What’s the “right” IT spending level?

In the past months we have been asked by three different IT organizations some variation of this question: “In our industry, what percent of revenue should we be spending on IT?” The question seems to be driven by one of the following three pressures, most coming from outside of IT:

Defensive pressure: Senior management is putting pressure on IT to justify budget increases or is demanding cuts. IT is responding with a “but all the other kids are doing it” strategy of comparing its budget to other comparable companies. The implicit argument is that if we want to be competitive in our industry, we have to spend at least as much if not more than everyone else.

Offensive pressure: IT has some sense that it doesn’t have enough resources to do the things that business is asking of it. The way to make this case, some people think, is the “other kids are getting a bigger allowance than me” strategy. IT is constrained because the business isn’t giving it enough money, and management can fix this. This argument implies that more money solves all issues in IT.

Performance measurement pressure: IT is making a good-faith effort to understand how well it is performing on a price/performance basis, given the resources it has to work with. The strategy here is “it’s my parents’ fault, they raised me wrong.” If IT thinks it is doing well on a relatively smaller budget, the argument becomes “think of what we could do with the ‘right’ budget.” If IT is performing poorly, the argument is “it’s management’s fault for squeezing us.” Either way, it is a feel-good strategy to explain IT’s performance based on external factors.

Airline magazine pressure: Someone in senior management has read a story in the airline magazine, talked to someone on the airplane or at a conference, or otherwise heard what a competitor is spending on IT. Management wants to know, how do we compare? Are we spending too much, not enough?

What’s most interesting, though, is that when asking us the “how much should we spend” question, we’ve discovered that no one wants to be told that that is the wrong question. But we believe it is, for a number of reasons.

First, in looking at research from reputable sources, it is difficult to be sure that numbers from one company to the next have been comparably reported. Companies do not budget in similar ways, they don’t categorize in similar ways, and they don’t include/exclude IT costs in similar ways. “Industry averages” are notoriously difficult to compile because of this. For practical purposes, close examination of the underlying data shows that it is often useless for comparing companies.

Second, defining an “industry” for most companies is difficult. Is it competitors? Is it companies with the same products? Is it competitors with the same products, with about the same revenue? What about companies in our industry with additional products and business lines? The bottom line here is that we believe it is very difficult to find comparable companies in any “industry category.” (In some ways, that is good news … some IT leaders have looked for the data that supports their case within an “industry,” as there is so much from which to choose).

More fundamentally, though, it seems to be the wrong question because it doesn’t tell the story that IT or the business needs told. The right story is: what is IT doing with the money it gets and how effective is it in helping the business? Management wants to know: how well is the IT portfolio performing?

Assessing the IT portfolio is the same as assessing any investment portfolio:

1. For existing investments, find the assets that are underperforming and fix them, and find the assets that aren’t performing at all and get rid of them.

2. Redeploy the resources from the nonperforming assets to higher- return activities.

3. For new investments, balance the risk and return profiles to achieve the long-term investment strategies.

The key data that IT should be reporting in these situations is the cost, quality, and effectiveness of the applications, infrastructure, and services it is providing to the business. How the IT budget compares to other organizations and what percentage of revenue is spent is irrelevant. What is relevant is how well those investments are performing, from an investment perspective.

We propose that as an ongoing strategy for analysis and reporting, IT managers should focus on the following three categories of performance reporting:

Asset portfolios: What are the overall cost, quality, and service levels (from the business perspective) and the technical risk profiles of the individual applications and of the application portfolios? How do those applications and portfolios support the current business strategies? The same questions are asked for infrastructure services.

Underperforming IT assets: What IT resources are underperforming in those same measures? What is IT’s spending plan for fixing or eliminating them? What is IT’s plan for putting those resources to work in higher-return activities?

New investments: How do our new investments relate to fixing underperforming assets? How do they provide “coverage” of the business strategies that the company is pursuing?

By casting expense numbers in these contexts and reporting this data on a quarterly basis, IT can create a management dashboard that translates IT activities and expenses into IT investment assets and related performance.

Expenses and expense control is important, and living within budgets is critical in any area of business. By recasting the “percent of revenue” question into an investment performance question, IT can provide better and more relevant performance information to management, and at the same time set the stage for improving the performance of its portfolios.

— Bob Benson, Tom Bugnitz, and Bill Walton, Senior Consultants, Cutter Consortium

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