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Cost Allocation Metrics and Challanges

June 11, 2008
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When starting to quantify and distribute IT service costs, it is very useful to also start quantifying IT performance in order to demonstrate value for money to IT’s customers and to be able to benchmark IT performance against peers and third-party service providers. An IT function that thinks and acts like a business will be better for its organization and IT employees alike.

Few businesses would disagree that cost recovery through allocations should be service-level based. There are many ways to do this, all beyond the scope of this paper except for brief mention. One way of approaching this is to establish service level agreements (SLAs) supported with metrics to bolster a cost allocation program. A performance measurement and tracking program, even with a formal SLA, can also be used to support allocated costs. Without some way of supporting costs, resistance to allocations can be fierce.

Performance metrics – whether managed by SLA or not – can measure the volume of work, quality of work, responsiveness, efficiency, and compliance with controls. Some popular metrics include:

  • Cost of support as a percentage of revenues.

  • Support headcount as a percentage of total company staffing.

  • Headcount allocation ratios (managerial/supervisory, telephone support, e-mail support, Web content development, services, clerical/ administrative, other).

  • IT incident mix.

  • Percentage of help desk calls resolved by first level support.

  • Performance by application.

  • Successfully implemented changes per application.

  • Application uptime.

  • Network uptime.

  • Monthly payroll per employee.

  • Monthly overhead per employee Incidents per employee.

  • Average call length.

  • Number of “process exceptions” per month.

  • Number of audit issues resolved.

  • Number of training days received by IT staff.

  • Number of security incidents.

  • Components of the business recovery plan that were tested.


Missing Business Case

The first challenge to confront is organizational resistance to IT cost allocation. Many organizations will look to better manage IT costs through alternatives to allocation, including implementation of best practices in IT, detailed audits of IT services conducted by internal or external auditors, and implementation of better business governance over IT (as, for example IT steering committees can provide). IT departments themselves may not be easily convinced that cost allocation and functioning as a separate business unit will be in their interest.

These (and other) tools and methods are valid ways of managing IT services and costs in their own right. The thing to remember is that a decision not to allocate costs is usually made because of an unclear cost-benefit proposition (or simply because it is considered too much effort). That is why you must spend time up front in making a clear business case for IT cost allocation, and explaining why it is better for departments and entities to have a clearer picture of their IT costs, and better for the overall organization to do so. Always keep in mind the balance between getting the allocations “right,” and the costs of doing so. If the rest of the organization appreciates the cost-benefit and understands that this will make IT more accountable for the services it provides and charges for, then this challenge can be met successfully.

Lack of Transparency

Resistance to the cost allocation methodology may also arise if the allocation methodology is not well publicized and understood. To counter this it is advisable to agree to the allocation methodology with senior management and publish it. A black box methodology only invites problems. Also, it is important to review the allocation methodology regularly to make sure it works and produces the desired effects.


The primary symptom of an overly complex cost allocation system is one in which the costs of implementing and maintaining this system outweigh the benefits. Contend with this by using the 80/20 rule – most of the benefits will most likely be realized by allocating 20 percent of the most critical costs. Remember that cost tracking has a price – you may need additional software and/or hardware to log and track certain cost drivers at the level of detail required. Also, the systems integration work and manual effort involved in putting together an allocation system will have staffing and perhaps software costs. Do not try to be too exacting in assigning every last cost element, or recognizing every possible interdependency between departments, projects, and costs. Doing so will escalate costs too much.


One common challenge results from being “married” to one particular choice of cost methodology. Accountants will argue for one approach over the other, but the bottom line is that the methodology must be right for your organization, which means:

  • It achieves the right cost/benefit mix.

  • Is simple and understandable to line and senior management.

  • Motivates and informs the right behavior and decisions.

If any of these objectives are not being met, then you will need to revise your allocation methodology.

And recall that allocation bases, cost estimates, services provided, and rates can change regularly, as can organizational structure and product/service mix. Simpler allocation systems are usually more flexible in these cases.

Difficulties in Tracking Usage

Technology change has made tracking and charging for some services more difficult. Remote/Internet access to services and use of wireless technologies can make it more difficult to identify who uses certain services. Where there are no easy technical solutions, some organizations are allocating costs based upon whom might reasonably be expected to use these services (rather than actual usage. The important thing is not to get waylaid into trying to find a technical solution for all possible ways of subverting the methodology (again, think cost-benefit).

Allocation Cannot Value Business Knowledge

It is always difficult to fully quantify the value of internal organizational, process, and business knowledge by IT staff. To some extent this will be built into salaries/contract rates and in training costs – both of which should be allocated. When comparing your organization’s benchmark IT performance metrics and costs with peer or external figures keep this in mind. Many organizations that outsource all or part of their IT services function have noted that while programming costs may decline, costs of hiring new business analysts and/or technical writers to capture and communicate process and business knowledge to the outsourcer may increase.

Business Unit Responsibilities Not Met

One challenge to any cost allocation strategy is that it does not take into account the responsibilities of the business units to IT – such as providing clean input data, following IT procedures for end users, being available to test applicable systems fixes, and the like. Where business units fail to meet IT expectations or are unresponsive, IT costs will rise through the need for data fixes, re-work, and other activities arising from the need to compensate for these deficiencies.

This is where a service level agreement between the business and IT is crucial. The SLA would describe not only IT responsibilities to the business, but also IT’s requirements of the business. If the business is allocated higher-than-expected costs as a result of unmet IT expectations, the reason for such will be clear.

Tax Surprises

Remember that allocating costs internationally and/or across legal entities constitutes what is known as transfer pricing. This takes cost allocation completely out of the realm of “funny money” and into a situation where actual profits, losses, and tax liabilities (and compliance) can be affected. Besides taxes, there may be an impact upon tariffs and customs duties. Where IT costs are denominated in one currency and are allocated to a unit that uses another currency, foreign currency risks arise. Because of these impacts, it is essential to design international or cross-entity cost allocation along with expert resources in transfer pricing and international taxation.

Failure to Consider the Systems Implications

Don’t forget to plan for systems integration and processing considerations when thinking about a cost allocation system. Consider the following:

  • Where will allocations be managed? In your ERP/accounting package? A specialist cost allocation system? An end-user developed spreadsheet or database? Whatever the choice, make sure it will support the allocation methodology and can be configured to do so.

  • Can you capture accurate and effective cost driver information for the chosen drivers? Most telephone systems, for example, have fairly good call logging capabilities. Increasingly sophisticated network management systems can also support very detailed usage tracking and network traffic analysis. How about your application systems?

  • Even where you can capture the required cost information, how will this information be fed into the cost allocation system – manually or automatically interfaced?

  • If you will be allocating IT costs to projects, then these feeds may need to include HR feeds of permanent staff costs, contractor costs, timesheets, travel expenditures and other expenses, purchasing information, A/P, inventory, G/L, manufacturing, and possibly from project management systems.

  • Beyond just the software, does your chart of accounts setup include the cost activities (departments, products, services) required by the allocation program? Chart of account changes must be done carefully and in coordination with your accounting function


By making IT costs more visible vis-à-vis the services provided, a successful implementation of IT cost allocation may in fact bring on momentum to deploy value-cost strategies like:

  • Workflow and process improvement.

  • Data center consolidation.

  • Server consolidation.

  • Application rationalization.

  • Implementation of enterprise applications.

  • Implementation of self-service applications.

  • Database rationalization.

  • Storage consolidation.

  • Centralization of purchasing/better negotiated contracts.

  • Software application deployment and usage management and tracking.

  • Selective outsourcing of low value/high cost IT activities.

Implemented in tandem with IT performance metrics and SLAs, IT services cost allocation can provide an effective benchmark of internal IT service costs with external service provider (outsourcer) pricing. The organization can then factor in the extra costs of selecting an external provider, setting up the infrastructure to use that provider, and providing oversight to the provider, to make an informed decision about outsourcing (or not).

A successful IT services cost allocation program is mainly a function of following these steps:

  • Understand cost allocation and what it can do for your organization, and for your IT department.

  • Treat a cost allocation deployment like any other business/IT project.

  • Bring together business, IT, accounting, and tax professionals in this effort.

  • Analyze processes, activities, and costs.

  • Choose an allocation methodology.

  • Analyze allocation results with affected stakeholders.

  • Gain consensus on service levels and how to measure them.

  • Avoid over-complexity in your allocation model – and pass all of your allocation results through a common-sense check

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