Trimming for Dollars

CIOs have been cutting costs for years - and not seeing those savings coming back to IT. That's why you have to learn to cut strategically

Reader ROI?

• Where the savings are
• Separating the operations budget line from the innovation moneys
• Five rules for infrastructure rationalization

Two years ago, when Richard Toole became pharmacy service provider PharMerica, he faced two very tough challenges: reduce IT costs and earn the trust of the business. At the time, IT organizations all over the US were facing similar pressures. The country's economy was still stumbling after the double blow of 2001's terrorist attacks and the turn-of-the-century financial scandals. At PharMerica, the pressure was even greater. The IT organization that Toole inherited had little credibility within the organization, and had even less when it came to driving cost savings itself.

"We used to be called the 'helpless desk' when I joined," recalls Toole.

Toole knew that unless he changed his department's relationship with the business, IT would always be viewed as a cost centre, facing an endless stream of declining budgets dictated by others. So he was determined to demonstrate financial discipline by managing IT strategically, correcting inefficiencies to cut costs before he was asked to. That strategy paid off, and the trust Toole earned not only allowed him to determine the cuts and their nature but also permitted him newfound say in where the savings he reaped could be redirected.

"I wanted to not just cut costs but also build capacity for the future," he recalls.

First, Toole invested in building a help desk system so he could bring the poorly performing outsourced desk back inside the company. That addressed IT's most visible failure. He diverted some resources to creating an architectural team so IT would no longer be managed in silos, reducing redundancy while increasing agility. And he invested in increasing business, leadership and developer skills so his staff could deliver better service and applications with an eye toward adopting modern approaches such as service-oriented architecture and Web services.

Toole's experience is hardly unique. A CIO Executive Council survey in April found that 12 percent of the 51 CIOs interviewed faced what they called "very high" pressure to cut costs, while another 28 percent had "significant" pressure. "In a lot of cases, all the business expects of IT are tactical decisions. It's viewed as an order-taker, a big cost, just data processing," says Dennis Gaughan, research director for IT governance at AMR Research.

CIOs have already done a great deal of work cutting costs. But all too often the money they've saved has disappeared into the maw of the business, never to be seen again - at least not by IT. That's why CIOs can't just cut costs; they have to have a strategic plan to cut costs. And they have to leverage that plan to gain or maintain a seat at the organization's strategic table. In that way, the cuts they make can be transformed from a way of slowly bleeding IT to death to a way of adding value to the company.

Cut, but Cut Smart

"A lot of the [IT] cost savings in the last three to four years have been accomplished by shrinking budgets," says Greg Bell, a partner in the information risk management practice at audit, tax and advisory firm KPMG. In most cases, IT cut costs without determining whether those efficiencies increased costs elsewhere, increased business risk or short-circuited a potential strategic initiative for the business. For example, the management team of residential real estate company Crye Leike Group asked CIO Gurtej Sodhi to consider outsourcing the company's call centre. Sodhi declined.

"My call centre is one of the biggest advantages we have over our competition. The potential savings did not justify [outsourcing] it," he says. Sodhi saw the call centre as the customer's touchstone to the company, and he wanted to invest in it by taking better advantage of customer intelligence for cross-selling and targeted services. That's hard or impossible to do with an external, outsourced call centre, he says.

"CIOs may find themselves in a hole by not managing [cost cutting]," says James Kaplan, a partner at the consultancy McKinsey & Company. "Fortunately, we're seeing in the last 18 months more strategic direction from the CIOs on cost cutting." That's because optimism about future growth has turned the businesses' priority from cutting costs across the board to building long-term efficiencies that will permit IT to focus on helping the business grow.

"In 2002-2003, there was a need to reduce costs quickly," he says. That period, according to Kaplan, is over.

While CIOs will arrive at different conclusions about what costs to cut and how to make those cuts, there are several universally applicable strategies that Toole and other CIOs have found successful. They include making the IT costs of business technology demands clear to senior management so you're not stuck with supporting unfunded mandates long-term, separating IT operations from innovation initiatives, and making the infrastructure - which Forrester Research says typically consumes 76 percent of IT budgets - both more efficient and less complex.

The implementation elements of a successful long-term infrastructure reduction strategy are deceptively simple: standardize as much as possible to reduce complexity; get rid of hardware, data and applications you no longer need; and understand the cost and value of delivering each IT service so you can determine what to outsource, automate or manage at the appropriate level of staff.

But while these elements are straightforward, translating them into action can be hard. That's where your department heads and technology experts come in. With a clear strategy in place, they can choose the right solutions. And IT can then focus on delivering what the business really wants and needs, says Alex Cullen, principal analyst for IT management at Forrester Research, "not just be some general corporate overhead target".

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Know the Value Before You Cut

To cut costs strategically, you need to understand your actual costs and the value of your various technologies, services and business deliverables. Otherwise, the cuts you make may degrade important business processes and reduce their value. A good way to clarify these issues is to seek expertise.

"Add a finance person to your staff to help you understand your costs and cost drivers," suggests Forrester's Cullen. And be sure to make the costs associated with specific business initiatives clear to the business process owners so that they understand how much you're spending to support them. That can help the CIO team up with other business managers to re-evaluate the service levels they demand or the value of the IT they're using and demanding. Essentially, this approach treats IT as a portfolio of services and resources. "This improves demand management, so the enterprise picks the right things to spend money on," says AMR's Gaughan. "Portfolio management is a good approach for long-term savings," he adds.

PharMerica's Toole used this approach, following the accumulated costs of each business application through the accounting ledgers, to figure out what his largest application support costs were and how they were accounted for in both business and IT budgets. (Hardware leases and purchases were his biggest expense, followed by software support and maintenance, then long-distance, local and data communications.) "We then made some attempt to calculate the value these expenses returned to the business," he says. This exercise uncovered significant waste in equipment leasing costs (mostly for old, unused or underused equipment). Not only was Toole able to reduce his leasing costs, he also got some rebates for unused equipment. But he also went further, citing the discovered inefficiencies as reasons to launch a more sweeping IT consolidation effort, getting rid of unnecessary servers, consolidating data and applications onto fewer servers where possible, and reducing special-purpose servers, applications and oper ating systems. That resulted in both equipment savings and lower labour costs, as less management overhead was needed.

Toole's cost and value analysis also led him to stop outsourcing his "helpless desk". He applied the labour savings from the infrastructure consolidation to manage the help desk internally. Although his dollar cost didn't go down, the quality of service went up dramatically. And that showed his company he could both drive fiscal restraint and improve service. Over time, that approach won Toole a separate IT innovation budget - a recognition that IT was not merely a service organization. And that in turn let Toole focus on building the right IT infrastructure (as well as applications and integrations) instead of just squeezing the one he inherited.

Other CIOs have benefited from similar cost and value analyses. For example, Crye Leike CIO Sodhi analyzes every IT infrastructure project through three lenses: project cost, the impact on productivity and competitiveness. Like Toole, he found many inefficiencies in the organization he inherited, including 28 percent in excessive costs for telecom circuits and PBXs, 25 percent wastage in server utilization, 30 percent wastage in storage and inefficient distribution of IT staff to regional offices. "My CEO still says that I'm the biggest spend in the company, but he knows it could be a lot worse if we weren't as efficient as possible," Sodhi says.

To ensure that his company's cost and value analyses are on target, John Von Stein has created an IT service catalogue to benchmark unit costs against peers and research firms' recommendations. The CIO at the financial transaction processor The Options Clearing Corporation works closely with the finance department on this effort. As a result "we have a good handle on the costs", Von Stein says. "And our business partners understand that if you put several straws in the milk shake, it's coming out of the same pool."

Separate Operations from Innovation

With the costs and values understood, CIOs can separate their operations from their new initiatives. This not only lets the business understand the balance between the services it has come to count on and the services it may want to add, but also the long-term implications of making new demands on the infrastructure. "Remember that every project you did the year before goes into maintenance," says Forrester's Cullen. Truly appreciating that cold calculation helps the business team comprehend the long-term implications of technology initiatives, and also helps ensure that the CIO is always on the lookout for efficiencies to make room for those new operational requirements, he says. The average company spends about 76 percent of its IT budget on maintenance, operations and support, Cullen notes, while efficient companies fall between 50 percent and 60 percent.

But the separation should not be just about budget lines. The separation also helps CIOs identify which staff and technologies are core to the business and which ones aren't. By definition, innovation is core to the business, but that doesn't mean everything else is not. Within the operations part of IT, the CIO needs to understand which aspects require special skills or focus, and which are routine. This analysis helps determine both where to target efficiencies and where to invest.

For example, manufacturer ThyssenKrupp Elevator discovered that it could safely outsource mainframe and AS/400 operations to reduce costs, but it could not outsource network management. That's because the mainframe and AS/400 systems management is "fully stable, fairly repetitive and low-volatility", says CIO Jim Miller. But it made more sense to invest in internal network management skills since ThyssenKrupp's 180 or so locations required intimate knowledge of the network connections and relationships among the locations, a level of ongoing focus that Miller concluded an outside vendor could not deliver.

Similarly, document-processing equipment manufacturer Bowe Bell & Howell concluded it could outsource desktop support but needed to reallocate some of the IT staff budget to work on its ERP deployment. "We were heavily invested in resources for the infrastructure, which were not lined up to our strategic areas," recalls CIO Ron Ridge. Properly providing desktop support for the company's 2000 employees, 1400 of whom are in the field, would have required a significant investment in help desk management systems, he says, yet what the company really needed was to build on its ERP deployment to help the business team improve productivity and increase revenue. Understanding the operational/innovation separation made the need to change the IT strategy clear.

By understanding which functions are strategic, ADP Employer Services CIO Bob Bongiorno has been able to increase the budget for IT staff working on new development efforts by 17 percent from 2005 to 2006, permitting growth from 575 to about 690 people, while keeping his overall budget nearly flat, rising just $US1 million this year to $US116 million. The extra money for new development efforts came from a variety of sources, including streamlining data centre operations and reducing maintenance costs.

While such separation is useful for strategic management, there needs to be communication among these two IT groups and the business to ensure that each does not go its own way and end up creating an environment where operations prevents innovation or where innovation strains the infrastructure. At the diversified manufacturer United Technologies, CIO John Doucette uses a CIO council to coordinate savings strategies among the company's divisions.

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Five Rules for Rationalizing the Infrastructure

While there are many ways to achieve efficiencies in IT infrastructures, they tend to be variations on one basic approach: reducing complexity. "The key levers are simplifying, standardizing, consolidating and centralizing," says John Balboni, CIO of International Paper, who has cut IT costs by 25 percent over three years even though his company has been involved in a number of acquisitions during that time.

"It requires standard processes to do real consolidation," advises KPMG's Bell. So any infrastructure rationalization needs to start with understanding the underlying business and IT processes, making them efficient, then adjusting the infrastructure to support them. Part of that effort includes rethinking the service levels IT provides to the business, says McKinsey's Kaplan. "Do you need 24/7 support for all applications?" he asks. "Do you need disaster recovery for all applications?"

Service levels should reflect business criticality, since achieving high service levels adds significant labour and technology costs. "You have to show [business departments] what they can live with - service is really a level of grey," says Khris Hruska, technology director at child-care and education provider Learning Care Group. To do that, Hruska worked closely with business managers to help them understand what service levels they really needed. Then he tuned his resources accordingly.

1.Don't Keep Multiple Systems

One way Balboni has kept costs down is by not keeping acquired companies' IT infrastructures. That allows efficient usage of technology and staff while also ensuring that the business has a unified view of its customers and operations. "You don't want to serve the customer out of two systems," he says.

"You have to have the same system," agrees John Williams, CIO at retailer Party America, which has grown from 36 stores to 300 in three years through a series of mergers and acquisitions. During that time, his IT staff only doubled from six to 13, thanks to enforcing the same point-of-sale and back-end systems on all the acquired entities. "Every time you have a merger, you're at a crossroads. Do you go with theirs, or do you go with ours?" he says. At Party America, Williams went with his. It wasn't a question of which technology was better - both his Oracle-on-Linux environment and the acquired companies' AS/400 environments could do the job. It was a question of what skills his IT staff had. They knew the Oracle-on-Linux environment. Williams is also reducing the number of broadband providers to his stores to make vendor management and support easier.

It's not just companies dealing with mergers and acquisitions that can take advantage of platform reduction. For example, ADP's Bongiorno expects ADP to save $US50 million per year by consolidating 30 data centres into two by 2009. The company had been decentralized, with separate IT operations at each customer centre. Centralizing the operations not only will reduce IT staff but also will allow higher utilization of equipment. "The biggest piece has been around getting more clients on a server," says Bongiorno. Doing so reduces labour, licensing and hardware costs.

2.Routinize the Routine

The easiest way to save is to invest fewer resources in repetitive, predictable tasks, since labour is usually the largest cost in any IT organization (typically half the budget, says McKinsey's Kaplan). There are several ways to reduce that labour cost: automation, simplification and outsourcing. Often, companies employ a combination of these tactics.

Outsourcing can save money, but not always. "A lot of companies don't know the cost of a service before they outsource it," says AMR's Gaughan, so they don't know if their actual costs have gone up or down. For outsourcing to be effective, "you need to think through the control issues up front so you have the ability to hold them accountable", says Bowe Bell & Howell's Ridge. "You need a higher degree of process management when you offshore," adds Kaplan.

CIOs should approach outsourcing in a nuanced way. For example, Bowe Bell & Howell found it cheaper to outsource desktop support and ERP hosting than to maintain its own staff and IT infrastructure for these tasks. But it manages its telecommunications systems because it doesn't want to take any risks with the customer data that telecomms brings in, Ridge notes. ADP has hired cheap staff in India and Brazil to code its applications, while retaining the higher-skill project management and development staff in the US, says CIO Bongiorno. And ThyssenKrupp saved by outsourcing its mainframe and AS/400 operations, but it also saved by firing its network management outsourcer and bringing those operations back inside the company.

On the technology front, CIOs are often pitched automation systems and virtualization as ways to gain labour efficiencies. Both are new technologies and thus tend to come from start-up providers focusing on one aspect of IT, says AMR's Gaughan.

At International Paper, "we work a lot on automation", says Mark Snyder, the senior manager for connectivity solutions. But some of that effort has involved developing its own monitoring tools to ensure they map to the company's specific processes.

Virtualization technology saves labour by simplifying the provisioning of servers, making it a software operation rather than a hardware setup task. Virtualization also promises to use more of your existing server resources, reducing the need for additional hardware. It does that by treating the hardware as a pool of computation and storage. So if an application needs just half a server's capacity, the other half can be allocated to another application rather than sitting idle. But because virtualization is a new technology, it requires a more highly skilled staff to manage and can require additional overhead to maintain the load balancing, says Gaughan, adding: "That should decrease over time."

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3.Shift to Cheaper Equipment and Services

The rise of standards-based platforms has helped lower technology costs, and CIOs should take advantage of that (see "Built to Out of Order", page 72). That's why, as part of his data centre consolidation effort, ADP's Bongiorno is replacing expensive proprietary servers with cheaper standards-based ones. Similarly, when it was time for a technology refresh, ThyssenKrupp replaced its Cisco networking equipment with Adtran hardware because of a significant cost difference. And Crye Leike has shifted from installing dedicated T1 and DS3 data circuits at its new offices (it opens several each month on average) to using cheaper DSL connections secured through virtual private networks, says CIO Sodhi.

4.Only Pay for What You Use

An easy way to save money, says AMR's Gaughan, is to know what you have. "Often, companies have more licences than they need," he says, because they manage licences manually and sometimes they lose track. "You won't get your [licence] money back, but you might be able to stop paying for maintenance" on those unused licences, he suggests. PharMerica's Toole even got rebates for some leased equipment after his inventory revealed he was paying for equipment he was not using.

There are tools for asset management, but they tend to be fairly manual and lots of IT groups that use them still lose track.

5.Broom That Closet

Perhaps the most neglected cost-savings opportunity is junking old equipment and software. Companies often leave old applications running or use older hardware as hand-me-downs for noncritical use, such as archival storage or departmental file servers. That's a mistake, as it just adds more stuff to manage, thereby driving up infrastructure and support costs. "Old stuff is evil," says United Technologies' Doucette. "Every asset needs to have a set life."

An added plus is that getting rid of old stuff makes room for new stuff. For example, The Options Clearing Corporation replaces its Solaris servers every three to five years with new models that have two or three times the previous capacity, typically for the same price. That strategy keeps the number of boxes to manage low, even as processing demands increase, says Scott Everhart, the company's first vice president of technology services.

The Best Cutting Enables Innovation

To reduce costs in a way that supports the business strategy requires aligning IT costs to the value of the services they provide, says Forrester's Cullen. "The solution to the CIO's problem is not something he buys from his vendor," he says. "People and processes are the big issues."

The CIO should not expect to retain all the money he saves his organization, but routinely gaining efficiencies "builds credibility with the CFO, COO and the board", says The Options Clearing Corporation's Von Stein. "So we get more latitude in getting a 'yes'." At Crye Leike, CIO Sodhi has a seat at the management table, "so I have a say in how we will use some of the savings".

By having management trust and continually demonstrating a commitment to efficiency, some CIOs get a discretionary innovation budget. PharMerica's Toole has such a budget, and so does ADP's Bongiorno, who gets to keep any savings beyond a set target. "The only way we're going to get more for IT is for us to find the savings," he says.

And that's just fine with him.

SIDEBAR: Chargeback: The Pros and Cons

Should you charge business units for operations?

One way to keep business units from forcing your operational costs to rise is to charge them for their share of those operations. This can rein in ever-increasing requests for technology deployments. For example, at United Technologies, "everything is in the customer's budget", says CIO John Doucette. Well, almost everything: of Doucette's approximately $US200 million IT budget, $US5 million is considered general corporate overhead. "The businesses have to believe there's value in what they're getting. The only way to get that is for them to pay for it," he says.

Other CIOs think linking operations costs directly to specific deployments or business units is a bad idea. "I'm not a fan of chargebacks," says Jim Miller, CIO at ThyssenKrupp Elevator. While business managers can understand why they might be charged for a data line, charging business units a share of basic IT infrastructure "gets us into more arguments than it's worth", he says.

If you do try to charge business units for their share of operational costs, be prepared to do some tough work, says Dennis Gaughan, research director for IT governance at AMR Research. Not only do you have to determine the costs per activity, you need to calculate its value to the business. "That's not trivial," he says. "You have to earn a level of respect with the business before you can even begin to do this level of analysis."

Even if you don't charge back for operations, it does help to have an idea of those rough costs, notes Alex Cullen, principal analyst for IT management at Forrester Research. "Add a finance person to your staff to help you understand your costs and cost drivers," he advises. That strategy works well for Learning Company's CIO John Von Stein. "We don't need to do allocation [to business units] because we have a good handle on the costs," he says, thanks to a partnership with the finance department.