Next year looms as a tough budget cycle for most CIOs. In the private sector, corporate revenues are showing little growth with a weak economic recovery and corporate profits remaining under pressure despite some recoveries this year. In the public sector, tax revenues are down and state and local governments are struggling to balance budgets after several years of surplus. In this environment, most CIOs will be expected to show flat or lower IT budgets for 2003. CIOs will be under even more pressure than usual to justify and defend their IT budgets. Giga has been receiving calls from CIOs about benchmarks they can use to show that IT budgets are in line with or lower than industry peers. Generally, IT budget benchmarking is a misleading and potentially dangerous practice. Still, CIOs do need to have effective arguments to justify and defend their proposed budgets - and in this article we will provide advice on how to do so.
Justifying the Budget: Three Components
The first step in justifying an IT budget is to recognize that it typically has three components (see Figure 1):
Breaking the IT budget into these three components is a critical first step in any justification effort. Why? Because each component will have different kinds of justifications - and there should be different constituencies within the enterprise that should make the arguments for why this IT spending is important.
In the first category, the CIO will be the one making the justification. Moreover, the size of this component should almost always be flat or lower than the previous year unless there have been major one-time events (like an acquisition or merger, or the final implementation of a new enterprise resource planning (ERP) system) that have shifted the cost base for current IT operations higher. This is one part of the IT budget where benchmarking may make sense - though more to identify potential areas where costs may be too high than to set arbitrary targets for where the IT budget should be. There can be many reasons why comparable companies may have different relative costs of operating the IT infrastructure, such as differences in number of employees (which impacts the cost of supporting and maintaining employee PCs or the number of user seat licenses for a human resources management system), differences in geographic scope or the age of the IT infrastructure.
In the second category, the business units, not the CIO, should be the ones making the justification. Ideally, all new initiatives in the IT budget that directly support new strategic priorities and plans of specific business units should have a business sponsor who is prepared to step up and defend that strategy to senior management - and to justify the IT initiatives that support that strategy. If the business sponsor fails to convince senior management, then those IT initiatives should disappear from the budget. IT should not be pushing business-benefiting initiatives without a business sponsor. Countless failed IT projects and wasted IT investments have taken place when this occurs, and we would strongly advise CIOs not to include any such initiatives in their IT budget. CIOs can and should work with business partners to identify technology solutions that can help business partners achieve their goals - and Giga has published ample research on how CIOs can be successful in these persuasive efforts. But, the business units should be ones that justify these investments, not the CIO.
In the third category, the CEO should be the one making the justification. These are investments that benefit the enterprise as a whole, rather than any specific business unit. Some of these investments may be essential ones to protect corporate assets - such as the Year 2000 compliance initiatives in 1998-1999, or the security upgrades and disaster recovery initiatives that have risen in importance since the Sept. 11, 2001, terrorist attacks. Others are investments in which there can be cost-savings for the enterprise as a whole by making a single, centralized investment instead of multiple, often duplicative decentralized investments. The job of the CIO is to build and document the case for these investments well in advance, present that case to the CEO and other relevant senior business leaders like the CFO, the general counsel or the head of corporate auditing, and convince these executives of their importance. Any initiative of this kind that does not have CEO backing and support should not be in the IT budget. At the same time, the CEO should not serve as the executive sponsor of any of these initiatives, assuming they are approved for the budget. CEOs make lousy IT initiative sponsors - they have too many other priorities to devote adequate time to being a project sponsor, they are generally too far from the day-to-day business to provide effective project guidance and it is a rare (and lucky) CEO who can be successfully challenged by underlings when his or her ideas are wrong or off base. Instead, an executive from the business unit that would benefit the most from the enterprise initiative should serve as the project sponsor, with a mandate to represent the interests of his or her colleagues from other units.
Companies need to remember that the IT investment budget (both business and IT categories) is an investment fund and needs to be managed as such. This means that all the best practices of investment portfolio management need to feature in how that budget is managed:
Most IT departments do not currently have the financial know-how to manage investments in this way, nor to ensure the necessary rigor in the management of the recurring budget. Large IT departments should seriously consider the creation of an IT financial controller position to help do this, or if this is not feasible, they might negotiate a half-time resource from corporate finance. Although many controller profiles do not have the creativity of investment portfolio managers, they bring much more knowledge and experience to the table in value measurement (for example, which metric(s) should be used? ROI, ROE, ROA, EVA, etc.). They can also help ensure consistency in investment evaluation and prioritization so that apples are not compared to oranges when making project selection decisions.