- 06 August, 2004 10:30
There's more than one way to skin the IT-budget cat.
IT-enabled business initiatives: they're all great ideas, but who pays? Most enterprises either raid the corporate budget or resort to a user pays policy.
The recent downturn in IT spending choked off corporate IT budgets and reduced users' abilities to pay for IT services. This double whammy forced many CIOs to look for other sources of funds. From recent research done with our Gartner EXP members, it seems that CIOs are becoming much more creative when it comes to generating the wherewithal to invest in IT-enabled business initiatives. It turns out that there are eight different funding models in use: four internal and four external.
Internal funding is the most common. The funding model we're most familiar with is the corporately-funded annual budget. In corporate funding the enterprise allocates funds to the IT budget that are then used to fund planned initiatives. This has the advantage of being simple, but not without its challenges. Getting corporate funding takes time and the internal committees who approve the initiatives are rarely generous. This type of funding suits long-term, strategic IT initiatives, like large infrastructure upgrades, where benefits are spread across the enterprise. But it increasingly fails to address more tactical IT initiatives.
In addition to (or perhaps instead of) corporate funding, CIOs turn to the second most common funding model: business-unit funding. Business-unit funding replaces the single central corporate source with funds from multiple business units. Like corporate budgets, business-unit funding is simple to run, but requires strong IT governance if wholesale duplication is to be avoided and enterprise-wide IT initiatives successful.
If the idea of a centrally funded or business-unit funded "IT tax" does not play well in your enterprise, there's always fee-for-use. It's possible to use chargeback to create a pool of "funds on hand" for funding IT initiatives. This approach works for some projects with a long operational life and reasonable levels of investments. However, for expensive or short payback projects, the chargeback payments are necessarily very high, and can be even higher by the need for a risk contingency, making chargeback unattractive.
For very risky projects there is another way. Superficially similar to centrally-funded models, an internal venture capital pool could be used to structure funding. The funds are invested in projects that offer a high payoff, but involve a high level of risk. Among the challenges of funding from a venture capital pool is the selecting of initiatives. Each initiative must be subject to rigorous financial analysis and have a business sponsor who can vouch for the benefit and is willing to pay the chargeback. Sounds like a "must have" for everyone.
There are four ways to get someone else to pay. If none of these internal funding sources appeals, or if all of the sources of internal funds have been exhausted, it's always possible to turn to "the market" for funds. Although there's no such thing as a free lunch, external funding sources have three benefits: lower up-front costs, savings can be used to run other initiatives and the risk is spread across several parties.
The first place to look for external funds is external service providers (ESP). It is not uncommon for an ESP to make an investment in return for a share of a long tail business. In return for upfront funds, the customer commits to regular payments, usually over a number of years. The two most common examples of ESP funding are outsourcing and vendor financing.
If you can't entice your ESP to pay, or don't wish to commit to a long-term contract, another form of external funding you might consider is government grants and incentives. Most government agencies offer grants or incentives to encourage enterprises to invest locally for the right type of initiative. But grants come well wrapped in red tape and require projects to clear some pretty high hurdles. Grants are best suited to long-term strategic initiatives - usually of the sort that employ lots of people, like call centres.
If neither ESP nor government funding works, there is a third type of external funding: consortium funding. With consortium funding, several enterprises pool their funds and resources to develop a common solution, which spreads risk across the parties involved. But consortia are difficult and time consuming to set up. Participants need to agree on the working arrangements and how much funding each enterprise will contribute. The challenge is keeping the consortium together and controlling and protecting intellectual property. Consortia also absorb huge amounts of management time so this model may be unattractive from the perspective of non-financial costs.
If consortia are not for you, and you do not wish to turn to government or your ESPs for funds, there's always the opportunity of turning IT into a business and living off the income you can earn from the marketplace. This final external funding model, revenue attraction, creates funds from selling an IT service on the open market. Revenue attraction is especially useful where the IT service is a commodity and can be offered as marginal capacity. Examples are data centre capacity, Web hosting and banking back-office systems. But as you would imagine there are significant disadvantages too. These include the need to be able to compete for, win and execute work profitably: No small challenges.
Another Set of Skills
It seems that there is a trend in funding that will see, over the next three years, a larger proportion of IS funding come from external sources, rather than from internal sources. Outsourcing, a form of ESP funding, will continue to grow both in IT and on the business side, and turn IT fixed capital to operating cost. To make a success of external funding, IS departments need new skills and competencies.
First and foremost, IS must develop four new financial skills. They need to ensure they have financial modelling skills to accurately forecast the initiative's funding requirements and costs. Risk analysis skills will provide an understanding of the variances in benefits and costs that can occur. In addition to skills, the IS department needs to develop financial controls to measure and monitor the flow of funds and chargeback. And it needs data-collection discipline to accurately capture the actual costs and expenditures.
All of these necessary competencies demand a highly skilled individual with a finance and IT background. The role of VP Finance, IS's CFO reporting to the CIO, is becoming increasingly common.
The wider use of external funding brings with it a wider range of stakeholders. IS must manage these relationships and contracts. The contractual arrangements often require detailed recordkeeping and reporting. This is something else that IS must put in place. Grants and incentives are particularly sensitive because they use public funds and require elaborate reporting to Oversight and other bodies. Care needs to be taken to avoid "co-mingling", as grants are, by definition, for specific purposes.
External funding models help to spread the financial risks of an initiative; but external sources often introduce financial risks of their own. As more funding approaches are used, a wider range of risks is introduced, so IS must develop sophisticated financial risk management.
Managing financial risk is highly complex. IS needs to be careful not to over-expose itself to a particular financial risk. Adding just one new model might increase the complexity to the point where it is not justifiable.
Introducing the enterprise to different funding models can lower the up-front expense of an initiative, allow more initiatives to run and spread financial risk. And it can pave the way to fund more innovative or opportunistic initiatives.
But as IS organizations move toward external funding approaches, challenges are set to become more significant. Pursuing these funding sources require the IS department to up-skill in financial modelling, financial risk management, financial control and financial data collection. And it means dealing with more stakeholders.
Are the benefits worth it? Using more funding models can lower the up-front expense of an initiative, allow more initiatives to run and spreads financial risk. Still, it's best to move slowly towards using external funding and take the time to build the vital skills and get the experience required to achieve the desired outcomes.
Andrew Rowsell-Jones is vice president and research director for Gartner's CIO Executive Programs