IT 'Shadow Spending' Has Doubled

From 1995 to 2000, IT spending became the king of capital expenditures, rising from 18.2% of all U.S. business capital investments to a peak of 46.7% -- a substantial jump from $225 billion to $642 billion in five years. Clearly, IT spending has experienced a pullback over the past three years -- as much as 20% from the 2000 peak, according to government statistics. But even though budgets have been challenged, businesses are still hungry for technology. Backlog requests for IT projects have risen over the past three years by more than 30% as older projects remain unfulfilled and new ones continue to arise. These projects include infrastructure upgrades, regulatory compliance, security, integrations and new productivity and business application requests.

The result of the formal budget shortfalls and growing backlog is a remarkable increase in shadow IT spending, also known as "rogue" IT. Business leaders have been gaining stealth approval for technology spending by wrapping equipment purchases, applications and development projects within other business investments. As IT requests continue to pile up, business-unit managers have had a hard time taking no for an answer, and rightfully so. Many of these projects deserve funding, since they deliver quick paybacks and great returns and offer low risk to the company.

Armed with their own capital budgets and resources, savvy executives have found a way around the formal IT spending logjam. But while shadow projects may seem necessary today, they come at a steep cost for the future, when centralized IT will need to integrate these systems back into the mainstream and provide ongoing evolution and support. Original expenditures on project hardware and software typically represent only 20% of the total cost of the project -- meaning that 80% of future project costs may be borne by the formal IT organization.

In the late 1990s, shadow IT spending was estimated to be 10% of the formal IT budget. Most of the shadow IT spending was due to support and training shortfalls from formal IT. Business-unit resources often provide informal support for various technologies and applications as users seek "how to" or technical assistance from local peer experts rather than the service desk. This informal support mechanism was estimated to be four times more costly than formal support. By improving service levels and running public relations campaigns to improve the image of the service desk, CIOs sought to reduce this hidden cost and, in turn, reduce shadow IT. Such best-practice efforts were effective for many companies -- often resulting in 40% reductions in shadow IT costs.

But today's new form of shadow IT spending is much more costly and extremely difficult to manage. Recent research estimates that shadow IT spending has doubled from 2000 to 2003 to consume 20% of total IT spending in the average organization. According to our research, the average U.S. company spent around 3.7% of revenue on IT in 2003, or $10,283 per employee. With rogue spending at 20% of the official IT budget, shadow spending adds more than $2,000 per employee. In several organizations where the business was rapidly changing (typically because of mergers and acquisitions) and formal IT spending was severely constrained, we found shadow IT expenses as high as formal IT spending.

With some budget relief promised in 2004, hopefully the issue has peaked. However, there is a hidden tax for redeveloping or integrating, maintaining, evolving and supporting these stealth projects, and this will weigh heavily on future budget increases. These future expenses cause a dangerous spiral where the growing backlog of needed business innovations drives more shadow spending, which in turn continues to constrain spending on innovation.

So what is the CIO to do? In several organizations, realistic CIOs haven't sought revenge on this wayward spending; they acknowledged that business units had little choice but to go around the system to accomplish their business goals. These CIOs have turned to collaboration: working with the business units to assure conformance to corporate technology standards and to develop transition plans to formal IT for ongoing maintenance and support. CIOs may even be able to use the evidence of shadow spending to get an IT budget increase from senior management. In the long run, companies will need IT governance changes, including refined return-on-investment project reviews and enterprise portfolio management, to bring order to the budget planning chaos and to eliminate hidden IT projects.

Tom Pisello is the CEO of Orlando-based Alinean LLC, an ROI consultancy helping CIOs, consultants and vendors assess and articulate the business value of IT investments. He can be reached at tpisello@alinean.com.

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