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Where did my IT budget go? Lessons to live by

November 20, 2008

One of the greatest challenges facing businesses and IT organizations is the management of the IT budget. In some cases, containment is a more accurate term than management, as IT’s leadership struggles to meet increasing demand for information services. In the extreme, some firms are struggling to avoid a runaway train scenario where IT consumption increases rapidly, and yet they see little obvious business value to be gained from the increased spending. Unless the supply-and-demand equilibrium is managed properly, IT organizations can find themselves in what consultants called the abyss. When all of the IT budget is consumed to maintain existing applications and no budget is available for future investments, the enterprise has gone into the abyss.
Enterprises need to have a proactive and explicit strategy for finding a sustainable economic model for IT products and services. This strategy must include an aggressive unit cost reduction component, perhaps a set of consumption reporting controls, a method for identifying rapidly maturing low-cost technologies (i.e., disruptive technologies), and a mechanism for shifting saved money into investment budgets.
Inertia, often an unmentioned or overlooked part of IT investment justifications, is the root source of many budgetary problems. If we examine the typical enterprise IT budget today, we would likely find that the majority of the budget is spent on keeping the business running with existing applications and infrastructure. Only a small portion of the budget can be appropriated for new strategic ideas. But, ironically, the biggest opportunities are found when putting new ideas into action.

Moreover, the IT budget in a firm can either exhibit the strengths of a virtuous circle or the symptoms of a vicious circle.

Technology Hype Cycle

Waves and troughs are known in the IT industry as the technology hype cycle. As described by the Gartner Group, when a new technology or solution emerges, unrealistic expectations are set by a mixture of marketing hyperbole and high user expectations for a new solution to an existing problem. Typically, aggressive initial spending is driven by the hyperbole and high user expectations. In most cases, however, the first-to-market products are immature and users become disappointed or disillusioned. The trough of disillusionment follows and spending typically declines in proportion to user disappointment. Finally, a plateau of productivity is reached when the technology matures and products begin to deliver real value, meet user needs, and are offered at sensible price points.
A great example of technology hype cycle is eCommerce. Online selling offerings flourished in the late 90s as the Internet and rich media technology together promised to be a panacea for shopping. While the technology did offere a new and richer platform, many developers of eCommerce solutions really did not understand how to utilize the new IT enabled improvements. As a result, many eCommerce applications were simply web versions of existing stores or catalogs. A significant decline in eCommerce revenues resulted when users came to realize what was available. Today, the eCommerce industry is beginning to emerge from the trough of disillusionment as customers begin to understand how eCommerce fits as part of an overall blended consumer strategy and as eCommerce suppliers take advantage of maturing technology to deliver better eCommerce solutions.
Firm Revenue and IT Budget and Demand
As ServiceXen’s CEO, I have, struggled to make sense of ServiceXen IT’s own budget after the Internet crash, I began to wonder if there was a pattern for IT budgets related to a firm’s business cycle. The diagram is the first I drew on my white board to show the relationship among firm revenue, IT budget, and demand for IT services for three different business scenarios. This graph provided insights as we struggled to make sense of ServiceXen’s IT budget and an ever-increasing demand for IT services. Since then we have validated the graph through discussions with many CIOs and IT Directors who recognize the same business performance, budget and demand trends in their own organizations. The diagram shows that, irrespective of the firm’s revenue trend, IT demand continues to increase.
• In times of revenue growth, IT budgets will likely expand but probably not at the same rate as revenue growth unless IT is understood to be a direct driver of increased revenue.
• In a flat revenue scenario, IT is often used as a tool to help reduce spending and improve operational efficiencies to improve or maintain profit margins. In such a scenario the IT budget is likely to be held flat or decline slightly.
• In revenue down cycles, IT may be primarily used to reduce fixed and variable costs. As revenue declines IT budgets are likely decline more steeply than the revenue decline, as IT is sometime perceived as having high variable cost that is easy to turn on or off.
• A vicious circle emerges when IT organizations do not invest in developing future IT solutions. The steadily increasing demand for IT services will lead to a scenario where the entire IT budget is consumed by what I call a “keep the business running” mentality.
• A virtuous circle exists when an IT organization successfully develops new solutions that deliver new capabilities at a lower cost. Cost-saving success reinforces itself by providing more funding that can be diverted to further investment in new solutions.

The vicious circle must be avoided. New strategic ideas that will drive the biggest benefit for the business going forward cannot be the investments that receive the lowest amount of funding. If firms do not invest in future-based IT solutions, they are likely to lose competitive advantage. How can IT organizations overcome the inertia that requires the budget to keep existing products and services operational? I believe that firms need to reduce costs aggressively while allotting more of their IT budgets for investment in new IT solutions, solutions that are far more likely to produce strategic value. In other words, firms must strive to develop a virtuous circle.
Notice that demand for IT services continues to grow in each of these business scenarios. I believe that IT is used as a tool for different business objectives depending on the business scenario. The IT demand trend means that when growth is flat or negative, IT organizations will be under severe pressure to meet increasing demand while attempting to reduce costs.
IT organizations themselves need to take advantage of IT to help manage through such scenarios. Namely, the efficiencies that IT has provided to line-of-business functions needs to be deployed within the IT organization. Providing more IT services with a smaller IT budget is increasingly common. In fact, many CIOs and IT directors consider this mode of operation to be business as usual.

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