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How to Create a More Accurate, Useful, and Equitable Service Costing Process

By Khalid Hakim

In my last post, I described the pressing need for a more effective IT service costing process (as a solution to the pressing need for tighter business/IT alignment!). The question now… is how.

How can companies create a service costing process that is fast, accurate, transparent, granular, fair, and consistent—without introducing yet another time-consuming and expensive project to the IT docket?

To answer this question, I’ll use a real-world example—a company that has recently been through the process and achieved excellent results.  I won’t name the company but I can assure you it’s a real enterprise, and the results were also quite real. I’ll refer to it as “The Company.”

In the past, The Company charged for IT services by simply allocating the total IT costs among service consumers based on the number of desktops and laptops they used. This “lump sum” cost allocation of course led to the perception that “IT is always expensive.” The Company knew it needed to move to a more service-oriented, customer-centric model.

Our team provided guidance in setting up a better service costing process. The implementation began with three key steps:

1. Create a service-based cost model diagram.
A cost diagram depicts the flow of IT costs from the general ledger or cost sources all the way to the services being provisioned—in such a way that IT can present consumers with a statement showing all service costs.

2. Develop a service-based cost allocation strategy.
The Company already had a cost allocation process in place, but it did not deal with service-to-service cost allocation. So The Company’s lump-sum allocation did not demonstrate any IT value but only the cost of IT when running the business. That’s why a service-to-service costing method was needed that would account for everything:

  • Servers and their related hardware
  • Network and security allocation to servers
  • Data center, storage and data center facilities costs
  • Software and enterprise license agreements
  • Support and operations contracts
  • IT project costs
  • Labor costs
  • IT overhead

This way The Company was able to fully load IT costs into services being delivered and transfer these costs to the business.

3. Develop a service-based cost classification strategy.
The Company classified all IT service costs into the following categories:

  • In/Out Service Costs: All direct service-related costs should be part of a service cost, while non-related service costs should be part of accounting period costs.
  • Fixed vs. Variable costs. Variable costs vary based on usage or time (i.e. data center utility bills, support tickets, or service consumption). Fixed costs are fixed regardless of service or resource usage (i.e.  software license costs, hardware purchases and support contracts).
  • Direct vs. Indirect. A direct cost is directly related to a service and can be easily traced. Indirect costs are indirectly related to a service and are typically spread over a number of services.
  • CapEx vs. OpEx. Capital expenditures are major expenses incurred whose costs have to be depreciated (split over) over the useful life of an IT asset, while operational expenditures are incurred periodically.

After the strategic IT/business processes were carried out, service-specific tasks began. These included defining and charting individual services, developing service-specific cost packages, and tracking and managing service costs over time.

Next it was time to consider the “people” aspects of service costing. Technology cannot provide a solution on its own; it must be developed and deployed in conjunction with stakeholders.

Along the same lines, handling IT financial management (ITFM) activities is not a one-man show. At The Company, the following roles were defined, along with specific responsibilities:

  • Financial Controller
  • IT Financial Manager
  • Service Manager
  • IT Manager
  • CIO
  • Customer Relationship Manager
  • VP of Infrastructure Services

Developing a roles/responsibilities chart (known as a RACI) then provided a concise and easy way to track who does what along with the level of contribution and accountability.

Next came identifying the right technologies to use in the service costing process. In this case The Company made a strategic investment with VMware and deployed the VMware IT Business Management Suite. This is the technology that will help them gain cost transparency, align with the business, enable the CIO’s transformation agenda, and control and optimize the IT budget and costs.

In addition, The Company has implemented basic CIO and Service Manager dashboards to provide insight into the financial performance of all managed services. The dashboards define the visual layout of the user experience. Each dashboard is composed of frames that display customized information designed for the intended user. The dashboards enable the CIO, IT Financial Manager, and Service Managers to gain access to cost information and make data-driven decisions.

SCP white paper coverToday The Company’s IT department is well on its way to being more business-oriented and service-oriented through better service costing. The Company can now trace IT costs from general ledger all the way to all business units consuming IT services. The new costing model also lays out the key roles and responsibilities, and VMware technology helps provide cost automation, transparency, and service-based cost modeling.

I’d encourage you to get full details about the service costing process outlined in this blog post by reading my white paper, Real IT Transformation Requires a Real IT Service Costing Process.”

Until next time—may all of your IT service costs be allocated with fine granularity and full transparency!

Khalid Hakim is an operations architect with the VMware Operations Transformation global practice. You can follow him on Twitter @KhalidHakim47.

VMworld-graphicAnd if you’re heading to VMworld, don’t miss Khalid’s session #OPT1572!

Accelerate Your IT Transformation — How to Build Service-based Cost Models with VMware IT Business Management (ITBM)
A recent VMware survey showed 75% of IT decision makers list the number one challenge in IT financial management as lack of understanding of the true cost of IT services. ITBM experts and VMware Operations Transformation Architects Khalid Hakim and Gary Roos shed light on this alarming figure, and give practical advice for obtaining in-depth knowledge of the cost of IT services so you can provide cost transparency back to the business.

When you visit the VMworld 2014 Schedule Builder, be sure to check out the SDDC > Operations Transformation track for these and other sessions to help you focus on all the aspects of IT transformation.


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  1. Pingback: Fresh Links Sundae – September 14, 2014 Edition from David Lowe of Disciplined IT and Actionable ITSM | Disciplined IT

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