Integrated ServIceS coStIng and Performance managementHelping tHe CiO get a Firmer grip On it Spending

SAP Thought Leadershipenterprise performance management

Overview

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content

4 Executive Summary

5 Understanding the Cost of Shared Services

6 Aligning Shared-Services Resources with Business Demands

6 it infrastructure library

7 Adopting an Activity-Based Costing Approach 7 data integration for Streamlined processing 8 Compiling an activity dictionary 8 Options for Cross-Charging 8 demand-Based pricing 8 Capacity-Based pricing 8 Underrecovery or Overrecovery of it Costs

9 Activity-Based Planning and Budgeting for IT

10 Completing the Picture with IT Metrics

11 Summary

in recent years, many organizations have effectively reduced the costs of providing support services by con-centrating them in corporate shared-services departments, outsourcing, or relocating parts of their operation offshore. this resulted in a step change in the costs of support services – such as it, Hr, and facilities – and gave many organizations a short-term cost advan-tage over their com petitors. at the same time, organizations started to cross-charge internal customers for it with the belief that having a line item for it expenses in a business unit’s profit and loss account would help restrain its consumption of it services.

two things happened. First, the short-term cost advantages soon disap-peared as competitors who were late to implement a shared-services strate-gy and adopt outsourcing played catch-up. Second, cross-charging failed to curtail consumption, so that it expens-es continued to spiral. it also caused so much internal bickering that many companies abandoned it. Both of these unanticipated outcomes can be attribut-ed to the fact that many organizations still have a limited understanding of what drives costs in shared-services functions. the net result is that CiOs often find themselves in the unenviable position of being caught between a board demanding a firmer grip on it spending and a user community constantly challenging charges.

the twin challenges for the CiO are to fully understand the cost of shared services and to align shared-services resources with business-unit demands. given the complexity of the disparate resources managed by it, this can only be achieved by adopting an activity-based costing (aBC) methodology to deliver both services costing and plan-ning and budgeting functionality. With this methodology, business units can routinely reforecast the key nonfinancial data that drives their shared-services demands. the ideal solution is one that provides this functionality together with a reporting function for visualizing objectives and metrics in drill-through dials. Such a solution would fulfill the complete financial performance man-agement needs of the CiO.

executIve SummaryCHallengeS COnFrOnting SHared ServiCeS

With costs in operating units pared back to the bone, the attention has turned to shared services – in par ticular, the it function – which can be as much as 20% of total expenses in certain sectors.

4 SAP Thought Leadership – integrated Services Costing and performance management

You can easily identify and reliably cross-charge the direct costs of spe-cific applications and projects to inter-nal clients. However, the majority of it resources, such as it management, infrastructure, and system architects, are both indirect and shared, making it very difficult to accurately assign them to a specific service, application, or client. more recent trends present further challenges. One example is the move from dedicated servers to “virtualization” and dynamic resource allocation, where various elements of a system-oriented architecture are auto-matically utilized to process demands coming from the business according to their assigned priority.

Certainly the traditional method of charging out it costs by apportioning cost pools to business units based on some easily available metric is inade-quate. Where large elements of cost are apportioned based on the number of users, network connections, or a crude metric such as business unit rev-enue or headcount, the resulting charg-es are unlikely to be in line with actual consumption. even where charges are based on metered usage (for example, gigabyte, CpU, or hard disk drive usage), the results will still be inaccurate if the indirect costs are not reliably assigned to cost pools.

the twin challenges for the CiO are to fully under-stand the cost of shared services and to align shared-services resources with business-unit demands. given the complexity of the disparate resources managed by it, this can only be achieved by adopt-ing an activity-based costing (aBC) methodology to deliver both services costing and planning and bud-geting functionality.

underStandIng the coSt of Shared ServIceS tHe FirSt CHallenge

5SAP Thought Leadership – integrated Services Costing and performance management

Shared-services departments tend to plan their resources and budget sepa-rately from the operational planning and budgeting process of business units. as the financial year progresses, the capacity of shared-services depart-ments and the demands of operational business units can become grossly misaligned. Over time, any variance above the budgeted cost of the shared-services functions that appears on a responsibility center manager’s profit and loss account becomes an increas-ing source of frustration and annoy-ance. Without robust and accurate costing, the shared-services provider struggles to explain it. the responsibili-ty center manager, who has probably been diligent at managing his or her own direct costs throughout the year, can only argue that the apportionment is unfair and that other business units

should pick up a bigger share. the reality is neither the shared-services provider nor the responsibility center manager has sufficient insight to have a productive discussion.

the situation is not helped when bud-geting and costing are done in separate applications. Companies often use a corporate application for budgeting and an in-house solution typically built in a spreadsheet environment for costing. many it departments also report key performance metrics such as availabili-ty, response times, and implementation deadlines in an entirely separate dash-board or scorecard tool, although many of the metrics are service costs. in addition to these three core applica-tions, most it departments rely on a myriad of spreadsheets to model staff-ing and other resource needs. as a

result, the budgeting application usually only contains consolidated line item expenses.

IT Infrastructure Library

the result of all this is that the it department has not equipped itself with the systems needed to manage the complex array of resources it con-trols. in addition, it is unable to have an informed discussion with business users about the services they need, how best to provide them, and what the resulting cost will be. When discussing how the it department’s own perfor-mance management and accounting systems have failed to keep in step with the burgeoning demand for and expenditure on it, many analysts talk about the “it business management gap.” version 3 of the it infrastructure library (itil), the worldwide de facto standard for best practices in the provi-sion of it service, now documents best-practice approaches for it finan-cial management and governance (see Figure 1).

in essence, itil is a series of publica-tions that an organization can use to guide it toward the vision set out for professional management within it. Since itil is not definitive on how best to reach that vision, you would need to customize the best practices for your organization’s particular situation. One of the first tasks you face is to identify what systems and processes are need-ed to support itil best practices.

alIgnIng Shared-ServIceS reSourceS wIth BuSIneSS demandStHe SeCOnd CHallenge

Figure 1: Scope of IT Financial Management and Governance in ITIL V3.0

visible and consistent

cost structure

Service consumption modeling and

valuation

Serviceinvestment

analysis

planning confidence

Service portfolio

management

variable cost dynamics

Service provisioning optimization

Financial compliance

IT F

inancial Management

IT Governance

Commonality of interests and benefits

• Serviceconsumptionmodelingand valuation– Quantification of funding sought for a

defined set of services

• Serviceinvestmentanalysis– investment appraisals: rOi and total cost

of ownership

• Planningconfidence– Budgeting based on demand and supply

• Serviceportfoliomanagement– Comparison of external versus internal

costs for optimal provisioning

• Variablecostdynamics– determination of what fixed and variable

costs are linked to a service

• Serviceprovisioningoptimization– Capacity management and continual

improvement

• Financialcompliance– proper and consistent accounting methods

• Visibleandconsistentcoststructure– robust accounting methodology

6 SAP Thought Leadership – integrated Services Costing and performance management

the costing methodology you adopt to accurately assign indirect and shared it resources must be robust enough to handle additional complexities. it should be able to:• reassign an appropriate share of the

costs incurred in other departments, such as facilities and Hr, to it since it takes up property space and con-sumes utilities and services such as payroll.

• realistically reflect that just as Hr pro-vides services to it, it provides ser-vices to Hr – and that to calculate the true cost of providing a service, these reciprocal costs should be passed between these departments reitera-tively until they become insignificant, while still providing an audit trail.

• reflect the reality that business units may use the same it services differ-ently. For example, an it service such as help desk support may be allocat-ed to business units based on the number of times they use it. Howev-er, due to a lack of internal expertise, the time taken to resolve the help desk queries for some business units may be far in excess of others. Using reliable call logging and metering can help here.

in addition to the complexity that can result from multiple line items, services, cost drivers, and business units, there is a need for being able to trace cross-charges right back through the assign-ment to line items in the general ledger. the only way to reliably understand complex shared-services costs is by

adopting an activity-based costing (aBC) methodology and deploying an application capable of managing the true dimensionality of costs involved.

Some line item expenses in the general ledger of an it department, such as the maintenance charge for a specific piece of hardware dedicated to a single busi-ness unit, can be directly assigned to the business unit. Others need to be reallocated to cost pools, where they can be combined with other expenses in departments that provide support to it – such as Hr and facilities. Some of these cost pools may then be allocated directly to services, but the majority will be assigned to the activities that it staff perform to better understand how they relate to it services. Figure 2 shows how aBC might be applied to it shared-services costing.

Data Integration for Streamlined Processing

evidently, the costs of hardware and software need to be amortized over their lifetime to avoid spikes in calculat-ed costs at the time of the investment. You can directly import much of this data into the aBC model from the asset register. Similarly, many it depart-ments deploy time-capture systems to record the time staff spend on individu-al projects and metering systems to measure the amount of processing power, time, or storage consumed by different requirements and business users. all of the data from these sys-tems can be directly integrated to enable “lights out” processing so that cross-charges can be rapidly produced and incorporated in management reports within a few days of month end.

adoPtIng an actIvIty-BaSed coStIng aPProachtHe KeYStOne tO tHe COmplexitY OF it reSOUrCeS

Figure 2: Flow of Costs in an Activity-Based Costing Model for IT Services

Activities

Total cost of service For example,

help desk, production, security

typically 50% to 60% of costs taken through an activity-based costing methodology

expenses specifically incurred for the business

unit

IT line-item expenses

Unit cost of service

demandBusiness unit

Cross-charge

expenses specifically incurred for a service

Cost pools

Other line-item expenses Hr, facilities

7SAP Thought Leadership – integrated Services Costing and performance management

Compiling an Activity Dictionary

Organizations that have adopted itil services management may benefit by starting with the standard itil services library when compiling an activity dic-tionary. not only does this provide internal consistency, it is also useful when benchmarking against external organizations. However, in many instances, it may be necessary to expand beyond the standard frame-work provided by itil, COBit, or other programs used as the template for it management.1

Options for Cross-Charging

Once the total cost of a service is cal-culated, there are various options for deriving a unit rate for cross-charging the business units for their use of the service.

demand-Based pricing if you want to fully allocate the total cost of the it function across business units, the unit rate charge is typically based on the total cost of the service during the period, divided by the actual demand for the service during the peri-od. this leaves the it function with no residual costs.

Capacity-Based pricing With a capacity-based pricing method-ology, you can base the rate on the total cost of the service during the period, divided by the amount of the service available during the period. that is, it’s based on the capacity of the it function rather than the demand of the business units. if the service is overresourced and the it department

can provide more than the business units consume, it will be left with resid-ual costs – and this may drive capacity reduction during the next period. this pricing methodology is particularly useful for pricing in situations where storage, network, or virtualized servers are provisioned but not yet utilized at optimum capacity.

Underrecovery or Overrecovery of it CostsSome shared-services units operate as profit centers and, in these instances, aBC may be used to calculate a rate based on either of the methodologies above. in this situation, you can add a fixed or percentage markup to the rate before it is charged out to the business units.

Ultimately, the choice of pricing meth-odology can lead to an underrecovery or overrecovery of it costs. Unless you set governance rules for how any under- or overrecovery of it costs will be balanced out in future periods, the business units may be resentful, feeling that they’re being “overcharged.” You should also explore whether it’s pru-dent to have underrecovered or over-recovered amounts in your year-end accounts; you may want to involve your auditors in this discussion.

there is also scope for bundling and pricing services in various ways – both to make it easier for the internal cus-tomer to understand and, more impor-tant, to motivate business users to change their behavior. this may involve bundling the provision of a laptop with standard software, e-mail, security, and internet access or varying unit rates

across the day in an attempt to utilize off-peak capacity.

adopting an aBC methodology for costing it services provides a detailed understanding of the services provided by it, the activities involved in providing them, and how they consume resourc-es and costs. detailed invoices can be produced showing the business units’ use of a service, the unit price, and the total cross-charge. Should more detail be required, an aBC methodology makes it possible to trace costs back to their origins. By fully understanding what activities are consuming resourc-es and costs, and which are value add-ing or non–value adding, business units and the it department are better placed to discuss and understand how they can work together to reduce costs. this may involve no more than taking simple steps to adjust service levels, such as response times or batching transaction processing, to give reduced setup costs. removing unnecessary, non–value adding activities can help to reduce costs far in excess of the cost of deploying aBC, giving an immediate return on any investment.

1. the control objectives for information and related technology (COBit) is a set of best practices for it management created by the information Systems audit and Control association (iSaCa) and the it governance institute (itgi) in 1992.

8 SAP Thought Leadership – integrated Services Costing and performance management

Your it department needs to keep its resources and operational capacity aligned with business-unit needs. For this to happen, your organization should progress toward more frequent reforecasting so that business units are routinely updating the key nonfinancial data that drives their shared-services demands. the it department can use this information to realign its own resource requirements for the coming periods, taking its reforecast expenses through an aBC methodology to ca l- culate monthly cross-charges that are passed back to the business units. Figure 3 shows how this activity-based budgeting approach fits with activity-based services costing as described above.

the closed-loop methodology de -scribed above depends on a robust activity-based costing model and it is inappropriate to introduce the activity-based budgeting element until a num-ber of iterations of services costing and cross-charging have been done. these iterations provide internal cus-tomers with detailed invoices that help them understand how their depart-ments consume it services.

the first cycle of activity-based budget-ing can be part of an annual budgeting cycle. Once successfully completed, your organization can move to more frequent reforecasting to keep it capacity in line with the changing needs of the business.

actIvIty-BaSed PlannIng and BudgetIng for IttHe WaY tO Keep it reSOUrCeS aligned WitH BUSineSS needS

Figure 3: Closed-Loop Activity-Based Budgeting and Activity-Based Service Costing

Unit cost of resources

resource drivers

activity drivers

resource drivers

Activity-based budgeting

Activity-based service costing Activities

Cost pools

Service costs

New expense budget Changes to both fixed and

variable expenses

activity drivers

Customer Forecasts 10% increase

in staff . . .

Service this means 10% (50) more e-mail accounts for this business unit

New activity level this means increased activity: • 50 user setups • 20 gB additional storage • 20 password resets • 15 help desk calls

New resource level this requires additional resources: • 1 additional support staff • 1 new hardware lease • 50 new software licenses • 10% more disk space

Cross-charges

9SAP Thought Leadership – integrated Services Costing and performance management

a robust costing and performance management solution will bring togeth-er it metrics with service costing, cross-charging, planning, and budget-ing. With a single, integrated solution, you can:• make a piece of data calculated in

one model available to any other model. For example, the unit cost of providing tier-one access to the enterprise customer relationship management solution is calculated in a combined budgeting and costing model. this data is available to anoth-er model where metrics such as unit rates are tracked as part of it perfor-mance management.

• replenish a piece of data required as part of the calculation routine in another model on demand or in batch mode.

• incorporate a piece of data from any model into a user view for both reporting and data entry, giving a single instance update.

Figure 4 shows the architecture of an integrated costing and performance management solution.

comPletIng the PIcture wIth It metrIcSan integrated COSting and perFOrmanCe management SOlUtiOn

many it departments will also have some form of dashboard or scorecard deployed to track their performance across a plethora of metrics. examples of data tracked include availability, incident resolution, and pieces of data present in the closed-loop model above, such as service costs and driv-er volumes. typically, it dashboards and scorecards are backward looking and many seem to exist as a report card to business units rather than being of direct use to it in planning and man-aging its performance in the future. they can also be built as a stand-alone application requiring a large amount of manual maintenance.

Figure 4: Integrated Costing and Performance Management Solution for IT

•What-ifscenarioplanning •Capacityplanning •Driver-basedbudgeting •Activity-basedbudgeting

End-user data entry, query, and analysis

Web or lan

•ITservicescosting •Pricing •Cross-charging •Reconciliation

•Keyperformanceindicators •Performancemetrics •Benchmarking •What-ifscenarios

Plan and budget

resources

Service costing and cross-charging

Measure and

monitor

End-user data entry, query, and analysis

Web or lan

Single open database

One or more interlinked models

10 SAP Thought Leadership – integrated Services Costing and performance management

Summarya mOre COnSidered COnSUmptiOn OF it ServiCeS

Sap® BusinessObjects™ enterprise per-formance management solutions are a comprehensive set of solutions that help your company capitalize on the value of your existing data assets. With these solutions, your organization becomes more agile, gaining organizational align-ment, visibility, and confidence that give you optimal control and competi-tive advantage. these solutions can integrate with Sap Business Suite applications; Sap BusinessObjects governance, risk, and compliance solutions; Sap BusinessObjects busi-ness intelligence solutions; and Sap BusinessObjects information manage-ment solutions. as a result, you can maximize business profitability, manage risk and compliance, and optimize cor-porate systems, people, and processes.

implementing a closed-loop costing and budgeting methodology requires cost-ing and budgeting data to be held and manipulated in an application that offers sophisticated functionality for activity-based costing and activity-based budgeting. the Sap BusinessObjects profitability and Cost management application provides such functionality with on-demand calculation so users can test the impact of changes and receive results in near real time. the application also provides functionality for monitoring objectives and metrics using the same multidimensional data structure, user interface, and assign-ment screens. instead of assigning resources to activities or activities to cost objects, users assign metrics to objectives of differing levels. the net result is data-driven objectives and metrics monitoring with an automated drill-through option that requires mini-mal maintenance or report building.

although an integrated services costing and performance management solution for it may well result in improved pro-ductivity within the it financial manage-ment team, it is not an end in itself. You need to use the insight provided to make more informed decisions – deci-sions that lead to a more considered consumption of it services. the benefit is slower growth of it spending and potentially bankable cost savings, both of which help you reduce it spend to an advantageous level when compared with your benchmarked competitors.

providing internal customers with a monthly invoice that details how they consume technology services can quickly deter the “free buffet” mentali-ty that can prevail inside organizations. it can also lead to a more measured use of those services and remove much of the dissent that can accom-pany charge outs. at the same time, being able to reflect the true cost of it services and support in new business initiatives, such as new product launch-es and geographic expansion, leads to far more commercial decision making.

But one should not ignore the value of the information to the it department itself. there are obvious benefits in

having faster and more accurate bud-geting. With midyear reforecasts, the it department can continually review operational capacity to make sure it is aligned with business needs. Such an alignment can result in additional bank-able savings. Beyond this, there aremyriads of opportunities to leverage the information when making invest-ment, make-or-buy, total-cost-of-owner-ship, or replacement decisions.

the analysis of the it department’s activities is ultimately the foundation of an aBC model and can be a source of cost savings in a way that a charge-out model based on simple apportionment can never be. By systematically classi-fying activities as value adding or non–value adding, a model typically identi-fies costs that you can aggressively target for removal by eradicating need-less tasks and reengineering process-es. the benchmark often cited for cost savings is between 3% to 5% of the total expense base. in many instances, organizations are able to save a higher percentage of the expense base. How-ever, even a modest cost saving of less than 1% of it expenses delivers a com-pelling return on an investment in it performance management.

Shared-services departments tend to plan their resources and budget separately from the operational planning and budgeting process of business units. as the financial year progresses, the capacity of shared-services departments and the demands of operational business units can become grossly misaligned.

11SAP Thought Leadership – integrated Services Costing and performance management

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