Part 2: The Economics of IT Service Management

In the first article I offered a definition and a way to think about ITSM. In this article I present an economic framework and characteristics of different operating models.

Economics deals with the efficient use of limited resources.  An ITSM function operates within a larger organization that has the same concerns and needs to make periodic decisions about the top priorities for allocating limited resources for the enterprise. A central question is how the ITSM should be paid for both in terms of any initial or periodic investments and in terms of ongoing operations.

A charge-back model and investment strategy are critical aspects of determining how the ITSM will be sustained by defining financial incentives for the organization as well as detailed accounting practices. To that end, this section introduces a framework for evaluating funding alternatives and the organizational behavior that results from them. But financial considerations alone are not sufficient. This section also outlines nonfinancial incentives that are important to an overall ITSM program.

The figure below presents the two dimensions to the framework. The first dimension is the investment category with strategic demands at one end of the spectrum and tactical demands at the other end. Strategic demands typically involve projects that drive business transformations or process changes and usually have a well-defined business case. Tactical demands are associated with day-to-day operations or keeping the lights on. In the middle of the spectrum, some organizations have an additional category for “infrastructure investments”—that is, project-based funding focused on technology refresh or mandatory compliance-related initiatives. These are projects that are generally considered nondiscretionary and hence appear to be maintenance.

ITSM Operating Models

The second dimension is the funding source and refers to who pays for the services: the consumer or the provider. In a free market economy, money is used in the exchange of products or services. For internal shared services organizations, rather than exchanging real money, accounting procedures are used to move costs between accounting units. When costs are transferred from an internal service provider to the consumer of the service, it is generally referred to as a chargeback.

If we lay these two dimensions out along the X and Y axis and a dividing line in the middle, we end up with these quadrants:

  1. Demand-Based Sourcing: This operating model responds to enterprise needs by scaling its deliver resource in response to fluctuating project demands.  It seeks to recover all costs through internal accounting allocations to the projects it supports.  The general premise is that the ITSM can drive down costs and increase value by modeling itself after external service providers and operating as a competitive entity.
  2. Usage-Based Chargeback: This operating model is similar to the Demand-Based Sourcing model but is generally focused on providing services for ongoing IT operations rather than project work.  The emphasis once again is that the ITSM operates like a standalone business that is consumer-centric, market-driven, and constantly improving its processes to remain competitive. While the Demand-Based Sourcing model may have a project-based pricing approach, the Usage-based model may use utility-based pricing schemes.
  3. Enterprise Cost Center: This operating model is a typical centrally funded function. This model views the ITSM as a relatively stable support function with predictable costs and limited opportunities for process improvements.
  4. Capacity-Based Sourcing: This operating model strives to support investment projects using a centrally funded project support function. Centrally funded ITSMs that support projects are an excellent model for implementing practices or changes that project teams may resist. Not charging project teams for central services is one way to encourage their use. The challenge with this model is to staff the group with adequate resources to handle peak workloads and to have enough non-project work to keep the staff busy during nonpeak periods.

The specific charge-back models and accounting processes vary greatly from company to company, but we can group the methods into three general categories.

  1. Full Cost Recovery: At the consumer end of the spectrum, we see models where 100 percent of the costs of the provider are paid by the consuming business units based on their usage. Exactly how usage is determined can vary greatly and may include measures of resource consumption, number of service requests, or other measures of service provider activity.
  2. Hybrid Funding Model: A variety of hybrid models can be used. For example, the provider may charge for project work but the ongoing operations may be centrally funded. Or a high-level allocation scheme may be used such as the percentage of staff in the consumer unit.
  3. Centrally Funded: In this model, there is generally little or no chargeback to the consumer. The costs of the provider are planned and managed as a central cost center.

For further information about financial management practices for shared service functions, check out Informatica’s Velocity Best Practices.

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