CAUSE97 Pre-Conference Seminar December 2, 1997 Understanding, Modeling and Managing the Cost of Information Technology: The Activity-Based Costing Approach.

CAUSE97CAUSE97Pre-Conference SeminarPre-Conference Seminar

December 2, 1997December 2, 1997

Understanding, Modeling and Managing the Cost of Understanding, Modeling and Managing the Cost of Information Technology: The Activity-Based Costing Information Technology: The Activity-Based Costing

ApproachApproach

Laurie G. Antolovic’Laurie G. Antolovic’Chief Financial OfficerChief Financial Officer

Office of the Vice President for Information TechnologyOffice of the Vice President for Information TechnologyIndiana UniversityIndiana University

E-mail: [email protected]: [email protected]

Points to CoverPoints to Cover What is Activity-Based Costing? Why should you implement Activity-Based

Costing? What are the benefits of using Activity-Based

Costing How do you implement Activity-Based

Costing? Sharing the Indiana University Experience

What is ABC? ABM? What is ABC? ABM? 11

ABC: Focus on accurate information about the true cost of products, services, processes, activities, distribution channels, customer segments, contracts and projects

ABM: makes ABC information useful by providing value analysis, cost drivers and performance measures to initiate, drive, or support improvement efforts and to improve decision-making.

Why ABC/M?Why ABC/M? Rising cost of information technology (IT) Constrained resources Rising demand for IT services Demand for greater accountability Ramifications of distributed computing External Requirements: compliance with the federal

government’s Cost Accounting Standards (CAS) The total cost of ownership (TOC) concept

What benefits did Indiana What benefits did Indiana University gain?University gain?

Enhanced understanding of IT costs (by the IT organization, the customers and university administration

Proof of accountability (benchmarks, measurements, customer satisfaction, business value)

Understanding the value chain (process improvement, new service and funding models, partnerships and collaborations)

Begin assessing the impact of IT on the university’s core business

What are the uses of ABC? What are the uses of ABC? 22

to determine product/service cost to improve performance of processes and

activities to benchmark to support improvement initiatives evaluate outsourcing of activities to focus improvement efforts by identifying the

“biggest bang for the buck..”

What are the uses of ABC?What are the uses of ABC? (continued)(continued)

to drive a cultural change toward accountability and responsibility for the activities and processes of the business

to effect strategy deployment to improve performance measurement

system to determine value-added/non-value-added

activity costs and ratios

What are the uses of ABC?What are the uses of ABC?(continued)(continued)

to cut cost/downsize to budget to determine and optimize activity capacity to isolate/eliminate cost drivers to charge intercompany cost for support

services performed to kick start dead total quality initiatives

What are the uses of ABC?What are the uses of ABC?(continued)(continued)

to set target costs to quantify the result of improvement

initiatives to estimate/bid on customer work to manage projects and contracts to consolidate operations to evaluate acquisition candidates

How do you implement ABC?How do you implement ABC?A. Design Guidelines A. Design Guidelines 33

1. Simplicity is the key. “Far better an approximate answer to the right question, which is often vague, than the exact answer to the wrong question, which can always be made precise.” (John Tukey, Princeton University.)

How do you implement ABC?How do you implement ABC?A. Design Guidelines A. Design Guidelines (continued)(continued)

2. Remember that every organization is different. The nature of costs varies widely from organization to organization. As such, cost drivers should be different.

How do you implement ABC?How do you implement ABC?A. Design Guidelines A. Design Guidelines (continued)(continued)

3. Understand the objectives you want your cost system to support

Implementation at Indiana Implementation at Indiana University - IT UnitUniversity - IT Unit

AA. The Impetus. The Impetus July, 1995 - A new CIO position (full Vice

Presidency) was just created. Indiana University wanted an analysis of existing IT budget and projection of future funding requirements.

B. Environmental ScanB. Environmental Scan

IT Budget has been flat for 10 years Demand for IT services has skyrocketed Distributed computing: “Why do we a need

a central IT unit?” Constrained resources: “What do we get

out of our tax assessments for IT?”

B. Environmental Scan (cont.)B. Environmental Scan (cont.)

IU’s Strategic Directions Charter: circulating in draft mode but contained a goal of increasing accountability through implementation of ABC

Responsibility Center Management IT unit was organized around service

delivery

B. Environmental Scan B. Environmental Scan (cont.)(cont.)

IT budget authority was distributed; thus various activity centers already had their direct costs identified (e.g. Help Desk- Walk In; Help Desk- Phone-in; Help Desk - E-mail; Help Desk - KnowledgeBase)

Annual User Surveys

C. The ProcessC. The Process Senior IT staff met with University Budget

Director to clarify the charge and the goals Senior IT staff decided on new approach to

presenting IT costs IT CFO designed implementation plan IT CFO served as project leader Involved all staff who have budget authority

D. The ImplementationD. The Implementation

IT CFO conducted series of meetings with budget managers to articulate the goals, outline the steps, outline the finished product, and set completion date

Decision made to report costs based on services to IT customers

Decision made to initially use measures or activity levels already being captured

D. The Implementation D. The Implementation (continued)(continued)

Project calendar, budgets, templates and instructions distributed to budget managers

CFO and staff coached and assisted managers every inch of the way

ABC project completed in 10 weeks Report submitted to IU administration

included ABC report and 5-year projection of additional funding required

Notes:Notes:

1 1 Miller, John A. Implementing Activity-Based Management in Daily Operations, New York: Wiley, 1996.Miller, John A. Implementing Activity-Based Management in Daily Operations, New York: Wiley, 1996.

2 2 Miller, John A. Implementing Activity-Based Management in Daily Operations, New York: Wiley, 1996.Miller, John A. Implementing Activity-Based Management in Daily Operations, New York: Wiley, 1996.

3 3 O’Guin, Michael C. The Complete Guide to Activity-Based Costing, New Jersey: Prentice-O’Guin, Michael C. The Complete Guide to Activity-Based Costing, New Jersey: Prentice-Hall, 1991.Hall, 1991.

Fast Track ABC:Fast Track ABC:

“From the Experience of “From the Experience of Indiana University - Indiana University -

BloomingtonBloomingtonInformation Technology UnitInformation Technology Unit””

Fast Track ABC:Fast Track ABC: Where do you start?Where do you start?

1. Decide on the information you want 1. Decide on the information you want.. Think of your customers: they don’t really care

about your “activities” but they do care about your “output” (the services they receive).

Your activities and associated costs are important to your organization for internal review, process improvement, etc.

Fast Track ABC:Fast Track ABC: 2. Identify your business processes 2. Identify your business processes

--Use information that is already Use information that is already availableavailable

University Information Technology Unit Applications Services (write/select, test, modify,

run software) Data Center (test, select and operate systems) Networks (Data, Voice, Video) (test, select,

operate systems)

FastTrack ABC:FastTrack ABC: 2. Identify your business processes2. Identify your business processes

(cont.)(cont.) Customer Support (answer help desk phone

lines, walk-in consultations, advise on hardware/software acquisition, etc.)

Administrative/Sustaining (Accounting, Payroll, Human Resources, Building Services)

Fast Track ABC:Fast Track ABC: 3. Identify the activities/services3. Identify the activities/services

Example: Support Customers

Maintain KnowledgeBase

Answer help desk phone lines

Provide walk-in consulting

Fast Track ABC:Fast Track ABC: How do you gather information? How do you gather information?

Use historical records and documents (budget document, general ledger, org charts) **

Interview senior and line managers Interview staff Review time sheets or logs Brainstorming session with managers **

Fast Track ABC:Fast Track ABC: 4. List ALL your services/activities 4. List ALL your services/activities

and distribute to ALL involved in and distribute to ALL involved in the analysis.the analysis.

Also provide complete financial information, templates, clear instructions and insure assistance from finance office staff

Fast Track ABC:Fast Track ABC: 5. Identify costs of business 5. Identify costs of business processes or areas. Use your budget processes or areas. Use your budget to obtain the following breakdown:to obtain the following breakdown:

Personnel Hardware and Software Maintenance Data Lines Inventory for Resale Administrative/Sustaining

Fast Track ABC:Fast Track ABC: 6. Allocate the cost of every 6. Allocate the cost of every business process or operational unit business process or operational unit to services/activities.to services/activities.

7. Aggregate your cost of 7. Aggregate your cost of services/activities by process unit, services/activities by process unit, operational unit, funding source, operational unit, funding source, and entire organization)and entire organization)

Fast Track ABC:Fast Track ABC: 8. Share your results with managers 8. Share your results with managers and senior staff. Ask for their and senior staff. Ask for their reactions. If they question the results, reactions. If they question the results, ask them to work with you in ask them to work with you in reviewing and validating the analysis.reviewing and validating the analysis.(This exercise emphasizes the (This exercise emphasizes the operational unit’s ownership of a operational unit’s ownership of a service/activity.)service/activity.)

Fast Track ABC:Fast Track ABC: 9. 9. Incorporate output or activity levels that are already being captured for various purposes. Calculate unit costs. Ask managers to react. Solicit their input on more appropriate measurements. Ask them to help you capture those measurements.

Fast Track ABC:Fast Track ABC: 10. Incorporate customer satisfaction 10. Incorporate customer satisfaction ratings from your survey. Modify your ratings from your survey. Modify your survey if necessary to assure alignment survey if necessary to assure alignment

with the services identifiedwith the services identified..

Fast Track ABC:Fast Track ABC:

11. Make your results available to the 11. Make your results available to the university community. Analyze the university community. Analyze the impact of your IT investments.impact of your IT investments.

12. Use your analysis in your budget 12. Use your analysis in your budget process. At the end of the fiscal period, process. At the end of the fiscal period, validate your costs and measurements.validate your costs and measurements.

The Indiana Experience:The Indiana Experience:Lessons LearnedLessons Learned

Because many university IT services are not directly billed, it is difficult to come up with a list of services or relevant activities (rule: where the rubber meets the road)

Combined bottom up and top down approaches are effective. (If you want a group of managers to come up with your list of services, give them a preliminary list to work from)

The Indiana Experience:The Indiana Experience:Lessons LearnedLessons Learned

Breaking the rule sometimes pays off: Do not blindly follow the textbook rule on cost drivers. IT organizations have large non-personnel costs that cannot simply be allocated based on percentage of personnel activity!

The Indiana Experience:The Indiana Experience:Lessons LearnedLessons Learned

The results of this exercise are quite eye-opening! List your services in descending order according to cost. Graph your results. What services consume the biggest chunk of your IT dollars? See what your customer tells you about those services.

The Indiana Experience:The Indiana Experience:Lessons LearnedLessons Learned

Begin to look at assessing the impact of IT on your organization. Start by looking at how much of your IT dollars go to computerizing overhead operations (e.g. accounting) versus those that have economic value added to your customers (e.g. student computing)