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IT Spending Budget Practices

Beyond Service-Level Agreements
By 2003, one third of large enterprises (i.e., more than $1 billion in annual revenue) in
mature industries will attempt to recentralize infrastructure and IT spending. Those that are
successful will recapture 85 percent to 90 percent of total IT spending. Through 2003, IT
managers who do not actively seek synergies of enterprise IT capabilities will show IT
spending levels 15 percent to 25 percent higher than competitors.

Harvesting synergies is a term associated with three enterprise goals for business and IT
managers:

 Sharing enterprise IT best practices to enhance revenue generation

 Exploiting IT economies of scale within an enterprise (i.e., centralization, cost cutting
and consolidation)
 Increasing cross business-unit capability and flexibility

However, enterprises actively engaged in synergistic initiatives should ensure that projects
with time-to-market imperatives are not inhibited by a rush to centralize for the sake of
centralization. Over-zealous harvesting of synergies can hurt an enterprise. The application
portfolio analysis model enables IT managers to view the adverse impact of harvesting.
Each enterprise must determine the extent to which applications and their accompanying
infrastructure are centralized. For example, IT managers can use the following framework to
identify the extent to which synergies can be harvested for different types of applications.

Infrastructure represents the foundation of essential elements (e.g., networks, PCs,

development tools, training and help desks) and the maintenance that is required to deploy,
run and support applications within an enterprise. Utility applications are those that are
essential but not differentiating. These applications may be mission-critical (e.g., payroll and
human resources) but offer essentially no contribution toward improved enterprise
performance. Enhancement applications are those that make an enterprise perform better
than without the application. Better performance is measured in various ways (e.g., speed,
convenience, cost of business operations, working capital requirements and quality).
Frontier applications are those that make a major change in business performance, that
may change the competitive landscape and that tend to be risky at the outset. Examples
include the introduction of the automated teller machine and package tracking.

These are example guideline ratios for centralization vs. decentralization (see Figure 1):

Frontier - 80/20 for enterprise applications and 20/80 for business applications
Enhancement applications - 50/50
Utility applications - 80/20
Infrastructure - 90/10

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Figure 1.

IT managers must ensure that the business shares in the decision-making process for
harvesting synergies. A drive to achieve synergies led by an IT mind-set is destined to
create misalignments. Identification of the business drivers behind synergistic initiatives
should guide technology decisions.

By 2005, the ratio of IT workforce to total enterprise employees will increase to 8.5 percent
from the current level of 6.6 percent for a typical enterprise. That ratio will increase to a
level of 17 percent for enterprises in IT-intensive industries. Furthermore, internal and
external IT workforce costs consume more than 50 percent of the IS budget, comprise a
major component of TCO and are a major determinant in TCO planning. The ratio of IT
workforce to total enterprise employees includes internal and external employees (see
Figure 2 and Figure 3). However, no IT staffing ratio for an enterprise is absolute. IT
managers should determine the most appropriate staffing for their enterprise by assessing
the level of information, its intensity and the capacity to pay for real-time business
intelligence. They should provide appropriate resources and work to improve staff
effectiveness and retention with the knowledge that increasing staff size does not solve all
IT management problems. The effective IS department should have appropriate processes,
systems and automated support, as well as the right staff numbers. These variables
influence IT staffing levels:

 IS organization's sourcing approach (i.e., insourcing vs. outsourcing)

 Skill level of the staff
 IS organization's technology adoption profile (e.g., aggressive vs. conservative)
 Degree of centralization/decentralization of IT services
 Technical architecture complexity
 End users' desired service levels
 Funding and investment approach taken by the IS function

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Figure 2.

Figure 3.

It is critical not to underestimate staffing needs. Failure to anticipate appropriate IS

organization staffing levels will shift spending outside of the IS budget, typically with higher
TCO levels.

By 2003, the combined percentage of internal personnel and external services providers
(ESPs) for large enterprises will consume more than 60 percent of the IS budget. By 2005,
the external workforce will exceed 30 percent of the total labor and headcount. Presently,
external personnel consume 19 percent of the headcount and 23 percent of expenses, which
means per-IT-employee TCO will increase. This is evidence that sourcing outside an IS
organization is, on average, more expensive on a per-person basis.

However, IT managers should plan for a higher percentage of external IT workforce and a
higher portion of the IS budget devoted to ESPs. Driving these staffing statistics higher is
the extent to which global 2000 enterprises will practice selective outsourcing. By 2003, 50
percent of global 2000 enterprises will outsource selectively their application maintenance,
new application development and distributed service. The degree of outsourcing other IT
functions will be far below the 50 percent mark.

Moreover, many enterprises are applying a litmus test for sourcing outside the IS
organization: if the skills for a new project or function will not be relevant past two years,

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then they are outsourced. Redeploying IT staff to new skill areas is difficult for many IS
organizations that consume costs long after staff roles are rationalized. This "cost tail"
makes sourcing externally less expensive if the total cost of staff with orphan skills is added
to the cost of completed projects or initiatives. Ultimately, IT managers should prepare for
greater use of ESPs.

Another important factor for enterprises to address concerns major package

implementation. Contrary to sales hype, completion of package implementation seldom
means a lower IT cost structure. The trend toward outsourcing new development in the form
of major enterprise package implementations is a conspicuous reason for IS budgets higher
than the norm that result in a higher per-person TCO. A typical example of the before-and-
after IS budget "bubble" associated with a shift to a package architecture is that the IS
budget is higher after an enterprise "goes live" with the package, as opposed to the IS
budget figures before implementation planning. This is an expectation problem created by
aggressive vendors and media hype. An IS budget does not necessarily decline after a
package is installed. Figure 4 depicts a case study that is typical of this phenomenon.

Figure 4.

An IS budget-to-revenue ratio may decline over time if revenue increases at a rate higher
than the rate of increase - or decrease - in IT spending. For the case study in Figure 4,
enterprise depreciation and amortization is 20 percent of the IS budget. This figure can be
as high as 50 percent for newly implemented enterprises. A primary reason for higher
spending after implementation is a centralized IT infrastructure and spending around
package implementations. For a typical enterprise, a major implementation will consume 25
percent to 35 percent of the IS budget for a two-year implementation, whereas problem
implementations reflect a total IS budget that is 300 percent of industry norms.

Consequently, enterprises should prepare to spend 10 percent to 20 percent of an IS budget

on package version upgrades. Delayed major package implementation will double an IS
budget if the project enters its fourth year. Any time-to-market or functionality benefit from
the package will be minimized at year three of implementation.

Ultimately, many issues should be considered when establishing budget best practices that
drive effective and efficient IT planning, acquisition and deployment. Using application
portfolio analysis as a framework for cost and activity consolidation will help to prevent
extremes in harvesting synergies. Furthermore, anticipating staffing levels, especially the
effect of ESPs, is extremely important. ESPs will assume an ever-larger portion of the work,
and outsourcing in the form of major enterprise packages will have a tremendous impact on
IS budgets, as well. In addition, it is crucial that the business units be included in the
decision-making process. Thus, IT spending must be aligned with overall enterprise goals.
Analyst: Kurt Potter, Gartner
Writer: Carolyn LeVasseur

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