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CIO Habitat: Rebuilding the IT Budgeting Process

The IT budgeting process varies dramatically from best to worst practices. Where do yours stack up?

All over the map. That's where you'll find the practices, policies and executive mindset on the conflicted, sometimes baffling process of IT budgeting.

For most of IT, the budgeting landscape, particularly in the midmarket, still reflects an unstructured, let's-see-if-this-works mentality. In our latest round of CIO Habitat research, we asked 240 CIOs, IT executives and industry experts to characterize how much IT budgeting differs from one enterprise to another. An overwhelming 94.4% said these processes are "totally different," while the remaining 5.6% found "some variance from place to place."

One seasoned midmarket CIO, who has worked in eight organizations over the course of his career, confirms the broad spectrum of today's IT budgeting approaches. "The approach to IT budgeting is one of extremes: top-down, bottom-up, zero base, flat year-to-year or reduced by an arbitrary percentage," this CIO says. "Budgeting for most organizations is treated as a necessary annual function. When budgeting is viewed as a strategy -- not an annual goal -- it can be a means to competitive advantage."

In that context, the budgeting process should also serve as a communications forum for aligning IT with business needs.

Budgeting practices in transition
Budgeting practices in transition

Three Budgeting Practices

Ken Cohn, CIO of Pepco Holdings Inc. in Washington, D.C., identifies three factors that drive the differences in IT budget practices from company to company. The first is the current state of IT with respect to technology. If IT isn't keeping pace with industry advances (such as vendor software releases, operating systems, hardware and security), Cohn says, "the best expenditure of IT dollars is to catch up. It makes relatively little sense to build a strategy of alignment with the plans of business units if the platform upon which that strategy is built is ready to collapse."

The second factor is the top-down view of alignment between IT and the lines of business. "If the CEO views alignment of IT expenditures with the plans of the lines of business as key to driving the corporation ahead, then the CIO would be foolish to plan expenditures otherwise," Cohn points out. But to achieve alignment, the IT department has to be well-versed in the company's strategic plans as well as in the business plans of the various divisions, he adds.

The third factor has to do with IT's push for innovation beyond the infrastructure, those keeping-the-lights-on decisions. "These might well begin with leveraging off of existing technology such as an ERP platform all the way to showing the way to process improvements based around, but not on, IT tools," Cohn notes.

A diversity of practices is not a bad thing. What is bad is that few organizations have IT budget processes today that run smoothly (see "Budget Practices in Transition," above), and that has very real performance implications. Numerous executive research studies have shown a direct correlation between organizations that are highly satisfied with existing IT budgeting practices, IT performance and business performance. Conversely, organizations with poorly orchestrated budgeting practices are rarely considered high-performing enterprises.

12 Worst Practices in IT Budgeting

In the "been there, done that" category, many of our CIO Habitat survey respondents have experienced these depressingly familiar tactics. Any of these can turn the annual financial process into a recurring nightmare.

  1. Mandating across-the-board budget cuts so that every department has to reduce its IT spending by a certain percentage.
  2. Locking in on a fixed number, as in "the IT budget must be X percentage of revenue."
  3. Requiring too much financial detail or, conversely, not enough.
  4. Ignoring emerging technologies because they cost too much.
  5. Creating budgets without input from the other side, whether it's the CFO ignoring IT or the CIO ignoring the business needs.
  6. Understating the true costs of an initiative so it will slide under perceived spending ceilings.
  7. Using spreadsheets that are not linked or backed up, a practice that is especially dangerous in these days of rising compliance demands.
  8. Varying budget processes between departments inside the enterprise so no one is really comparing apples to apples.
  9. Allowing unscreened projects into the IT project stream, or allowing initiatives with no business sponsor into the IT project stream.
  10. Failing to provide centralized supervision of the en-terprise budgeting process.
  11. Omitting training from the budget.
  12. Waiting for something to break before putting a replacement cost in the budget.

What's Broken About the IT Budgeting Process?

Organizations laboring in bad budget process purgatory (see "12 Worst Practices in IT Budgeting," at right) waste lots of energy just going through the motions of getting the budget done. As one very bright, honest CIO at a multinational bank puts it, "The IT budgeting process is an evil thing. Obviously, organizations need to understand what they are investing in and have a means to prioritize their expenditures. But it seems very difficult, complex and time-consuming to have a large number of people running about based on artificial deadlines."

This bank spends a great deal of its executive time and energy "tracking allocations from client to supplier with a mix of internal, contract and outsourced suppliers," the CIO adds. "It remains a challenge to move resources (dollars, people, assets) from one project to another as priorities shift."

Another bad practice stems from CFOs or business execs creating the IT budget with no input from the technology side of the house. As one southern California IT leader explains, "Worst practice is treating budgets like a Middle East bazaar. Department heads propose ridiculously high spending; the CFO tells them to cut below any sane level. Hopefully they end up in the middle. In this scenario, there's no process content, no thought to anything but numbers and nothing behind the numbers."

That experience echoes the No. 1 complaint in our Habitat survey about the disconnect between business strategy and budgeting. Business schools tell their students that budgeting is part of management, not leadership. Yet in organizations fortunate enough to have well-run IT budget processes (see 12 Best Practices), IT and business leaders make sure the big-picture strategy is linked to where the money actually goes.

Another encouraging finding from our research is that 62.5% of today's business execs are more involved in setting IT strategy and budgets than in previous years. Only 12.5% of the execs were deemed "more involved in setting budgets, less on strategy."

"The only risk mitigation in IT project time and budget estimation is experience. Period," says Gary Baney, a visiting professor of computer science at Case Western Reserve University in Cleveland and CEO of IT consultancy Boundless Flight. "I have seen all sorts of [IT budget processes] based on function point counts, lines of code, [Capability Maturity Model] maturity, etc.," he adds, but the bottom line is that "someone has to estimate the project who has done it, or something like it, before."

12 Best Practices in IT Budgeting

CIO Habitat members whose companies have steadily improved their budgeting approach recommend processes that are:

  1. Outcomes-based. Business, IT and the supplier/contractor ecosystem are moving from a cost-plus-funding model to a "What can you do for $X?" mode of operation. Buy business outcomes, not technology pieces and parts.
  2. Vision-based. Keeping the big-picture view visible to all parts of the organization ensures that what's being invested in is clear to all.
  3. Performance-based. Vendors don't get paid until the benefits materialize.
  4. Fact-based. Provide tunable views of the IT budget, so the big-picture people see reports at a higher level while the microdetail people see everything.
  5. Tool-enabled. Use real-time portfolio management to kill unproductive projects in an early stage.
  6. Understandable. Create an understandable story on the economics of IT across the organization. This creates awareness of operational IT costs but also an understanding of the "IT crumple zone." This zone comprises the financial fenders of IT -- the parts that can be eliminated without impacting business performance.
  7. Connected to business strategies. Link budgets to enterprise and line-of-business objectives.
  8. Measured and managed. Create scorecards linking the business value generated to IT monies spent. Measure outcomes associated with every IT dollar spent.
  9. Innovation-sensitized. Use pilots to test new technologies.
  10. Inclusive. Engage the intellect of the business people who like to experiment with technology rather than frustrating or alienating them.
  11. Truthful. Make sure the total multiyear costs of various IT initiatives are honestly revealed. The business needs to be aware of the real cost implications of technology decisions.
  12. Incentive-based. Eliminate perverse incentives like spending extra monies at fiscal year-end to make sure the funds aren't cancelled.

Why is Technology Budgeting So Hard?

We live in an age where information fuels commerce, informs politics and enables social interaction. This information is created, filtered and stored by underlying technologies that most nontechnical senior executives don't fully understand. This is a problem akin to explaining air to fish, and most of these execs have no grounding in why IT costs what it does.

In the absence of understanding comes the delegated expert. IT was supposed to be the "expert" on how this stuff works and how much it costs. But a systemic problem emerges when the nontechnical business executive no longer trusts the IT leader. When this happens, as it does in many organizations, a sad, hyperaccelerated search for knowledge ensues, with the business being guided by a cabal of less-than-objective solution suppliers.

One of the ongoing problems with budgeting is the hidden post-purchase cost of computing. For every dollar invested in putting an IT system into production, some percentage of cost "drops down" into subsequent years in the form of maintenance and enhancement charges. This is called the drop-down ratio by IT budgeters. Some IT budget processes erroneously fail to account for these cash outflows, making the purchase decision based only on the acquisition cost.

Another problem in the IT budgeting process is that certain expenditures. such as those for architecture and governance, materially improve long-term organizational performance, yet are difficult to link to specific dollar savings.

Are Things Getting Better?

There is some good news, in a back-handed way. Only 13.7% of the organizations we talked with think the process could get any worse. The factors contributing to improvement include business executives getting more involved, IT resources being allocated in real-time and the budget process itself becoming less political.

Thankfully, the path out of the budget badlands is not a Homerian Odyssey. Rather, it is a series of straightforward steps:

Step 1: Map your current IT budget process. At the IT Leadership Academy we have assembled more than 300 such budget maps.

Step 2: Re-engineer the IT budget process to eliminate activities that don't make sense.

Step 3: Interview select business colleagues and get them to draw a map of how they think the IT budget process works.

Step 4: Take a page out of General Electric's book and conduct "dreaming" sessions with the business execs or with external customers to paint a picture of what you want the future to look like. This moves you into the budgeting-as-executive leadership space.

Step 5: With your findings from steps 1-4 in hand, go to the CFO and enlist help in applying best-in-class contemporary cost-accounting practices to the flow of IT monies.

Step 6: Make sure your IT team understands how to manage, manipulate and discount future period cash flows associated with IT investments.

Cohn of Pepco sums up the IT budget conundrum: "The CIO needs to be prepared to defend IT's proposals, but also must be prepared to accept defeat gracefully. In the long run, this helps make IT a valuable partner."

This was last published in July 2005

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