we? We do not do it the way we should actually do it i.e. we do not categorize them into exogenous and endogenous factors. Exogenous factors (factors outside the direct control of the CIO or the corporation) being power consumption, real-estate usage costs and telecommunication costs (data and voice). Endogenous factors (factors within the control of the CIO and the corporation) being annual license costs of software and hardware, and staffing costs. The causal effect of the endogenous factors implicitly impacts our use of the exogenous factors priced outside the corporation (even though the corporations may end-up negotiating extremely competitive prices). Example – the decision to use x86-based hardware reduces hardware CAPEX (though you may end-up buying more quantities) but end-up increasing power consumption over a longer period thereby increasing IT costs or making the model un-sustainable. Another example is reducing IT staff costs for the short-term by outsourcing without evaluating the hidden costs of managing an outsourced arrangement resulting in paying more over the long term.

The tendency is usually to cut down Capital projects and Staff – both of which reduce enterprise value (Enterprise Value defined in financial terms as the present value of the current assets plus the present value of the future growth opportunities).

In summary, the reactive nature of IT Cost reduction by cutting capital in the form of people and capital projects often results in an un-sustainable operating cost model. On the other hand, analyzing the impact of the endogenous factors on the exogenous factors to determine the appropriate cost-reduction areas is a more sustainable IT Cost Reduction strategy.

Sumitro Sarkar has over 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 interests are redefining technology value propositions, resolving bleeding-edge technology myths, using technology to change the rules of business and financial impacts of technology decisions. Sumitro holds a BA in Economics and Mathematics, and an MBA from New Delhi, India. He also has an MBA from the Johnson Graduate School of Management, Cornell University.