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Headcount Caps

Headcount Caps

The chief operating officer and chief financial officer of a Fortune 1000 company faced a challenge: Revenues were growing, but profits weren't. They had to get a handle on costs, especially corporate overhead (G&A).

Limiting the Chequebook

If IT charges for its products and services, then spending on IT is limited by clients' budgets. With chargebacks, IT costs can be contained only by managing business units' budgets (for example, by setting appropriate profit targets).

However, if IT gets a budget directly (or through allocations) rather than through chargebacks, then IT sees the limits of this spending power but clients do not. Even if they understand the limits of the IT budget, they might not care; they may feel that IT is tasked with meeting its budget, and this is not their problem.

The solution is to treat the portion of the IT budget intended to benefit clients (the bulk of it) as a "prepaid" account - money put on deposit with IT at the beginning of the year, but owned by clients rather than by IT. Then, clients can be given the power to write cheques within the limits of this chequebook. Decisions may be made by a single committee, or the chequebook may be divided among the business units. In either case, clients must live within their means, and there's no need to cap IT headcount or spending.

Thus, even without chargebacks, a market effect can be created. And since clients cannot buy more than their chequebook permits, IT costs are fully controlled with no need for caps on headcount or expenses.

For clients to make decisions on which cheques to write, and for IT to decrement the chequebook when work is delivered, IT must calculate the fully burdened cost of all its products and services. Using concepts of activity-based costing, it must forecast its budget in terms of the cost of deliverables (not just expense codes by manager). This is the only way to know what its budget does and doesn't include. In addition, it must calculate rates (prices) consistent with its budget, and use these rates to decrement the chequebook as work is completed.

The fully burdened cost includes direct costs plus a fair share of all indirect (so-called fixed) costs. This is a critical concept. If the indirect costs are paid by IT or put in a pool and allocated to the business units, and the chequebook given to the purser covers only direct costs, the market will not work properly. It misleads clients into thinking things are less expensive than their true cost to shareholders, so they tend to buy more than is economic.

Furthermore, the indirect costs do not expand or contract as the IT business grows or shrinks. Indeed, they become a target for arbitrary cuts. Soon, IT will find it cannot deliver on its commitments for lack of needed internal support services.

The Bottom Line

Markets work. And caps don't. It's that simple.

The only practical way to manage IT spending is to create a marketplace where clients' demand is constrained by the limits to their chequebooks.

Implementing a market without chargebacks takes a bit of thought, but the mechanics and the process are well understood. What it really takes is a commitment to control costs systemically, rather than through ineffective caps and budget cuts.

We all believe in market economics outside the office. Let's apply the same dynamics within corporations to govern resources effectively with minimal bureaucracy.

Dean Meyer helps IT leadership teams design high-performance organizations. Author of six books, numerous monographs, columns and articles, he brings innovative systematic approaches to what others consider the "soft" side of leadership. Contact him at dean@ndma.com or visit his Web site (www.ndma.com/resources/ndma.htm)

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