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Pay Up for IT Services: How to Create an IT Chargeback Model

The practice of charging lines of business for their share of IT has a checkered past -- with good reason. Here's why, and how, to try it.

Business managers are increasingly being asked to shell out for the IT they use. Here's why they find it painful...

-- and how you can create a billing model that best meets the business' needs.

Tell business folks that you'll be charging them for IT services, and get ready for pushback. Let's face it: Business managers don't like bills, especially for things that used to be free.

From a CIO's perspective, chargeback is great. When a CIO charges back IT costs to business units, he makes them accountable for their own spending. Got business-unit managers who need a slick new marketing database or Blackberrys for all? No problem. As long as they're willing to live with the costs on their profit-and-loss statements, they can have whatever they want.

From a business executive's perspective, chargeback isn't so great. Lots can go wrong, according to survivors of failed chargeback efforts. For starters, most line managers simply believe that IT purchases and services shouldn't be allocated. Then there are administrative problems. Depending on how you do it, chargeback can be expensive to implement. At some companies, new and costly bureaucracies have sprung up as IT has tried to figure out who uses how much IT.

Yet businesses have become more interested in chargeback since 2001, when tech stocks collapsed and companies that had been splurging on IT suddenly reversed course and cut costs. In this environment, "everybody wanted to manage demand when there were not enough resources," says Barbara Gomolski, a research vice president at Stamford, Conn.-based Gartner Inc.

The Sarbanes-Oxley Act of 2002 sharpened companies' focus on IT governance, which has added to chargeback's allure. Now many vendors offer cost-tracking software. And many companies, particularly larger ones, are starting to track costs, including those for IT. Some are content to do so by business unit; others try to calculate costs for specific services, like answering a help desk call or dispensing money through an ATM. Cost tracking "has been a really hot area the last year or so," Gomolski says. "People are trying to associate costs with services they provide."

It's no surprise that chargeback makes the end of the quarter look a lot different. CIOs can show top management which business units spent how many IT dollars. This makes IT look more like an internal business partner that manages technology investments and less like a black hole with a burgeoning budget. At the same time, CEOs get a better idea of which business units are truly profitable.

But the politics and tedium of tracking pennies often kill chargeback before it can produce meaningful results. Penny Collen knows exactly how this happens. Now an independent IT consultant to a midmarket physicians group in the early stages of implementing chargeback, she spent much of her career working as a finance manager for a major telecommunications company that tried and abandoned IT chargeback not once, not twice, but three times.

The first time, the company turned IT into a profit center that charged market rates (and thus included a profit margin) for its services. That ended with a merger. The second time, it tried to offer services at cost, but line managers fought back, saying the costs were still too high. The third time, the company tried a limited, cost-based version of chargeback, which was eventually dropped because it was ineffective.

In general, "all of the ins and outs followed a similar pattern," Collen says. "There was an idea put forth that this would be a great way to impart accountability and eventually save money because people would be more aware of costs. All three cycles of it came on with the same sort of euphoria.

"And in every case, [IT chargeback] would go in, and the people would find that it was a higher cost to maintain than they thought and that it did increase communication, but not always positive communication." To wit, when IT communicated costs to the lines of business, the lines of business shouted back. Amid the bickering, "the corporation lost interest in devoting enough energy to keep it alive," Collen says.

Indeed, chargeback is so contentious that some organizations wanting to implement it avoid the term entirely. "I don't even use the word 'chargeback,'" says Troy Stovall, senior vice president of finance and operations at Jackson State University in Jackson, Miss. Stovall has hired a consultancy to track costs across the university, including IT costs, which eventually will get charged back. "I'm just trying to get people into the mind-set of tracking what they're doing."

To get a better idea of how to make chargeback work in a midmarket company, we interviewed several experts and IT executives. Here is their advice.

Do it for the right reasons

A midmarket company's IT budget is likely to grow with the company. So it would be misleading to say that IT chargeback cuts IT spending. But it gives CIOs a way to know which IT initiatives are paying off and which aren't. More important, it gives management a way to figure out which business units are profitable and which aren't.

That is how Robert Odenheimer presented the idea at Magellan Health Services Inc., the country's largest behavioral disease health management company, with reported revenues of $1.82 billion in 2005. Odenheimer, a senior vice president in charge of IT operations and telecommunications until he left during a reorganization in November, said he planted the seed for IT chargeback in 1999. He asked Magellan's finance executives how they could know if a business unit was profitable without taking IT costs into account. "They said, 'Oh, we don't pick up any of those costs,'" Odenheimer recalls. "I said, 'How do you know if a business unit is profitable?' And they said, 'Oh, we really don't.'"

Odenheimer points out the dangers: "If a business-unit manager is really smart and knows how to leverage IT to improve his operation, and it doesn't cost him anything, he's going to use a ton of it. And he's going to look great because he will improve his productivity and he will improve his revenues. Whereas if you look at what he's spending in order to produce that revenue, he could be in the red, and no one will know," Odenheimer says. Magellan began tracking some of its major IT costs, mostly call center-related, and billing them back to business units.

Companies that implement chargeback in search of direct cost savings will be disappointed, says Ken Lynch, president of CIMS Lab Inc., a Roseville, Calif., vendor of chargeback software. Chargeback is "a management tool. Information gleaned from systems will be used to make a variety of management decisions: to invest in new equipment, to cut off unprofitable spending," he says. "I wish it could be as easy as 'Install this thing, and it will save you a million bucks.'"

Get the right people to buy in

The worst thing you can do is develop the chargeback idea within your IT department and only then foist it on the rest of the company. Without corporate support, "there is usually not the strength required to have the IT officer fight off all the objections," Collen says. "If it comes as a groundswell [from] IT alone, without broad popular support, it will fail."

After all, by definition, adopting IT chargeback means asking business managers to pay for expenses that were once covered by corporate overhead. And so winning hearts and minds is an art. "Chargeback is 80% politics and 20% finance," says Gomolski. Playing politics, of course, involves talking to business managers. "If you include them in the decision, they're much less likely to complain later on," says Gomolski. Yet most CIOs fail on this front. "Eighty percent of the people I talk to about chargeback have not talked to their business people. They're doing it in a vacuum," she says.

Donald Ward didn't make that mistake when he proposed chargeback almost 15 years ago at BancWest Corp.'s Bank of the West subsidiary, a retail bank based in San Francisco that reported net interest income of $1.1 billion in 2004. (BancWest itself is a unit of French bank BNP Paribas.) In the early 1990s, Ward, the bank's CIO, was looking for a way to make line managers more aware of their spending on IT. He was influenced partly by his experience at a chemical company that closely tracked manufacturing costs. Ward thought Bank of the West could do the same for IT.

At the time, the bank's managers were in the habit of promising great returns if only they could have the next new technology. But no one was ever sure if business managers delivered on those promises; there was no good system for mapping results with initial expenditures. Without knowing which IT investments paid off, Ward found it difficult to know which IT projects to spend on going forward.

Hoping to better prioritize spending, Ward proposed chargeback to bank CEO Don McGrath, whose own finance background made him amenable. McGrath then presented the idea to company executives, who all held graduate degrees in finance. Because of this shared background, "everyone had a common sense that we should create a reasonably accurate [idea of] profitability by line of business," Ward says.

More than a decade later, Ward believes the system has made a huge difference. He works together with line managers to focus IT spending on projects with the greatest returns; the bank's line managers are keenly aware of how much IT costs and therefore savvier about what they buy.

Did it matter that he sought concurrence? "Absolutely," Ward says. He notes that the operations division of the bank totals 1,300 people, including about 300 IT staff. (He is now senior executive vice president and operations and systems manager, which includes responsibility for IT.) "There's one reason why my department exists, and that is to provide services to the rest of the bank," Ward says. "I think I have an obligation to get concurrence or to at least share my plans" that affect the business units, he says.

Be fair, but not too fair

No one would pay for resources he didn't use, and this line of thinking has inspired some large corporations to hire virtual departments of accountants whose main task is to sort out which department is using how many CPU cycles or whom to bill for what portion of what server. And while such meticulous counting may make sense for some larger companies, the reality is that many midmarket companies can't afford it and settle for the opposite extreme: allocating costs by department or head count.

Research on this topic in the midmarket is rare. But in a 2003 vendor-sponsored survey of 1,000 heads of IT and senior managers at companies with more than 500 employees, two-thirds reported that their companies used some form of IT chargeback. But only 11% said they charged back based on actual usage of hardware or software. (The survey was conducted for Veritas Software, now a unit of Symantec Corp.) Instead, most chose a simpler method. About 25% said they distributed the cost of IT evenly across all departments. Another quarter divided costs by the number of PCs or network connections. Another 9% charged per employee. In addition, about a quarter of those surveyed didn't think the method was fair, and 8% said chargeback definitely wasn't fair.

Yet midmarket CIOs will find precision too pricey. "If you do chargeback for everything, you basically have to build an entire department to run it, and it's a lot of expense," says Odenheimer. As Ward says, "You can get 80% of the benefits with 20% of the effort. Trying to get that last 20% is just not worth it."

In other words, midmarket CIOs who institute chargeback need to get their internal customers used to the idea of rounding off for efficiency's sake. Odenheimer, for one, only allocated IT costs for expenses that were easy or only somewhat difficult to calculate. "Easy" candidates were call centers and desktop computers. There was no confusion about which departments used these resources. "People could not argue that it wasn't fair," Odenheimer says. More complicated resources, such as Web-based applications shared by different parts of the company, remained unallocated.

Ward takes a different tack at Bank of the West. He allocates all costs, including his own salary, using whatever method seems most efficient. His general philosophy: "Let's try to get the majority of the expenses allocated. But we're not going to go in and try and count [everything]."

For example, since almost everyone at the bank has a computer, PC costs -- which include the PC, plus productivity, network, security and backup software -- are allocated based on head count. Some costs, like those for certain software applications, are allocated by the number of bank accounts under management by each department. If only one department uses a certain piece of equipment, it lays out the cash.

Salaries are fairly straightforward

Many IT employees are already dedicated to specific departments, and those departments pay their salaries. But sometimes there's a need for a change in the formula. Ward and the finance department consider and make those changes about once a year.

Larger midmarket firms might consider hiring a chargeback consultancy for these decisions. Although some sell tools to count all costs, others can ease clients into the concept. Chargeback "doesn't have to be a full-blown system. It can be staged up and staged in," says Sid Finehirsh, founding chief executive of the CMX Group Inc., a chargeback consultancy based in New York City. The cost? "We would want it to stay below 1%" of the entire IT budget, Finehirsh says.

Control outsourcing

Outsourcing isn't intrinsically bad, but it can be if you let everyone hire the cheapest vendor. Most midmarket companies don't have the resources to meet their own IT needs in-house and need vendor help. Add on IT chargeback, and you introduce the possibility of chaos: Business managers who have to pay for their own IT will want to pick the vendor with the lowest-priced technology, even if that technology -- whether it's e-mail or Treos or a new database -- doesn't fit with the rest of the company's IT infrastructure.

When everyone is free to choose, the likely outcome is an IT version of the Tower of Babel. But there are two ways to prevent such chaos. One is to let business-unit managers do what they want but drive home the fact that the price might be too high. When a business unit wants technology that isn't compatible with other systems at the organization or isn't sold by a preferred vendor, the CIO should not veto the purchase, Gartner's Gomolski contends. "If the business unit wants it and they're willing to pay for it, let them have it. I always say to my clients, 'Never say no, as long as they're willing to understand the cost associated with it and to bear the consequences,'" she says. She recommends that CIOs add maintenance fees to cover the cost of working with a technology that isn't compatible with existing ones. If line managers think the costs are too high, they'll forgo the purchase.

The other way to prevent outsourcing chaos is to give the CIO final say on any vendor relationship. At Bank of the West, for instance, line managers know it's pointless to do an end run around Ward. "If a line of business goes to the CEO with an expenditure that involves hardware and software and it doesn't have my signature, he sends it back," he says.

Still, Ward tries to be diplomatic. He doesn't tell the business units what they need. Instead, he acts like a broker who helps his clients pick between competing services. When line managers invite a vendor to give a presentation, Ward attends. The line manager gets to decide if the product might help his business. "IT needs to decide if the promises made by vendors are realistic and compatible with the infrastructure that we operate," Ward says. If he is strongly opposed to the investment, he'll say no.

If he doesn't like a proposed IT investment but doesn't hate it either, he'll let the line manager go ahead. Ward recalls giving a few such reluctant approvals; in most cases, the business units later wished they had heeded his warnings. Still, Ward has been wrong. Once he advised a line manager not to buy software from a particular small vendor because the vendor might go belly up. The line manager made the purchase anyway, with Ward's reluctant acquiescence. As it turns out, the vendor was acquired by a much larger company that has done a fine job of supporting the product. The line manager still heckles Ward about the decision when the two pass each other in the hallways.

Watch your prices

When a line manager doesn't have the authority to do his IT shopping outside the company, he's captive to the CIO's prices. Those prices aren't likely to be popular because, besieged with ads for consumer devices, line managers often don't understand what goes into a price on the corporate side. "Users are always going to fight over the price," says Gomolski. "They're going to say, 'I think your pricing is too high. I can go to Best Buy and buy a PC for $500 right now. Why am I paying $2,000 a year for these?' That can be a problem if you don't have a defensible [price list]."

Gomolski recommends that larger midmarket companies do benchmarking studies or troll industry association data to show that their prices are comparable to those charged by similar operations. Companies that can't afford benchmarking should at least break down prices in detail so internal customers know exactly what they're getting. "Don't just say, 'PC, connection: $500 a month,'" Gomolski advises. Instead, categories could include "PC acquisition costs, capacity planning, security, virus protection, etc. That way people know that they're buying the entire package, not just the hardware and the software," she says.

Remember your original goals

The point of chargeback isn't saving money per se; it's getting business managers to factor the cost of IT into what they do. In the beginning, this can be a rude awakening. Ward, for instance, remembers a moment in the early days of corporate Internet use when a business-unit manager ordered Internet connections for his entire department of approximately 100 people. "I said, 'Fine, we'll set them up. By the way, I'm going to charge you X a month for that Internet access.'"

The manager asked, "Isn't that part of the bank's overall overhead?" And Ward explained it wasn't. "He said, 'OK, you know what? Give these 10 people access. They're the only ones that really need it,'" Ward laughs. The manager was fairly senior and had been privy to the meetings that heralded the arrival of chargeback. "I don't think he connected the dots" until that moment, Ward says.


Joan Indiana Rigdon was a contributing writer for CIO Decisions. To comment on this story, email [email protected].

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