IT Shared Services: Managing and Aligning Costs for

Better Performance
When CEOs sought cost savings in the past, typically they looked to the direct costs in
the business. Individual moves to reduce direct costs might cause limited pain at the
business unit level, but the organization could, and did, adapt. However, after several
years of cost reduction in many sectors, business units that carry the majority of direct
costs are likely to have little left to cut without impairing their ability to carry out their
main activities.
The next logical step is consolidation of commonly relied-upon services across the
entire organization. Many organizations have effectively reduced the costs of providing
support services to their businesses simply by concentrating them in corporate shared
services departments. Theoretically, by shifting the workload out of the individual
business units and into a consolidated center responsible for servicing the functional
needs of the organization, cost reductions could be achieved and service levels
maintained, if not improved. This move resulted in a step change in the costs of
support services such as IT, HR, and facilities, and was considered to be a best
practice.
But this practice has presented many CIOs with a growing dilemma. The boards and
executives of many organizations grapple with authorizing continuing investment from
shared services functions such as IT without insight as to how such spending relates to
the demands of the business units or how it will impact long-term profitability.
Regardless of whether shared services are provided in-house or by a third party,
organizations need far better insight into these costs and particularly the costs of the IT
function, which for many is simply a black hole. CIOs must understand these numbers
in support of future IT investment, corporate cost and profitability initiatives, and their
own continued career success.
The true strength offered to corporations by business performance management is the
underlying collaborative and synergistic efforts of the operational and financial sides of
an organization working towards set key performance indicators (KPIs) and
performance standards. IT shared services organizations and the business units that
they support have a unique opportunity to deliver direct cost savings to the
corporation, enhance profitability, and help the CEO, CIO, and each other meet and
exceed their own business objectives.

The Case For Focusing On Shared Services

For example, exhibit 1 shows a typical cost center for a telecommunications provider.
More than half the costs carried by the center's P&L are allocations from shared
services departments or other corporate overhead. Should this enterprise be seeking a
modest 5 percent reduction in costs, this manager has only two options: Remove 10
percent from his own direct costs, most of which are to do with people, or lobby the
executive to critically examine the costs of the shared services functions.

Despite the gains to be had by building shared services departments and by locating
them where the required skills can be obtained at the lowest cost, many organizations
still have a limited understanding of the relationships among shared service centers
and business units. One reason is that shared service departments tend to plan their
resources and budget separately from business units. As the financial year progresses,
the capacity of shared services departments and the demands of operational business
units can become grossly misaligned.
Frequent realignment of the resources and capacity of shared services functions with
the needs of the business units is needed. For this to happen, organizations need to

progress towards more frequent reforecasting so that business units are routinely
updating the key nonfinancial data that drives their shared services demands. The
shared services functions can then use this information to realign their own resource
requirements for the coming periods, taking their actual costs through an activitybased costing (ABC) methodology to calculate monthly cross charges that are passed
back to the business units.
Exhibit 2 can be used to represent where an organization's shared services functions
might lie in terms of their costing and planning. The vertical axis represents the
reliability and robustness of shared services costing while the horizontal axis
represents the degree to which the planning and budgeting of the business units and
the shared services are integrated.

As such, the top left quadrant represents any organization that has already adopted an
ABC methodology for costing IT shared services and is highly accountable to the
business units. But having implemented a reliable and robust costing methodology, its
challenge now is to receive more frequent forecasts of demand from the internal
business users. Once IT resources are more closely aligned with the needs and
demands of the business units, the company would move to the top right quadrant.

Assessing IT Costs By Unit

To fully understand the costs of the IT function so they can be allocated to the business
units in line with the way in which they consume IT resources, any costing
methodology needs to recognize that not all departments use IT resources in the same
way. For instance, some business units may need secure payment processing over the
Web in addition to more general firewall and anti-viral security on the desktop
network. Likewise, it should allow for business units to use the same service at varying
degrees.
Additionally, it must reflect reciprocal costs. Just as HR provides services to IT, IT
provides services to HR. To calculate the true cost of providing a service, these
reciprocal costs should be passed between these departments reiteratively until they
become insig-nificant, while still providing an audit trail.
Finally, the costing method must capture and incorporate other costs from other
departments that should be allocated to the provision of IT services. These may include
such things as property costs from the Facilities cost center and recruitment and
payroll costs from the HR cost center.
While some line item costs that appear in the G/L of an IT department are easy to
understand and can be allocated directly to a business unit, many line item costs will
need to be reallocated to new cost pools, where they can be combined with other costs
from the departments that provide support to IT, such as HR and Facilities. Some of
these cost pools may then be allocated directly to services, but the majority will be
allocated to the activities that IT staff perform to better understand how they relate to
the services the IT function provides.
Typically, the cost of hardware and software needs to be amortized over their lifetime
to avoid spikes in calculated costs at the time of the investment. Many IT departments
deploy time-capture systems to record the amount of time staff such as programmers
spend on individual projects.

What Makes Good Chargeback?

Two of the more typical methods of chargeback are apportionment and allocation.
Apportionment is the process of assigning a share of the total IT costs based on a
designated target such as business unit revenue or headcount. Allocation involves
assigning a deserved share of IT costs based on the actual consumption of the services
in question.

Correct methodology for use should be decided by the head of the IT department in
conjunction with the finance and accounting organizations. The methodology
employed may vary based on quantitative measurement requirements and the ability
of the organization to effectively and accurately compute the necessary billing agent.
When examining a chargeback policy, it is critical to ask if it is fair and based on
reality. Too often business units get hit with charges that they perceive to be another
way of IT covering its cost. Cooperation in deriving the chargeback methodology must
be reviewed with the business units prior to its implementation. Also, the chargeback
method must be comprehensive, help control costs for the IT department, and help IT
predict its costs.
One way to take the next step in developing an effective chargeback system is to ask
where your company is on this continuum:
High-level apportionment of total IT costs: All of the IT costs charged to a
business unit are based on a designated target such as revenue or headcount. While
this does not reflect actual consumption, it does cover all costs. This methodology can
have a debilitating effect on the P&L of the business units and potentially a serious
impact on overall corporate profitability by penalizing a very profitable business unit
with unwarranted expense that it did not incur.
Lower-level apportionment of specific IT costs: Total costs of specific items
are apportioned and charged back to the business unit. This method does not reflect
actual business unit usage. While a step in the right direction, this methodology
ignores the true cost associated with usage by simply apportioning back against an
arbitrary guidepost.
Direct cost allocation: Specific ownership can be identified, such as projects or
applications and where over 50 percent of IT costs are for shared services. This
approach is an improvement as it does take into account resource utilization by specific
areas. It is an improved reflection of costs as it incorporates a resource use. However,
resource requirements tend to vary over time for projects, and this method does a
limited amount to help in predicting future recurring cost requirements.
Measured usage allocation: All parties find value in this gauged usage of
products and services. Business units have a much better feel for why they incurred
specific costs and have an idea as to how they might control them better in the future.

IT shops provide a level of transparency for the charges billed to business units and
quantifiable information on usage, patterns, and predictability for the future.

Case Study: An Example of Measured Usage Allocation

A large multinational conglomerate with a diverse product offering that includes food
retailing, cookware, travel services, banking, insurance, and funeral services made the
move to a shared services model. A large insurer with more than 4.5 million customers
and more than $36 billion in funds under its management, it found that the insurance
market had become more competitive following a period of successive mergers and
new entrants. The company's chief accountant recognized the need to develop a better
understanding of how individual products were incurring costs from the IT
organization. To provide reliable costing information in a complex multi-product and
multi-channel business, it became evident that traditional costing techniques would
not be sufficient. The company employed activity-based costing (ABC) and used ABC
data to accurately assign IT costs to the departments and products that consume IT
activities.
The IT department itself carries no residual cost as all costs are continually allocated
out of IT into other departments. IT provides seven principal services under the
following headings: new systems, desktop support, mid-range system support,
mainframe system support, communication services, laptop services, and data
preparation. IT personnel enter their activities in these areas on timesheets and mark
them against the 1,000 codes in their database. Each of the codes represents an activity
against one of the services listed, categorized by product or product group.

Understanding the Cost of Shared Services

One of Canada's oldest mutual life insurance companies implemented centralized
shared services in the early 1990s. The company formed a corporate services division
with five main areas: information systems, finance, corporate affairs, strategic
planning, and shared business services (including HR, administrative services, and
legal).
At the time, corporate services employed more than 800 people and had a cost base of
more than $100 million, which was one-third of the company's total non-sales-related
expenses. Initially, the business units viewed corporate services as an overhead
function that added little value, so they placed tremendous pressure on corporate
services to cut expenses quickly. The business units also requested cost information to

support their pricing decisions. Many of the business units believed that the cost
system used by corporate services was inaccurate and that in some cases actually
motivated the wrong behavior.
In response to these concerns, corporate services employed a costing model so that it
might:
Identify costs that could be eliminated or reduced.
Provide a mechanism to accurately charge costs to business units based on
their consumption of the shared services on a monthly basis.
Provide accurate cost information to support pricing decisions and profitability
analysis.
Communicate the service levels provided and the costs of outside service
providers for evaluating outsourcing decisions.
Provide a better tool for facilitating budgeting by internal services providers.
Corporate services soon evolved from being perceived as an overhead department that
added little value to being viewed as a business partner that was critical to the success
of the business units and the organization as a whole. Corporate services now can
identify and bill consumers of the products and services it provides based on actual
consumption.

Benefits of Understanding IT Shared Services Costing

After adopting a methodology for costing IT services, your organization will have a
detailed understanding of the services provided by IT, the activities involved in
providing them, and how they consume resources and costs. Detailed invoices can be
produced showing the business units' use of the service, the unit price. and the total
cross charge. Should more detail be required, the costs can be traced back to their
origin.
By fully understanding what activities are consuming resources and costs and which
add value, the business unit and the IT function are better able to enter into a dialogue
and understand how they can work together to reduce costs. This may involve no more
than taking simple steps to adjust service levels such as response times or batching

transaction processing to reduce setup costs. Removing non-value-adding activities

can help to reduce costs and provide an immediate return on any investment.

Options for Cross-Charging

Once the total cost of a service is calculated, there are various options for calculating a unit
rate for cross-charging the business units for their use of the service.
Demand-based pricing
If the organization wishes to fully allocate the total cost of the IT function across the business
units, the unit rate charge is typically based on the total cost of the service during the period
divided by the actual demand for the service during the period. This leaves the IT function with
no residual costs. This can be represented by the equation below where TC(x)t is the total cost
of service (x) during period t, TD(x) t is the total demand for the service during period t and
UPdem(x)t is the unit price of the service based on demand for the service during the period.
TC(x)t / TD(x)t = UPdem(x)t
Capacity-based pricing
However, other options are possible. The rate could be based on the total cost of the service
during the period, divided by the amount of the service available during the period; that is,
based on the capacity of the IT function rather than the demand of the business units.
Here, if the service is over-resourced, and IT is able to provide more than the business units
consume, IT will be left with residual costs, and this may drive IT to reduce capacity during the
next period. The formula now becomes:
TC(x)t / TCap(x)t = UPcap(x)t
However, some shared services units are operating as profit centers, and in these instances,
calculate a rate based on either of the methodologies above, to which a fixed or percentage
mark-up may be added before being charged out to the business units.
Ultimately the choice of pricing methodology can lead to an under- or over-recovery of IT
costs. Unless rules are set for how any under- or over-recovery of IT costs will be balanced out
in future periods, this gives rise to resentment from the business units that they are "overcharged." Organizations also should explore whether it is prudent to have under- or over-

recovered amounts in their year-end accounts and may wish to involve their auditors in this
discussion.

Richard Barrett is vice president of global marketing for ALG Software. He first
became involved with ABC while working for DHL Worldwide in the late '80s, and his
interest in the topic has continued ever since.