Service Strategy

Financial Management

Financial Management

GOAL:

To provide cost effective stewardship of the IT assets

and the financial resources used in providing IT services.

Objective

Business

IT

Financial Management

Business

opportunities

IT capabilities

The great connector,

between desires and abilities!

Enterprise value and benefits of Financial Management

The landscape of IT is changing as a strategic business and delivery

models evolve rapidly, product development cycles shrink, and

disposable designer products become ubiquitous.

Much like their business counterparts, IT organizations are

increasingly incorporating Financial Management in the pursuit

of: • Enhanced decision making • Speed of change• Service Portfolio Management• Financial compliance and control• Operational control• Value capture and creation.

Shared imperatives framework: Business and IT

Customer

Service Provider

SLM

8Financial

Compliance

7Service

Provisioning Optimization

6Known Variable Cost Dynamics

5Service Portfolio Management and

Optimization

4Financial Processes

Supporting Rapid Change in:

- Budget - Business Need-Value Networks

3Service

Investment Analysis

2Service Consumption

Modelling, Valuation and Planning Confidence

1Visible, consistent run-cost structure

Commonality of Interests and Benefits

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M

Customer

Service Provider

SLM

8Financial

Compliance

7Service

Provisioning Optimization

6Known Variable Cost Dynamics

5Service Portfolio Management and

Optimization

4Financial Processes

Supporting Rapid Change in:

- Budget - Business Need-Value Networks

3Service

Investment Analysis

2Service Consumption

Modelling, Valuation and Planning Confidence

1Visible, consistent run-cost structure

Commonality of Interests and Benefits

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M

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Service Valuation

Service Valuation is used to help the business and the IT Service Provider agree on the value of the IT Service.

Total cost of

delivering

the service+

Total value to

the business

of the service

Service Valuation

Customerassets

Service levelperformance

designed and delivered

Desiredoutcome

Service valuerealization

Provisioning ValueValue Potential

Service Assets

Performancepotential

Unlocked value potential

++

+

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Demand modeling

Poorly managed service demand is a source of cost and risk.

The tight coupling of service demand and capacity

(consumption and production) requires Financial Management

to quantify funding variations resulting from changes in service

demand.

Service Portfolio Management

Financial Management is a key input to Service Portfolio

Management. By understanding cost structures applied in

provisioning of a service, a company can benchmark that

service cost against other providers.

In this way, companies can use IT Financial information,

together with service demand and internal service capability

information, to make beneficial decisions regarding whether a

certain service should be provisioned internally.

Service Provisioning Optimization (SPO)

Financial Management provides key inputs for Service

Provisioning Optimization. SPO examines the

financial inputs and constraints or delivery models to determine

if alternatives should be explored relating to how a service can

be provisioned differently to make it more competitive in terms

of cost or quality.

Planning Confidence

Planning provides financial translation and

qualification of expected future demand for IT

services.

Financial Management Planning departs from historical IT planning by focusing on demand and supply variances resulting from business

strategy, capacity inputs and forecasting, rather than traditionalindividual line item expenditures or business cost accounts.

Planning Confidence

Planning can be categorized into three main areas, each representing financial results that are required for

continued visibility and service valuation:

Operating and Capital (general & fixed asset ledgers)

Demand (need and use of IT services)

Regulatory and Environmental (compliance).

Service Investment Analysis

Assumptions about the service are a key component of analyzing investments.

The objective of Service Investment Analysis is to derive a value indication for the total lifecycle based on 1) value received, and 2)

costs incurred during the lifecycle of the service.

Accounting

Accounting within Financial Management differs from

traditional accounting in that additional category and

characteristics must be defined that enable the identification

and tracking of service-oriented expense or capital items.

Compliance

Compliance relates to the ability to demonstrate that proper

and consistent accounting methods and/or practices are being

employed. This relates to financial asset valuation,

capitalization practices, revenue recognition, access and

security controls etc.

If proper practices are documented and used, compliance can

be easily addressed.

Variable Cost Dynamics

Variable Cost Dynamics (VCD) focuses on analyzing and

understanding the multitude of variables that impact service

cost, how sensitive those elements are to variability, and the

related incremental value changes that result.

Among other benefits, VCD analysis can be used to identify a

marginal change in unit cost resulting from adding or

subtracting one or more incremental units of a service.

282,000

25,000

200,000

225,000

Traditional Chart of Accounts

Applying Invoice to Chart of Accounts

SalaryServer MaintenanceHardware Depreciation

60,000

25,000

15,000

TOTAL 100,000

Service-Orientated Accounting for IT and Identification

Service-Orientated Accounting for IT

Service Maintenance Invoice 25,000* Service: Collaboration Service A* Cost Type: Hardware* Classifications: > Operational vs. Capital Direct vs. > Indirect > Fixed vs. Variable *Unit Base for Charging serial number

Hardware Depreciation 15,000* Service: Financial Reporting* Cost Type: Hardware* Classifications: Operational vs. > Capital Direct vs. > Indirect > Fixed vs. Variable *Unit Base for Charging user extension

Salary 60,000* Service: Service Enhancement Project ABC* Cost Type: Labour* Classifications: Operational vs. > Capital > Direct vs. Indirect Fixed vs. > Variable *Unit Base for Charging personnel ID

Total Service-Orientated Accounting Entries 100,000

(Same 100,000 but service-orientated accounting treatment)

Service Cost Subset:

Collaboration Service

Total Costs for Collaboration Service

Service Cost #1 - 50,000Service, Collaboration ServiceAnnual Maintenance

Service Cost #2 - 125,000Collaboration ServiceSoftware

Service Cost #3 - 25,000Collaboration ServiceOther Characteristics, etc.

Total Service Expenditure

Server maintenance invoice is aggregated with other service specific invoices

Valuing the Collaboration Service

Sample Breakdown of Service Cost by Accounting Characteristic

Collaboration Service Total Cost Breakdown by CharacteristicsHardware 150,000Software 25,000 225,000 Traditional cost accountingLabour 50,000Operational 180,000Capital 45,000 225,000 Capital structureDirect 51,000 Indirect 55,000 225,000 Benefit structureFixed 100,000 Variable 125,000 225,000 Variability of costs

Subtotal Expenditure 225,000

Collaboration Service Potential Value AddUtility Optimizations E$ value of service improvementWarranty Enhancement 10,000 E$ value of service improvement

Subtotal Value Add 10,000

Subtotal: 225,000 Current Period Funding Base

Anticipated Peak Demand Variance 20%Increase (Decease) 47,000 Additional Funding Required

Total Service Valuation (future) 282,000 Future Funding Need

Methods, Models, Activities & Techniques

• Service Valuation• Service Provisioning Models

& Analysis• Funding Model Alternatives• Business Impact Analysis (BIA)

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Funding model alternatives

Funding addresses the financial impacts from changes to current and

future demand for IT services and the way in which IT will retain the

funds to continue operations.

Each model assumes a different perspective, yet rests on the same

financial data, an increased ability to generate the requisite

information translates to increased visibility into service costs and

perceived value.

The model chosen should always take into account and be

appropriate for the chosen should always take into account and be

appropriate for the current business culture and expectations.

Business Impact Analysis (BIA)

A BIA seeks to identify a company’s most critical business

services through analysis of outage severity translated into a

financial value, coupled with operational risk.

This information can help shape and enhance operational

performance by enabling better decision making regarding

prioritization of incident handling, problem management focus,

change and release management operations, project priority

etc.

Return On Investment (ROI)

ROI is a concept for quantifying the value of an investment. Its use and meaning are not always precise. When dealing with financial offers, ROI most likely means Return on Invested Capital (ROIC), a measure of business performance.

This is not the case with service management, ROI is used as a measure of the ability to use assets to generate additional value.

Keep it simple

In the simplest sense, it is the net profile of an investment

divided by the net worth of the assets invested. The

resulting % is applied to either additional top-line revenue

or the elimination of bottom-line cost.

Tactical Benefits

While a service can be directly linked and justified

through specific business imperatives, few companies

can readily identify the financial return for the specific

aspects of service management. It is often an investment

that companies must make in advance of any return.

Terms

Business Case

Pre-Program ROI

Post-Program ROI

Business Case

A decision support and planning tool that projects the

likely consequences of a business action. The

consequences can take on qualitative and quantitative

dimensions. A financial analysis, for example, is

frequently central to a good business case.

Business Objectives

The structure of a Business Case varies from organization

to organization. What they all have in common is a

detailed set of business impact or benefits.

Business impact is in turn linked to business objectives.

A business objective is the reason for considering a service

management initiative in the first place.

Business Impact

While most of the Business Case argument relies on cost

analysis, there is much more a service management

initiative than financials.

The scope of possible non-financial business impacts is

summarized as:

A business impact has no value unless it is linked to a business objective. There does not have to be a

one-to-one relationship between business impact and business objective.

Pre-program ROI

The term capital budgeting is used to describe how

managers plan significant outlays on projects that have

long-term implications.

A service management initiative may sometimes require

capital budgeting.

Capital budgeting

Capital Budgeting is the commitment of funds now in

order to receive a return in the future in the form of

additional cash inflows or reduced cost outflows.

Capital budgeting decisions fall into two broad categories:

• Screening Decisions

• Preference Decisions.

Screening Decisions (NPV)

An investment typically occurs early while returns do not

occur until some time later. Therefore, the time value of

money, or discounted cash flows, should be accounted

for.

There are two approaches to making capital budgeting

decisions using discounted cash flows:

• Net Present Value (NPV)

• Internal Rate of Return (IRR)

What is an organization’s discount rate?

A companies cost of capital is typically considered the

minimum required rate of return.

This is the average rate of return the company must pay

to its long-term shareholders or creditors for use of their

funds.

Therefore, the cost of capital serves as a minimum

screening device.

Other methods

There are other methods for making capital budgeting

decisions e.g.

• Pay-back

• Simple Rate of Return.

However, Pay-back is not a true measure of the

profitability of an investment and Simple Rate of Return

does not consider the time value of money.

Intangible benefits

Process improvement and automation are common

examples of difficult-to-estimate cash flows. The up-front

tangible costs are easy to estimate.

The intangible benefits, such as lessened risk, greater

reliability, quality and speed are much more difficult to

estimate. They are very real in impact but still challenging

in cash flows.

Preference Decisions (IRR)

There are often many opportunities that pass the

screening process. The bad news is not all can be acted

on. Financial or resource constraints may preclude

investing in every opportunity.

Preference decisions, sometimes called rationing or

ranking decisions, must be made. The competing

alternatives are ranked.

Post-program ROI

Without proof of value, executives may cease further

investment. Therefore, if a service management initiative

is initiated with prior ROI analysis, it is recommended that

analysis be conducted at an appropriate time after.

Program objectives should be clear as they serve to

guide the depth and scope of the ROI analysis.

Data Collection

The collection of data is vital for a valid and quantifiable

ROI results. There are two periods in which to collect

data; Pre – Implementation and Post – Implementation.

Program objectives should guide the source and nature

of data points e.g.

• Metrics for quality of service

• Costs for service transactions

• Questionnaire for customer satisfaction.

Isolate the effects

By this stage, the results of the service management

program are becoming evident. By isolating the effects,

there should be little doubt that the results should be

attributed to the program.

There are many techniques available e.g.

• Forecast Analysis

• Impact estimates

• Control group.

Data to monetary conversionTo calculate ROI, it is essential to convert the impact data to

monetary values. Only then can those values be compared to

program costs. The challenge is in assigning a value to each

unit of data. The technique applied will vary and will often

depend on the nature of the data:

A quality measure is assigned or calculated and reported as a standard value.

Staff reductions or efficiency improvements are reported as a standard value.

Improvements in business performance are reported as a standard value.

Internal and external experts are used to established the value of a measure.

Determine program costs

This requires tracking all the related costs of the ITIL

program. It can include:

• The planning, design and implementation costs. These are pro-rated over the expected life of the program.

• The technology acquisition costs

• The education expenses.