One of the loftiest goals as an ITaaS Provider is the ability to charge-back, or at least show-back cost of services. It can also be daunting to do so in a fair manner for all customers.
Leonardo da Vinci said “Simplicity is the ultimate sophistication” and Albert Einstein said “If you can’t explain it simply, you don’t understand it well enough.” In this blog I’ll walk through a quickly executable IT cost model to calculate Total Cost of Ownership (TCO), using mostly tools and data we already have, to establish a price that is:
STEP 1: Establish Labor Costs
Bob worked 40 hours this week. 16 hours in support of services including day-to-day operations, online training every other day, and daily staff meetings. 24 hours were spent working on a migration for Project 2. All employees had a holiday the first Monday of this particular month. As it happens, none of our employees took any leave for the rest of the month. Out-of-office equals $0 cost and is excluded. The reason for this will become more evident when we discuss burdened rates.
Highlighted in blue, each project is associated with a service. It is important to note Project 2 is associated with Service B. The cost of Project 2 is derived from our employees’ wage and a rate of 1.5. The wage is multiplied by this rate to equal a burdened rate. Burdened rates reflect wages plus benefits and fee if any. Bob worked 24 hours on the Project 2’s migration in Week 2 per our example and contributed to Project 2’s cost of $5,724.00 this month.
Highlighted in orange, Bob worked 16 hours in support of services in Week 2 per our example. Tickets (requests, incidents, problems, changes, etc.) are associated with each service. Out of the 112 total tickets this month, 30 were related to Service B or approximately 27%. Using the number of tickets per each service and total labor for service gives us the cost of service. In this case, $17,172.00 * (30/112) = $4,599.64 for Service B this month.
Highlighted in green, the total cost of Service B labor for this month is $10,323.64 by adding $4,599.64 for project labor and $5,724.00 for service labor from our previous calculations. Our service organization must recover $36,252.00 this month for just labor.
STEP 2: Distribute Operational Expense
Services may require operational expenditures (OPEX) like: leases, utilities, maintenance, etc.; some of which may be indirect and need to be fairly distributed across services based on relative service size. By dividing subscribers of a service by the total number of subscribers we arrive at a fair percentage of monthly operational expenses for Service B of 28%. Indirect operational expenses for Service B are calculated fairly by $18,000.00 * (250/900) = $5,000.00.
Some expenditures are so large that the expense cannot be recognized at one point in time and need to be amortized (for example building a new data center). Depending on your model, this expense may be captured as either a project expense or an operational expense. In keeping our model simple, amortization should be used sparingly. When absolutely necessary, it should be used consistently by establishing a concise policy like “All expenses over $500,000 will be amortized (spread) over 36 months.” In our example, no expenses exceeded half-a-million-dollars and so amortization does not apply. However, if we had an Expense E of $1,750,000 for our new data build-out it would be recognized as $1,750,000 / 36 = $46,611.11.
STEP 3: Calculate Total Cost of Ownership
Projects may require capital expenditures (CAPEX) beyond labor like: material procurements, suppliers of personnel, etc. plus travel. Project costs are often direct and simply added with project labor for total project cost. We can distribute these costs as well if needed. Total Cost of Ownership for Service B rises to $18,323.64 by adding capital expenses of $3,000.00 to our previous operational expenses and labor. Assuming our other services and projects require only labor, our service organization must recover $44,252.00 this month to remain solvent. Dividing Service B’s total cost by 250 subscribers gives us a cost of $73.29 per subscriber per month.
STEP 4: Establish Charge-back
Our previously mentioned 250 subscribers of Service B is spread over four service customers (departments in this example) as 100 + 100 + 25 + 25 = 250. A fee of 7% which is the difference between our cost and our price. Recovery from each customer of their fair share of services. Department A has 100 subscribers of Service B; which equates to 100 * ($73.29 *107%) = $7,842.03. 107% is a representation of 100% of the cost plus 7% fee. Our previous Total Cost of Ownership of $44,252.00 is now a price of $47,349.64, allowing our service organization to not just be solvent but also profitable to enable research, development, improvement, etc. of services.
If the culture of your organization does not allow for your IT department to charge customers for service the same principles can still be applied. Remove the fee (7% in our example) and communicate the same information as Service Consumption Report rather than an invoice to provide show-back to your customers. Though they may not be paying for services you can still influence their behavior by giving them comparative analysis against their peers.
The following table summarizes charge-back using an IT Cost and Price Model.
In my next blog post we will explore tips for how to ensure, as the new “CEO” or your IT department, that your transition to an agile, innovative, and profitable service provider is a successful one.
Jason Stevenson is a Transformation Consultant with VMware.