Activity Based Costing in ICT
For an employee IT is just something which is needed to be able to work. IT must support the employee at minimal cost. For an employee IT is everything that happens behind the screen of his workstation. The average employee does not want to know what it takes to deliver an IT service. IT is actually just an intelligent utility that can be used as needed. However, until now, IT is not often presented this way. IT organizations are often process oriented organized. They offer ITIL or COBIT processes to the end-user and try to explain why the use of its processes costs that much money. The worlds of the users of IT versus that of the process oriented IT organization are so far apart that this results in a complete incomprehension from both sides. The discussion is thus primarily about cost versus revenue, while the discussion should be about cost versus value. The IT organization compensates for this with an extreme form of user friendliness whereas the needed costumer focus is ignored. The IT department is thus reduced to a cost centre, often a very inefficient one, because most often departments are forced to make use of the IT organization.
Why ABC for IT?
The use of an Activity Based Costing (ABC) model is a first step towards added value analysis (see also the IT Added Value Model). By using ABC it becomes possible to link more process-related costs to products which a user can understand. This creates transparency for both the user and the IT organization and facilitates discussions on issues such as cost versus quality, volume steering, indirect cost charging, etc. A good match between IT processes and products simplifies benchmark activities, reduces the run time of a benchmark and also reduces the cost of data collection. At a later stage in the IT Added Value Model, IT products and processes can be linked to determine the added value.
What is ABC?
ABC is a method to calculate cost of a product or service, where the activities which cause the cost take a central stand. This is a deviation from the traditional method of costing as activities which can not be directly distributed, are allocated by means of a clear and transparent formula. ABC is meant to gain a purer insight in costs and prizes in order to improve efficiency.
The figure below shows the basic structure of an ABC model for an IT organization.
The IT model is slightly different from the classical presentation as separate layers are included for intermediate products and business processes.
Components
Components are the most important cost units that joined together determine the cost price of a product. By collecting all incoming costs in this level of the model, a good initial distribution can me made which makes it possible follow all incoming costs throughout the model to the moment they become outgoing costs. Activities for example are: Data center costs, application maintenance, application development, consultancy, etc.
“Intermediate products” (not shown in the model)
Intermediate products are primarily intended for infrastructure-related products. You could sell these products separately, but the average IT user can not use them in the daily work (think of servers, databases, data lines, etc.).
Services
Services are those products which are recognized by the user as complete ready to use. Think of a fully functional workstation, or a business application or a consulting service.
“Business processes” (not shown in the model)
Some services support multiple business processes. For example, a financial system supports both the “purchase to pay” process, as the “hire to retire” process, as the ABC process, etc. In this phase the costs must be allocated to the process causing the costs. For simplicity of the structure this layer is not shown in the model.
Customers
The Customer or business unit is defined as the location of the user in the primary process. These are usually different user organizations where IT services are provided for.
The advantage of creating different layers in an ABC model is that costs can be better monitored, the controllability is enhanced and the benchmarking process is simplified.
Linking IT processes and user products
By clever linking of IT processes to end products, the costs of these processes can be allocated to user products by using the principle of polluter pays. For example, in this way the cost of the incident or problem process can be allocated to the applications causing them. In this way direct costs caused by the incident/problem can be followed and the indirect costs of coordination and follow up of the incident/problem process can be allocated.
Underneath an example of the components of an business application.
The big advantage of this way of working is that for internal steering the components of a product can be changed, without influencing the way the customer sees the final product. This causes a stable situation for the customer in a rapidly evolving IT world. Next to that it gives both the costumer as the IT organisation itself the opportunity to steer on volumes.
Challenges
The design of an ABC model in an IT organization is not easy. The main challenges are:
Keep it simple. Enthusiasm for cost allocation can easily lead to a situation in which a lot of energy is spent on administration and allocation of non-relevant costs/volumes.
Create the appropriate level of management attention. Too little management attention leads to too little support (the model is a threat and will prove not to be viable). Too much management attention creates a highly accepted but uncontrollable model as too much micro management will come to life.
Make sure that the IT organization is at least part owner of the process. The execution of the ABC model in the finance organization often results in a situation in which IT can no longer identify with the model. The cost model is seen as a control mechanism of the finance department instead of a means of continuous improvement for the IT organization itself.