I applaud Dean Branton for driving the need for Cost Transparency and chargeback systems in his article “How to create a system for charging back IT services.” And I love his 5 key points: (paraphrasing)

     1. A chargeback system should be efficient—not require more administration than the value it provides.

     2. CIOs should champion new technologies and services, and showcase their value to the business through chargeback processes.

     3. IT needs to transform from a traditional cost centre to a vital business function, proving increasing levels of value.

     4. IT should reduce Capex and Opex expense through better utilisation and cost management.

     5. IT should partner and collaborate with the business to demonstrate commercial credibility. …or in my words, align with and help drive the business goals.

And while I agree with Mr. Branton’s five key points and conclusions and the intent of his advice—that IT needs transparency in the cost and value of IT and that chargeback systems shouldn’t be a burden unto themselves—I have to strongly disagree that flat fee allocation is the best approach to service costing.

I further very much agree that service costing and chargeback can be very powerful levers to drive cost efficiency, better alignment to the business priorities and better decision making around key initiatives or alternative service delivery models (Cloud.)  However, in each of these areas, IT’s ability to make accurate decisions is wholly dependent on the accuracy of their Service Cost data; if, due to a flat fee policy, the actual cost is significantly off the reported cost, wrong decisions will be made.

Activity Based Costing (ABC) is absolutely the ideal method for allocating costs—as proven by decades of Cost Accounting and ABC practices in other areas of the business—and should be maintained as the gold standard for IT service costing and chargeback.  A simple flat rate allocation may be a good first step into chargeback or “showback” policies, as it develops the system and the model for allocation to business units. But leaving that as the end state would be a big mistake.

Let me posit this to Mr. Branton, “If you could have an ABC model for allocating IT costs to IT Services and the business units that was NOT “overly burdensome,” would that be better than ‘flat fee’”? 

Consider these 3 points:

1. Flat fees and unit costs based on averages hide inefficiencies and cause bad behavior.  For example…

Many IT organizations struggle with the amount of storage required for users’ mailboxes.  In the flat fee model, based on a per head allocation, email service is unbound by the use of storage, and users are actually conditioned to use as much as they can within their maximum allocation.  IT becomes the bad guy in this scenario.  If the amount of storage used actually impacted the total cost per service,business managers would actually be the ones driving better storage management practices in order to save money.

 2nd example.  A large Midwestern hospital group was analyzing their cost of applications within the hospital.  Part of this analysis included looking at desktop productivity applications.  They had been buying licenses and allocating the cost based on the number of desktops they had—a simple and flat allocation.  Upon further inspection, they discovered that 25% of the licenses were applied to desktops for nursing stations in patient rooms—clearly not creating presentations or spreadsheets at these stations.  This was not only causing IT to spend too much on these licenses, but also creating a disproportionate allocation of license cost to the clinic side of the business whereas most of the users of productivity apps were in back office departments.

3rd example.  A fortune 50 financial services firm originally had been allocating networking costs based on an even spread across servers.  With more sophisticated allocation systems, and leveraging data from asset management systems, they were able to allocate the cost of networking based on the number of ports a server used.  This much more fairly allocated the costs based on usage, and more accurately shifted costs to applications that were more network intensive.

2. Visibility into the granular cost is one of the best opportunities for easy cost savings.  You can’t manage what you can’t measure.  As many customers as we have, I could tell you at least twice as many stories of quick and significant cost savings once they had good insight into the cost drivers.

For example, a large beverage company we work with analyzed their total cost of desktop devices—laptops and desktops.  They had planned to launch a big refresh of laptops based on a standard platform.  By analyzing their unit costs per service, they found (1) laptops cost nearly twice as much to maintain as desktops, (2) they had 1.6 devices per employee, (3) their maintenance contract was charging them too much, and (4) the actual lifetime of desktop devices was about a year longer than their refresh policy (discovered by mapping quantity of service tickets against the age of the laptop or desktop).  By postponing the refresh, standardizing on desktops unless mobility was required, and renegotiating their service contract, they saved $1.4M against that year’s budget, without spending a dime.

Many companies have mapped their use of storage per service, cost per gigabyte of storage used and service quality requirements, as storage usage and cost is constantly increasing.  In many cases, customers were using Tier 1 storage where it wasn’t necessary, were paying well above the industry average for storage, many found considerable cost savings through simple changes and a few took advantage of a much lower cost structure by moving Tier 3 storage to the cloud.

3. Business leaders will cry foul.  While starting with flat rates is a great first step to get cost transparency going, it won’t take long for a savvy business leader to say “Why am I getting charged so much for service X when I use so little of it?!”  We’ve seen this play out in many organizations as they mature their Cost Transparency and Chargeback processes.  Flat fees aren’t fair, they’re just simple.

Simple is good when just getting started.  And by all means, getting started provides a ton of value in providing transparency and aligning organizations.  But recognize that there is a lot more value and opportunity for savings in adopting IT Service costing based on ABC.  The good thing is there are companies—like Apptio, of course—that have developed technology to make this a lot easier and automates nearly all of the data acquisition steps, alleviating the manual effort of gathering data and creating spreadsheet based allocation models.