How to Find Your Balance

There is no optimal level for fixed versus flexible costs across all industries. A survey of the 2004 CIO (US) 100 honourees, recognized for their agility across many aspects of IT and the enterprise, revealed they averaged a relatively high level - 33 percent - of flexible costs in their total IT budgets. But the maximum flexible portion can vary widely, from a dramatic 90 percent in a company that had to downsize quickly and radically, to 20 percent at a university where the culture demands slower and more measured change in IT investments.

To determine the best mix of fixed and variable costs in an IT budget, CIOs should begin by assessing their companies' economic models, says CD Hobbs, president and COO at Meta Group. "You can't simply opt for a high variable cost posture and say it's good. Variable for the sake of variable can be very dangerous," he says. For example, companies in industries such as airlines, oil and financial services, where demand for IT services is volatile, should have higher variable IT costs than companies that foresee stable short-run markets.

Hobbs also warns that CIOs in search of flexibility should beware of more expensive short-term contracts. His analogy: "If you think interest rates are going to rise, you lock your mortgage in for 30 years," he says. The new trend in on-demand subscription types of software contracts offers a prime example of short-term risk. The on-demand model is appealing because CIOs can buy services in small amounts as demand scales upward. However, if demand exceeds the forecast, CIOs might face a surfeit of expensive short-term contracts. "In an expanding market, there might be more tears than cheers," Hobbs says.

With these cautions in mind, CIOs looking to increase their variable spending need to work closely with their CEOs and business unit leaders to accurately balance IT resources with internal demand. "For the CIO to do a good job with this balance, he or she has to be an intimate player in the strategy formation and modification process," Hobbs says.

At Hewlett-Packard, top IT executives collaborated with business units to reduce fixed costs and create flexibility after the merger with Compaq in May 2002. Prior to the merger, HP had 23 percent of its IT dollars earmarked for innovation, with the rest of the budget tied up in maintaining 25,000 servers, 7000 applications and 300 data centres. "We were overly complicated, and our fixed costs were very large," says John Buda, HP's vice president for strategy and planning for global operations and IT. Buda and his boss, CIO-to-be Gilles Bouchard, appointed a select group of IT staffers to handle the complex and politically sensitive process of deciding which resources were redundant and unnecessary. For example, the group worked closely with the human resources department to ascertain that the multiple systems it was using could be reduced to a single version of PeopleSoft and a single database. Ultimately, servers across the merged company were cut to 19,000, applications to 4000 and data centres to 85, with substantial further reductions expected. HP's cost flexibility has risen to 34 percent of the $US2.8 billion IT budget, with a goal of 50 percent, Buda says.

Stephen Fugale, CIO at Villanova University, focused on the organization's appetite for innovation to make the case for greater cost flexibility. When he arrived at the university three years ago, close to 90 percent of the $US12.7 million IT budget was locked into fixed costs such as hardware maintenance, servers, software licences and overall infrastructure. Universities, he says, often have a high level of fixed costs because standardization has lagged behind the corporate world. He analyzed his IT budget, which he says appeared to have been put together in the past without much planning, and broke it down into fixed and variable areas to see where he could find savings. Fugale huddled with university administrators to determine where fixed costs could be reduced and where there was a need for strategically oriented projects. He also compared his ratio to other universities'.

Over the past three years, he has been able to free up a small amount of those fixed costs by standardizing hardware and software platforms and finding some economies of scale in merging student and faculty hardware and support services. Fugale says 20 percent of his budget is now in the variable category, which has allowed him to move forward with an investment in wireless and mobile computing technology. His ceiling for cost flexibility is probably between 20 percent and 25 percent, at least for the time being, he says; a higher fraction of variable costs would be out of line with the appetite for IT innovation at most universities.

Cutter Consortium's Andriole cites Villanova as a good example of how a CIO can free up money for strategic investments after careful examination of the organization's budget and culture - even if that culture won't allow for a radical transformation. According to Andriole, CIOs seeking to change their fixed-variable cost ratio should first benchmark their company and industry to see where they stand in comparison. "If all of your competitors are at the 80-20 level and you are 90-10, you need to figure out how to get some more flexibility," he says.

Looking ahead, Fugale knows it will be a struggle to keep investing in new technologies with no expected increase in his IT budget during the next five years. Nonetheless, to plan for new investments, such as replacement of an ageing phone system, Fugale is looking for ways to cut fixed costs further and to generate revenue through his technology. At the moment, he is reselling videoconference space, computer equipment and phone service to students, bringing in $US350,000 in revenue in 2004 that can be earmarked for strategic investment. Fugale's strategy to hold onto this "found money" for strategically aligned academic IT projects rather than seeing it reallocated to other departments is straightforward: Keep in close touch with those who hold the purse strings and let them know he has clear plans for the extra money.