ITPS: Useful, or outdated metric?

Using IT as a percentage of sales as a stand-alone metric offers little insight

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Companies have tracked IT as a percentage of sales (ITPS) since the 1970s. Many boards and CEOs believe that having an ITPS below the industry average indicates that the IT department is functioning efficiently, with good financial control. But ITPS should never be used as a stand-alone metric, because it contains no information about the quality or quantity of IT services provided.

Using ITPS alone is similar to asking whether you want to buy a $20,000 car or a $25,000 car, without revealing the make, model, age or condition. The $25,000 car may be an excellent, two-year-old Mercedes that an estate wants to sell quickly, while the $20,000 car may be a 10-year-old, high-mileage junker with an optimistic seller. I was recently reminded of this principle when visiting a $10 billion retailer that was undertaking an analysis of IT costs. A major consulting firm identified a company with an ITPS far below the industry average and convinced the retailer to aim for a comparable percentage. But just as more data is needed to decide which car to purchase, the retailer needs more information to know whether the identified company's ITPS represents an appropriate target. Unfortunately, some companies achieve very low ITPS by cutting IT budgets to the bone and actually decreasing productivity. Arbitrarily cutting ITPS could harm your company.

A better assessment of IT costs begins with splitting the IT budget into discretionary and nondiscretionary components that can be tracked and evaluated separately. Discretionary costs include creating and installing new IT systems or capabilities. Creating a benchmark for discretionary spending across companies is very difficult. Instead, analysis should focus on comparing actual program costs and benefits against original business case estimates. Significant discrepancies require investigation.

Nondiscretionary costs include operating and supporting existing systems and services. The best evaluations of nondiscretionary spending are based on measuring the unit cost of standard IT services (help desk call, monthly mailbox operation, on-boarding a new employee, etc.) ITIL and COBIT provide excellent descriptions of many common IT services. It is obviously IT's responsibility to decrease unit costs over time.

Calculating the unit cost of each service requires significant effort (especially for multiple level services), but provides valuable data. Unit costs facilitate comparisons to other IT organizations, as well as clearly demonstrating IT's efficiency improvements over time. In addition, unit costs are particularly helpful during political skirmishes. When IT usage and associated costs rise as a result of growing business volumes, business executives often complain. Flat unit costs help address and deflect any attacks regarding the resulting increase in overall IT costs.

Finally, unit costs are critical for sourcing decisions. The cover of a recent BusinessWeek stated, "Cloud computing will save you millions." While this conclusion is debatable, the article will certainly prompt some CXOs to ask IT about cloud migration. Unit costs play a key role in helping IT analyze the financial impact of migrating to the cloud.

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