Fixing the budget

IS is being called on to provide a wider range of business services. Its financial approaches need to evolve as well.

Got wrong, annual budgets can foster all sorts of wrong behavior, limit IS’s room to maneuver and be a barrier to change. IS’s approach to budgeting, like so much in IS, evolves through stages, with the trick to pick the right one for your enterprise:

Stage 1 – Black box.
The IS budget is a single number. Business management does not know how the budget is spent. While this approach gives centralized control it does little to aid IS alignment with the business. But this stage of maturity is very easy to administer.

Stage 2 – Glass box.
The IS budget is more transparent. It is still a lump sum allocated as the CIO sees fit, but business management can influence IT investments because they can see where it’s going. This stage is a little more difficult to administer.

Stage 3 – Simple portfolio.
The IS budget has two goals: Keep the lights on and invest in the business. The breakthrough at this stage is that budget discussions shift from just “budget size” to “budget composition.” This change lays the foundation for delivering business value. But this stage starts taking some serious management time.

Stage 4 – Comprehensive portfolio.
IT is viewed as an investment portfolio. Finer subdivision of the budget allows each investment type to have a different target and even a different decision-making process. The entire budget – and its funding – become more flexible. This stage has a significant governance overhead.

Stage 5 – Enterprise portfolio.
IT expenditures are business expenditures. The IT budget is as flexible and business-aligned as possible. For some expenses, like post-merger integration and funding geographic expansion, these exceptional items don’t distort IS’s budgetary performance metrics of funding. Essentially IS now has a board of directors and requires high levels of management discipline and maturity to make work.

Improve alignment
by improving budgeting
Even if you pick the right maturity, you can still come unstuck if you go about things the wrong way. Budgets are supposed to provide three important financial control mechanisms: oversight, transparency, and direction. Oversight, especially at the lower maturity levels, is a problem because no one really knows what’s happening. Even at higher levels of maturity, lack of understanding can be substituted for paralysis. Clear governance rules are essential to avoid this.

In addition transparency fails when there’s confusion about what the budget means. There are some simple steps to take to avoid this: Clarify cost drivers: explain what drives IS costs and how business’s actions increase or decrease this. Use meaningful budget categories: use projects and outcomes, not accountants’ cost codes. Disclose appropriate levels of budget details: send out the information to your stakeholder’s need, not everything you have.

There’s a direction barrier in budgets too, if IS staff fail to take ownership of parts of the IS budget that govern what they do. Devolve budgetary responsibility down your organization to help IS staff better understand budgetary impacts of their actions.

Overcoming today’s oversight, transparency and direction barriers fixes problems in the short-term. Problem is, there’s a longer-term set of ‘tomorrow’ barriers too.

Tomorrow’s oversight barrier is that IT budgetary performance tracking rules are a disincentive to necessary investment. Adopting a more granular portfolio budget with predefined funding targets and established appropriate governance avoids this.

Tomorrow’s transparency barrier is caused by poorly understood cost drivers that give little insight into the true cost of peak-and-valley workloads. Techniques such as activity-based costing – tying costs back to the activities that cause them – helps enterprises make better informed decisions about the true nature of costs.

Finally, tomorrow’s direction barrier may be the annual fixed budget itself. Far better to move to an alternative based on attaining and being paid for incremental performance goals. Our research shows that, despite the attractive alternatives, for IS at least, annual budgets are to stay.

The challenge therefore is to change what we’ve got, not to hope to throw it out and get something new.

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