Determining the Cost of It Services

• Computing (provides desktop/laptop computing, application servers, demonstration systems, and training environments);
• Networking (provides network systems, data services, and Internet/intranet services);
• Voice (manages voice-related applications including telephone systems, voice messaging, cellular phones, and pagers);
• Global Delivery (provides end-user support for all IT services and training facilities); and
• Management Information Systems (supports internally developed business applications and the acquisition and integration of third-party solutions for managing the IT division).

These five major IT groups include approximately 150 business units. Generally, delivery of a single IT service involves participation by two or more groups and many business units. To understand an IT service cost, it is necessary to map the General Ledger costs through common activities that support IT services (see Figure 1). A horizontal cost flow through activities to IT services accurately reveals the resources that are consumed by each IT service.

The first step in ABC is to assign the cost of resources (such as IT support personnel salaries, computing equipment, and other assets such as office space) to the various activities performed by the IT division (such as IT planning, design, and technical support). A cost driver mathematically models the rate at which an activity consumes resources. For example, the percentage of time IT support personnel spend on planning and design could be used when assigning labor costs to the planning and design activity. However, assignments are more complex. The planning and design activity consumes more than labor; it consumes physical assets, such as hardware and software for computer-aided design. Therefore, additional cost drivers are needed to specify the rate at which the planning and design activity consumes these resources.

The second cost distribution step in ABC assigns activity costs to cost objects. A cost object represents an IT service (either an Internet/intranet service or PC service). An activity driver mathematically measures the rate at which an activity contributes to a cost object. Again, “time” is used as a driver. For example, the percentage of time IT planning and design activities are used for developing Internet/intranet services can be used to apportion a percentage of planning and design’s total costs to the Internet/intranet cost object. The end result—a cost object that represents an IT service—is based on the cost of performing those activities that ultimately produce the cost object. These cost objects are, in turn, used to calculate a recharge rate for recovering the cost of that service. A detailed description of each ABC component follows; Figure 2 depicts the ABC calculations.

 Resources.

The IT division budget incorporates all resources used to deliver IT services with General Ledger cost data classified into six pools for tracking purposes (see Table 1). These six cost pools, totaling $90.3M, are depicted in Figure 2. Of the $90.3M, $37.8M is first deducted as direct expenditures for either PC Services ($30.7M) or Phone ($7.1M). Such expenditures are allocated entirely to the corresponding cost object, thus bypassing the ABC calculations; from a cost accounting perspective, these direct charges are very accurate. The remaining $52.5M expenditures support multiple IT services and are traced through the ABC system. Since the Subject Company wants to track IT costs through the 150 business units, six cost pools are calculated for each business unit.

 Activities and Cost Drivers.

A critical decision in the ABC model’s design is the defining of activities at an appropriate level of detail. After all, the choice of activities greatly affects the accuracy and cost of developing and maintaining the model. Detailed activity modeling is usually needed for operations planning and process improvement, whereas more general activity models are sufficient for cost management.

Based on IT manager interviews, seven common activities were determined to describe the work performed by all 150 business units (see Table 2). Since the nature of IT tasks varied greatly across business units, defining activities at a greater level of detail posed the risk of creating tens, or even hundreds, of different activity categories. Furthermore, greater detail would substantially increase the time-tracking system’s data requirements and concern was noted that time-reporting inaccuracy might increase if added options were available.

Each cost driver assigns a specific resource cost to the activity that consumes it. The essential links between resources and cost objects, they are often ignored in most IT cost accounting systems even if they drive significant organizational costs. Reasons for such omissions are usually difficulties in capturing and analyzing pertinent data with which drivers are developed. Rather than disregard the drivers, Liebmann suggests collecting source data to analyze time spent on IT support activities [2]. Drivers can then be based on time allocations.

The Subject Company followed Liebmann’s recommendation. Cost drivers for labor were determined by each employee’s monthly duties, based on the percentage of time each employee directs toward each of the seven activities, with the data gathered from the time-tracking system and employee interviews. However, developing drivers for the other resources proved more difficult since it was impractical to ascertain, in many cases, each activity’s consumption of hardware, software, and physical space. Instead, these non-dedicated resources were assigned to the activities using labor’s activity drivers. This allocation assumes the IT division’s general-purpose usage of computing and physical space is spread proportionately across cost objects, a reasonable assumption since most high-tech labor-intensive functions require higher levels of support.

Figure 2 shows the cost drivers for three of the 150 business units. Each column of the cost driver matrix lists the percentage of effort each business unit expends on any one activity. For example, Business Unit One spends 10% of its total effort on each of four activities: requirement analysis, technical support, keeping current, and administration. The remaining 60% of its total effort is distributed evenly across planning and design (30%) and project management (30%). The cost drivers for each business unit are applied to the corresponding resources to generate the activity costs for each business unit. The activity costs matrix depicted in Figure 2 shows these costs. For example, Business Unit One’s planning and design activities cost $4.6M (30% of $15.3M). The IT division costs for each activity are computed by summing the activity costs across all business units. For example, the IT division spent $9.2M on technical support.

 Activity Drivers and Cost Objects.

Typically, the cost of performing an activity is spread across several cost objects (see Table 3) via multiple activity drivers. Meaningful activity drivers are based on an understanding of what factors would cause activity costs to increase significantly. The driver should capture both the frequency of an activity and its intensity [6]. Drivers such as the number and complexity of pre-project engagement requests, number and cost of projects, and number of help desk requests and call duration were all considered. Again, data limitations prevented many inclusions.

Figure 2 shows the activity drivers for the planning and design activity, which are based on time allocations. The matrix shows that 100% of Business Unit One’s planning and design activity supports PC services. Hence, Business Unit One’s $4.6M planning and design activity cost is allocated fully to PC services. For Business Unit Two, 64% of its $0.4M planning and design activity cost is for server platforms; the other 36% is allocated for administration expenses. Additional activity driver matrices were developed for the other six activities but are not shown in Figure 2.

The ABC assignment for each cost object is calculated by applying each of the seven matrices of activity drivers to the activity costs. Finally, the direct assignment and the ABC assignment are summed to compute the total cost for each cost object. The cost object, representing the total cost of providing that service, is ultimately recovered by chargebacks or user fees. Since the IT division is the sole user of MIS services and administration services, these costs are recovered internally through the division’s budgetary allocations using the recharge rates.

Recharge Rates. Table 4 lists the Subject Company’s recharge rates. In most cases the number of employees was the preferred basis. The fixed rate is justified since the service is based on infrastructure development and maintenance costs and is not affected by usage. However, where utilization was believed to be linked to the number of PCs a user has, then that number was used to form a variable rate. Dual pricing of variable and fixed costs directs clients’ attention to fees that can be controlled. The AT (Advanced Technology) labs, training, and marketing support are fee-for-service products and are negotiated.

To measure the impact of ABC on recharge rates an analysis of the Subject Company was performed. The fourth column of Table 4 lists the recharge rate the Subject Company believed it would have recovered under its pre-ABC budgeting procedures. This analysis combines network services (Internet/intranet, LAN/WAN, and messaging) since it reflects the Subject Companies recharge practices prior to ABC. The last column lists the percentage that would have gone unrecovered under the previous budgeting process. The analysis shows a 15–92% improvement in cost recovery when ABC enabled the IT division to charge out salary, common systems, and other ancillary costs that would otherwise go unrecovered. Similarly, the ABC assignments for training, AT labs, and marketing support provide a cost basis for establishing fees that recover a service’s full cost. Whereas training costs once went unrecovered, they are now being charged out.

Not surprisingly, fairness of charges is important to business unit managers who have no control over their rates [1]. ABC addresses this concern by explaining the cost of service delivery. For example, Table 5 lists the percentage each activity contributes to the cost object, PC Services. The data reveals 81% of PC software cost goes toward managerial and support activities, the most expensive being operations support (19%), technical support (12%), project management (15%), and planning and design (14%). Only 19% of the software’s cost pays for licenses. This analysis exemplifies and communicates the hidden costs. For PC equipment the situation is much different: 65% of the cost goes toward leases with the major hidden cost being technical support at 19%. This improved ability to explain IT charges can positively affect how managers view the IT division’s competence [4].