Today, customers drive business and battle lines have been drawn. Organizations are now obsessed with their customers and are competing as never before to win, serve, and retain them. According to Forrester, by 2020 every business will be either a digital predator or a digital prey; in other words, as prey a company will be a casualty of the battle to win customers.
This business trend has resulted in unrealistic demands being placed on CIOs. As business and marketing will most likely control more than half of tech spending, the traditional role of the CIO has been marginalized; and with new projects designed to win, serve, and retain customers, tech budgets will need to be rebalanced with 50 percent of the tech budget being spent on these new projects. Forrester applies this shift to “business technology” spending as tech purchases designed to influence the customer experience.
As a CIO, you must feel as though you are between a rock and a hard place: by keeping up with rapidly changing customer demands, your budget for ongoing operations and maintenance is reduced by about 50 percent.
This is a tough situation for you as a CIO. While technology is becoming increasingly important to meeting business outcomes, the role of business in tech purchases is also becoming increasingly important. According to Forrester, the segment of tech purchases that have been made by business across all stages of the tech-buying lifecycle is only at about 7 percent of total US new tech purchases. Therefore, CIOs will work collaboratively with business to drive tech investments.
Even though the role of business in tech purchases is increasing, primarily in tech-buying life cycles where business leads or collaborates in initiating the purchase process, the CIO’s department still plays a major part in the process: choosing the vendor, implementing the solution, managing the vendor relationship, and paying the bills. Thus, CIOs manage the purchasing, delivery, and reporting process that business leaders initiated.
The most important part of this process is making sure everyone at the table is speaking the same language. To help you do so we have put together what we consider to be the top four financial metrics for analyzing and prioritizing IT expenditures:
- IT Spend Ratio
As a CIO, you’re probably involved in IT portfolio management where you’ve stratified the IT investment portfolio into four investment categories: infrastructure, transactional, informational, and strategic. You’ve aligned these categories to the type of benefit delivered by the investment.Over the past few years, there has been a move from type-oriented categories to stratifying investments by benefit horizon and strategic nature, with a focus on top-line business growth. You can now manage investments in a way that better reflects the value of the investment to the business. Portfolios now include: run-the-business (RtB), grow-the-business (GtB), and transform-the-business (TtB).You’ll need to keep a balance regardless of how you stratify your investment portfolio. Many CIOs are looking for cost improvements that will reduce their RtB investment ratio as a percent of total IT spend, so that they can then increase their investment ratios in GtB and TtB.
- Return on Capital
One of the reasons why many SaaS companies have prospered is their ability to revolutionize this key metric. The ability to fund projects with OpEx (operating expenditure) flowing through an income statement, rather than CapEx (capital expenditure) burdening the balance sheet, has been a dramatic shift that has helped optimize return on capital. Nevertheless, key financial metrics still need to deliver fantastic ROI (return on investment), rapid payback (the number of months to recoup your investment), and the most valuable metric for ranking, IRR (internal rate of return).A key reminder: some of these metrics can be complex, and accounting practices that govern the capitalization of costs differ from organization to organization. Whether you’re an IT executive or a CIO, you need to clearly understand how the rules apply to your organization. It’s essential that IT Finance collaborate on this topic.
- Fixed to Variable Cost Ratio
When you consider that nearly two-thirds of most IT budgets are fixed costs, then it’s evident that a variable cost structure is an option that needs further investigation. As a variable cost structure delivers both agility and flexibility, a lower fixed-to-variable cost ratio could be better for your business. When you maintain a higher proportion of costs as variable, it’s frequently more cost effective to scale up or down based on changes in demand.It’s key to monitor the fixed-to-variable cost ratio. The ratio needs to balance with business requirements—and it’s not always advantageous for it to be lower. In the case of an organization with economies of scale and low volatility, a higher proportion of fixed costs might be beneficial. However, if you operate in an environment of regulatory change, technology disruption, industry consolidation, uncertainty, rapid growth or decline, or any other external factor beyond your control, then a lower ratio of fixed-to-variable cost will allow you to be more market-agile. In today’s climate, we view the ability to react immediately to changes in business environment as a distinct competitive advantage.
- Actuals versus Budget
Like most organizations, you probably work on your budget with Finance once a year, while every month you forecast for either a given period or for a project. You need clear definitions of IT services with associated compositions, allocation methods and pricing all incorporating fact-based fair market value. When you conduct monthly forecasts, you compare to actual expenses and determine variances from budget. Then what? Here’s where collaboration between Finance and IT, blended with the proper fixed-to-variable cost ratio, can really make a meaningful impact on the organization. Without an awareness of the “where” and “why” of those variances from budget, then it’s just meaningless numbers on a page, and it will be tough for you to manage an IT budget effectively.Healthy IT Finance collaboration and the right business insights will help you unlock these variances from budget, and turn them into proactive changes. Ensure your stakeholders are informed of the effect of these variances on business units and on the business as a whole. Proactively recommend that if shortfalls exist you can neutralize variances by reducing expenditures, and if a budget surplus exists you can invest it back into the business to focus on high-return strategic initiatives.
IT financial metrics are essential to the business
The core value they add to your business is invaluable. IT financial metrics:
- Demonstrate value to the business in a way business leaders understand
- Enable IT leaders, IT partners and business consumers to make decisions that enhance business value and optimize change-readiness
- Help to ensure a better business alignment
To ensure IT financial metrics add core value to your business, you require the skill sets, processes and systems to generate efficiency and transparency, as well as the people and mindset to take the actions necessary to be the digital hunter, rather than the digital prey.
Originally published in Direction IT Magazine.