Author Archives: khalidh

Rethinking IT for the Cloud, Pt. 2 – The Cloud Services Financial Model

By: Khalid Hakim

Attending VMworld? Please join my group discussion on IT Financial Management (OPT1004-GD) on Monday, August 26th at 3:30pm PT in Moscone West, Alcove 3. Hope to see you there!

This series looks at what it takes to transform a traditional, passive-order IT operation into a cloud-based IT ‘shop’ selling services – turning what’s typically regarded as a revenue drain into a business enabler, revenue supporter, and value creator.

In part one, I suggested a few key points to help you identify how much each and every service in your cloud service catalog is costing your company.

Now, let’s place those services within a broader context: to deliver IT as a Service and run IT like a business requires a business mindset and a business model. So what should that model look like?

To start off, take the key business functions of manufacturing organization. These include (but aren’t limited to) product manufacturing and management, sales, marketing, HR, and finance. The product manufacturing department is responsible for using raw materials, machinery and labor to create a physical product (i.e. a mug). Its marketing and finance teams then establish a unit cost for the product and set a pricing strategy. Marketing helps with product promotion, sales does the actual selling, and finance is a horizontal layer across all these functions to ensure that the organization will stay in business.

Now look at the IT organization as a service broker. What does it need on top of the traditional IT planning, project and service management, architecture, development, and operations functions? Answer: a business practice within IT that penetrates every function across the stack.

If you want IT to be a business-trusted advisor, in other words, then functions similar to those of the manufacturing business need to be deployed to help run the IT service factory as a real business.

Product management (i.e. service management), sales, and marketing functions will facilitate and market service provisioning, and a finance function will account for service costs and encompass planning and budgeting for investments. It might sound like I’m just suggesting that IT requires an improved focus on investments that help the business generate more revenue. And sure, such an organization could be described as business within a business. But, in this case, IT is the business!

The Cloud Financial Services Model

I call this model the Cloud Financial Services Model. At its core is a focus on the Accounting, Budgeting, and Charging/Showback processes. These are the basic processes around which you can flesh out a full service broker business, as shown in the diagram below.

The model’s three core areas encompass the following:

–       Service Accounting: A full accounting of the service costs and expenses incurred will include tracking actual services costs, allocating all IT costs to services being offered, and correctly categorizing costs in terms of Fixed and Variable expenses, Direct and Indirect costs, Period and Service costs, and CAPEX and OPEX. Failing to allocate or miss-categorize these costs will impact your overall cost accuracy and transparency.

–       Service Budgeting & Forecasting: This covers the process of predicting, anticipating, and controlling your organization’s services investment and any other planned expenditures on both an annual and ongoing basis.

–       Service Charging and Showback: The showback is a reporting of cloud service consumption and costs, but is a step prior to charging as there is no actual billing involved. Charging is the process of pricing and billing cloud service consumers for cost recovery and value creation.

With these three areas in place, you can now build a set of Cloud Service Management Activities. Each has its own role to play:

–       Service Definition: Your cornerstone, 360-degree process for reviewing a  service, covering business and consumer management, and service and operations management. This includes identifying all the components making up the service chain and all cost drivers and their associated cost classifications & categorization, along with allocation bases. It will also, in turn, drive overall service costing accuracy and improve cost transparency.

–       Service Catalog/Portfolio Management: Your service catalog is the one-stop shop from which your consumers pick and choose services, so it must contain the right level of information, including cost and/or price. A service portfolio management budgeting and planning-based approach can help realize investment value far better than component- or project-based budgeting. Also, aligning IT cloud portfolio investment categories with business categories is a key step to the path to turning IT into a generator of business value.

–       Service Demand and Investment Analysis: Understanding the demand and performance requirements of both the business and cloud services will help drive a planned demand pipeline that in turns boosts the overall cloud service workload’s efficiency.

–       Standardization and Configuration Management: Standardization and realistic configuration management drive simplicity in service automation and provisioning, and hence efficiency in overall operations. Creating standard cloud service offerings with a high degree of standardization and automation results in operational expenses (OPEX) savings.

–       Service Operations Cost Optimization: Continuously looking for operations improvement opportunities is necessary along the operations journey. New cost drivers may continue to pop up during cloud service operations (especially privately operated ones) and thus IT management may run into cost overruns when unmonitored.

–       Value Measurement: It is generally important to consider a combination of financial measures (such as reduction in costs, revenue increases, and productivity improvements) and non-financial measures (such as performance, satisfaction and compliance).

–       Consumer and SLA Management & Reporting: Running strategic service reviews with consumer stakeholders ensures the continuous alignment and meeting SLA expectations – and that they’re getting value for their money. Producing a bill of cloud services consumption and total cost incurred to consumers is one of your key reporting and billing activities. It can kick off service improvement initiatives, driving service quality while optimizing and lowering costs.

–       Contract and Vendor Management: One way to look at cloud computing is as a new delivery channel for IT services. As a service broker, an IT organization acts as an advisor trusted to provide the required services to its consumers at the right quality and cost, regardless of where those services actually reside. Contract & Vendor management becomes even more important with public cloud services to ensure that service levels are being met and that demand is being proactively managed.

While the core Accounting, Budgeting, and Charging IT financial management processes are required for the cloud business management, those in the model’s outer layer represent the cloud-specific activities that will actuate your cloud financial management practices on the ground.

For example, Service Definition is a cornerstone activity as you need to define the boundaries of what you want to offer for each service. You can’t manage what you can’t control, after all, and you can’t control what you can’t define. Indeed, everything starts with defining your cloud services – of which service accounting and pricing become key activities – followed by publishing the right information to a broader IT service catalog. Service demand and investment analysis is then required to plan for future demand and to deliver services more efficiently at the right quality level, and so on, down the list.

The bottom-line: The Cloud Financial Services Model reflects how cloud service management activities are strongly tied to financial management core processes. Adopting it will help position you for success as you seek to transform IT from a cost center to value creator.

In summary:

  • Delivering IT as a Service and running IT like a business requires a business mindset and business model.
  • The Cloud Financial Services Model is a useful business model in this regard – offering a core focus on Accounting, Budgeting, and Charging/Showback (ABC).
  • The model also includes the various Cloud Service Management Activities via which you will deliver your financial processes.

In my next post in the series, I’ll take you though a cloud service costing exercise to show how you can calculate a cost for a specific cloud service.

Follow @VMwareCloudOps on Twitter for future updates, and join the conversation by using the #CloudOps and #SDDC hashtags on Twitter.

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:

Follow @VMwareCloudOps on Twitter for future updates, and join the conversation by using the #CloudOps and #SDDC hashtags on Twitter.