7 July 2009 • 7:00 am

Irrational IT Budgets

Does your enterprise have a single, all-encompassing budget for information technology spending? If so, I’d like to share with you an argument for an alternative approach to IT budgeting that I developed a few years ago.

Instead of one overall IT budget, imagine putting all IT expenditures into two buckets, mandated and discretionary. Mandated spending “keeps the lights on” to operate the business into the foreseeable future “as is,” without making strategic changes. Discretionary spending is simply how the enterprise chooses to invest to change its technology capabilities.

The level of mandated spending can’t really be planned; it’s the result of two factors outside the control of the IT organization: the unit cost of hardware, which generally decreases over time, and the demand for existing technology resources, which increases as the enterprise grows, and with the intensity of technology use in the enterprise. It is no more practical to limit mandatory spending than to tell an executive to stop making long-distance phone calls after the budget for those calls has been exhausted. Because mandated spending is the product of unit cost and demand, which are independent of each other, it is difficult to predict the amount and direction of change from one year to the next.

As many as a third of all companies impose an annual cap on IT spending, according to the survey on which I collaborated with CIO Insight Magazine back in 2003. At such companies, discretionary spending is limited to what’s left over after the mandatory spending. Typically, the distinction between mandatory and discretionary spending isn’t clear because IT accounting doesn’t explicitly segregate them. The result is to artificially limit the level of discretionary spending.

Why a spending cap? When CEOs and CFOs see IT spending growing faster than revenue, they panic. Since most CEOs and CFOs can’t tell the difference between legitimate investments and waste, they fear that something really bad is going on in the IT organization, and that it’s becoming a black hole for money. Their natural reaction is to cap overall spending. But it’s irrational to cap overall spending when the majority of it is demand-driven and not the result of explicit decisions. Mandated and discretionary spending are fundamentally different, and need to be segregated and managed differently.

Capping IT spending across the corporation is a dangerous move, because each business unit requires its own technology investment to compete effectively. A cap puts either IT or top management in the position of making far-reaching decisions about which businesses are going to get the IT and which aren’t. Thus, the IT funding decision becomes a proxy for deciding which strategic initiatives will and won’t be executed.

The demand for IT resources in any organization exceeds the capacity to deliver them. To improve alignment, discretionary IT spending decisions must be made in the context of business strategy, not IT budgets. It’s as simple as that. But since most companies aren’t very good at describing or executing business strategy, there’s little or no strategic context in which to make the decisions. But the nature of IT investment decisions has far less to do with IT than in does with enterprise strategy, and should not be by IT. These crucial decisions should be made by enterprise leadership as part of the strategic management process.

The IT organization does have an important role to play in influencing certain types of decisions. Under a business initiative to improve customer information, for example, IT can and should weigh in on which of three CRM systems is the best fit with the current and planned infrastructures. But IT should not be in the position of deciding whether the business unit should use a CRM system in the first place.

Too many corporate leaders abdicate their responsibility to make the tough decisions. They should be saying to business unit executives,” You haven’t made a compelling business case for your strategy, so we’re not funding it.” Instead, they avoid the problem by capping overall IT spending at a level lower than needed to deliver on all proposed strategies, and letting IT pick the winning strategies by proxy through its funding decisions.

How does your organization allocate scarce resources for IT? Does IT make the decisions? Please share your experience below.

(This post was adapted from my article that appeared in CIO Insight Magazine in 2003.)

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