Increasingly, IT managers need to communicate the value of IT and reduce costs while maintaining quality. As a result, they need more visibility into the full costs of IT services to understand the cost burden placed on IT by specific business units. There are many methods for determining this "cost allocation" -- the trick is finding the best approach to provide the most accurate data.
Allocation strategies fall into six main categories:
- Even Spread - Dividing IT costs evenly among business units is the easiest way to perform cost allocation. With this approach, IT cost data is simply split into equal parts. For example, a company might spend $1M on server maintenance each year. If the company has 1,000 servers, that means they spend $1,000 annually per server. The Even Spread method makes good sense for a company that is in the early days of scrutinizing IT spending and wants to quickly establish a starting point.
- Manually Assigned Percentage – This method provides more accurate cost assignment than the Even Spread methodology. With this allocation model, someone in the company who can provide an educated guess of how costs should flow will assign percentages to various categories. For example, if the server maintenance team spent half of their time working on five troublesome servers, each of those servers could get 10 percent of the maintenance costs, or 50 percent of the total maintenance cost budget. This method recognizes there are generally some services consuming a greater share of IT resources than others. In many instances, the data in this method already exists in a spreadsheet-based financial model.
- Manually Weighted - With this allocation system, percentages are no longer important. Instead of adding up expense columns to total 100 percent, a model owner would plug in whole numbers, representing consumption or activity. The manual weightings have an advantage over percentages because they are rooted in solid numbers. With this approach, each asset (i.e. a server) is assigned its weighted share of the total expense and when totaled together, the named asset is linked to the cost of the particular application being supported (i.e. CRM).
- Direct Spend Weighting of Shared Expenses – This allocation strategy typically weighs shared expenses as a portion of overall spend. For example, an entire company may share a help desk or an email database, but dividing those expenses evenly across departments may neither be fair or accurate. To determine how much each department should pay, the cost-based method leverages other IT spending. Suppose a company has $10 million of shared IT expenses and $100 million of IT spending attributed to individual departments. The legal department spends $50 million on IT expenses, or half of the company's IT spending. Therefore, we can then assign half of the $10 million of shared IT expenses, or $5 million, to this department. Grand total for Legal: $50M + $5M = $55M. This strategy is advantageous because it requires no new data. The weighting of attributed dollars is the data.
- Activity Based Costing (ABC) – This method is even more accurate and tracks IT activity that actually happened -- as captured in a system of record -- and then uses those numbers to distribute shared costs. For example, helpdesk costs get allocated according to per-ticket costs that were driven by the helpdesk users. In IT, ABC is most popular where the usage data exists in a readily consumable format, so helpdesks and asset management systems are good sources of activity data. With ABC, each business division can be assured costs are being fairly allocated, not estimated. When a business unit can see they are being charged based on actual usage, they're less likely to object to the charge and more likely to be cognizant of how they're consuming IT services.
- Multi-dimensional – This strategy is a mix of strategies described above, in order to produce a new weighting. The multi-dimensional strategy consists of using two or more dimensions of data at once, in order to produce a single weighting for use in cost allocation. Picture a model with a cost pool of network charges, and above that, a pool of application charges. The goal is to allocate from network costs to the various applications. A multi-dimensional approach might say, "Take the web applications and multiply, for each one, (a) the number of logins, times (b) the number of critical network-related tickets." So, each web application gets a weighting that splits up a subset of network charges across the web applications.
Cost allocations are a core component of any IT financial model that aims to express cost in a manner that makes sense to business consumers. It is common to find several strategies in play at once, with strategies evolving over time and becoming more sophisticated when better data becomes available.
- Jesse Lee, Senior Director, Technical Product Marketing