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Rethinking IT for the Cloud, Pt. 1 – Calculating Your Cloud Service Costs

By: Khalid Hakim

So you’re the CIO of an organization and you’ve been asked to run IT like a business. What do you do?

You can start by seeing IT as a technology shop, with “services” displayed on its shelves. Each service is price-tagged, with specs printed on the back-tag. A service catalog is available for customers to pick up and request services from. Each service or set of services is managed by the “service manager/owner” role. Your IT shop would have an Income Statement (Profit-Loss P&L) and a Balance Sheet.

Think of it – in other words – as a business within a business: IT is just a smaller organization within the main business org. And where’s the value to you in that? Well, it’s because your boss is right: IT should be a business enabler, a revenue supporter, and a value creator. And because it helps you ditch your colleagues’ long-held impression that IT is nothing more than a revenue drain.

Next, you need to show exactly how your organization contributes to the success and profitability of the business. How can the CEO and CxOs further realize the value of the IT you’re supplying? How can you calculate the contribution of every dollar of investment in IT to their net income? These are just a few of the questions that you need to consider when positioning IT on a critical value path.

Cloud is Here to Help

As you look to transform IT from a passive order-taker to an IT service broker, or even to a strategic business partner, you’ll likely look to cloud computing for agility, reliability, and efficiency. Cloud can deliver all of these things, with stunning results. But this transformation cannot happen without a paradigm shift in how you operate and manage your technology.

Luckily, cloud computing embraces consumerization and commoditization and is a perfect fit for the IT shop/P&L model: Everything is expressed in terms of “services” and business value. If I could introduce a new English word, it would be “servicizing,” as in “servicizing your IT.” Part of this transformation means moving from C-bills to S-bills, that is, moving from Component level bills (e.g. an IT bill that has IT components) to Services bills, which are more clear and understandable. And to begin this process, you need to “servicize” your whole IT context.

There are multiple steps involved here, but for any of this to be worthwhile, what you do has to be justifiable within your new cost/benefit framework. So you need to start off with a true understanding of how much each and every service is costing your company.

In the remainder of this post, I’m going to suggest a few key points that will help you identify and calculate what each cloud service costs. Future blog posts in this series will address other important steps to IT transformation for the cloud, such as the importance of automating your IT cost transparency as well as a step-by-step guide to tagging costs as CAPEX and/or OPEX.

Calculating Cloud Service Costs

Step 0: Define your cloud service – I am calling this step zero because you first need to truly understand what makes up your cloud service before you can go any further. Service definition is a separate exercise and discipline whose foundations should be deeply rooted in your organization if you want to describe it as “service-oriented.” Defining a cloud service helps you see the boundaries of your service, as well as correctly understand and identify its components. And it solves one of your biggest service cost challenges, reducing the “unabsorbed costs” bucket by clearly identifying all cost components, including your service’s technology, processes and team.

Step 1: Identify direct and indirect fixed costs – With an accurate service definition, all components that contribute to your service delivery (technology, processes, and team) are now identified. This next step is to identify the direct costs that your drivers and elements contribute to your service. In addition, you’ll need to identify all indirect fixed cost drivers and apply the allocation percentage that has been agreed upon during the establishment of your service’s cost model. Your support contract is a common example of an indirect fixed cost: The cost of your support contract should be split over the number of products and calls, as previously detailed in your contract.

Step 2: Identify direct and indirect variable costs – Another challenge is dealing with your variable costs and how to allocate them to the services that depend on these costs. Much of this should have been defined in the service’s cost model, so you should apply those same policies on the identified variable-cost drivers and elements. Your monitoring tool is a great example of an indirect variable cost, as the costs need to be distributed over your fluctuating number of applications or services being monitored at any given time.

Step 3: Identify any unabsorbed costs – The “unabsorbed costs” bucket is a group of cost drivers and elements whose costs you cannot attribute to any particular service, meaning they must be attributed across all services. During the development of your service’s cost model, you need to decide how to deal with such costs. Typically, there will be a certain uplifting amount that needs to be added or allocated to each service. A good example of this would be the cost of labor (i.e. service managers) that should be distributed across all services.

Step 4: CAPEX/OPEX tag and adjust – There is no major decision-making in this step, as most of these Capex and Opex discussions should have taken place during the time you purchased your cloud service components. However, it is very important to tag each cost with a CAPEX or OPEX (or both in some cases) because that will eventually impact the way that you distribute and allocate operational or depreciated costs of each element.

Step 5: Finalize your service cost calculations – After identifying and defining all of your cost units (e.g. per User or Consumption: per GB) and metering options (e.g. hourly, weekly, monthly, etc.), finalize your service cost per cost unit calculations considering all the elements gathered in the previous steps I’ve just outlined.

In summary, when preparing your IT team for cloud computing, keep in mind the following:

  • Successfully implementing cloud computing in your company starts by changing the way you see IT (and making sure everyone on your team is aware and on-board as well).
  • It is essential to carefully and correctly define your cloud service and to keep in mind the cost model you established for your service as you do so.
  • Identifying the costs of your cloud service will let you illustrate the value of IT at your company and show how your cloud service positively impacts your business as a whole.
  • You can follow the 5-step process outlined above to ensure that you have fully identified your costs.

You may not be personally on the hook to figure all this out, but service owners/managers or someone in your IT department probably is.  So why not forward this post to folks you work with in IT, and suggest that they attend the IT Financial Management Association Conference in Savannah, Georgia next week. I’ll be hosting a workshop on Monday, July 8th at 8am on cloud IT service financial management, and on Wednesday, July 10th at 10am, I’ll be presenting an overview of cloud service financial management.

Stay tuned for the next post in this series, where I will discuss service definition in more detail. In the meantime, if you’re interested in reading more on the transformation of IT, check out these other posts:

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