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Assumptions about the service are a key component of analysing investments. The granularity of assumptions used in investment analysis can have significant impact on the outcome of the analysis. For example, a service obtained via an instantly self-deployable packaged software solution residing on a single desktop and requiring little user support will have a different investment profile than a service obtained through custom development, global customer interaction and other resources that go into creating, deploying and supporting an enterprise solution with multiple language users. In Service Investment Analysis, it is best to lean toward the use of an exhaustive inventory of assumptions rather than a limited set of high-level inputs, in order to generate a more realistic and accurate view of the investment being made.

5.1.2.7 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.

Financial Management plays a translational role between corporate financial systems and service management. The result of a service-oriented accounting function is that far greater detail and understanding is achieved regarding service provisioning and consumption, and the generation of data that feeds directly into the planning process. The functions and accounting characteristics that come into play are discussed below:

 Service recording – the assignment of a cost entry to the appropriate service. Depending on how services are defined, and the granularity of the definitions, there may be additional sub-service components.

 Cost Types – these are higher level expenses categories such as hardware, software, labour, administration, etc. These attributes assist with reporting and analysing demand and usage of services and their components in commonly used financial terms.

 Cost classifications – there are also classifications within services that designate the end purpose of the cost. These include classifications such as:

 Capital/operational – this classification addresses different accounting methodologies that are required by the business and regulatory agencies.

 Direct/indirect – this designation determines whether a cost will be assigned directly or indirectly to a consumer or service.

 Direct costs are charged directly to a service since it is the only consumer of the expense.

 Indirect or ‘shared’ costs are allocated across multiple services since each service may consume a portion of the expense.

 Fixed/variable – this segregation of costs is based on contractual commitments of time or price. The strategic issue around this classification is that the business should seek to optimize fixed service costs and minimize the variable in order to maximize predictability and stability.

 Cost Units – A Cost Unit is the identified unit of consumption that is accounted for a particular service or service asset.

As accounting processes and practices mature toward a service orientation, more evidence is created that substantiates the existence and performance of the IT organization. The information available by translating cost account data into service account information dramatically changes the dynamics and visibility of service management, enabling a higher level of service strategydevelopment and execution.

5.1.2.8 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 known, compliance can be easily addressed. It becomes imperative then to address responsibility for being aware of regulatory and environmental risks that can affect the service operation and the customer’s business.

Over the past decade a number of important regulatory and standards-related issues and opportunities have been introduced that impact Financial Management. Certain legislation has had enormous impact on financial audit and compliance activities. The public demand for accurate, meaningful data regarding the value of a company’s transactions and assets places greater pressure on Financial Management. There are wide variations in the impact of such legislation that should be considered. Public frameworks such as COBIT and the advice and consent of public accountants and auditors are valuable to service management.

The implementation of public frameworks and standards such as COBIT, ISO/IEC 20000, Basel II, and other industry specific regulation may appear to be pure costs with no tangible benefits. However, regulatory compliance tends to improve data security and quality processes, creating a greater need for understanding the costs of compliance. Services provisioned to one industry at a certain price may not necessarily be provisioned at the same price to a different industry segment. There are instances where the cost of compliance has been large enough to have an impact on the pricing of a service.

5.1.2.9 Variable Cost Dynamics

Variable Cost Dynamics (VCD) focuses on analysing 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. Such an analysis is helpful when applied toward the analysis of expected impacts from events such as acquisitions, divestitures, changes to the Service Portfolio or service provisioning alternatives etc.

This element of service value can be daunting since the number and type of variable elements can range dramatically depending on the type of service being analysed. The sensitivity analytics component of Variable Cost Dynamics is also a complex analytical tool because of the number and types of assumptions and scenarios that are often made around variable cost components. Below is a very brief list of possible variable service cost components that could be included in such an analysis:

 Number and type of users

 Number of software licences

 Cost/operating footprint of data centre

 Delivery mechanisms

 Number and type of resources

 The cost of adding one more storage device

 The cost of adding one more end-user licence.

The analysis of Variable Cost Dynamics often follows a line of thinking similar to market spaces, covered elsewhere in this publication. The key value derived from this body of knowledge focuses on more precisely determining what fixed and variable cost structures are linked to a service, and how they alter based on change (either incremental or monumental), what the service landscape should look like as a result, how a service should be designed and provisioned, and what value should be placed on a service.

5.1.3 Methods, models, activities and techniques

This section of the chapter is intended to provide guidance in the form of sample models, methods, activities and techniques for key areas. The guidance provided in this section is not intended to include all possibilities or alternatives, but to provide a sampling of best practice.

5.1.3.1 Service valuation

During the activities of service valuation, regardless of the lifecycle, time horizon or service chosen, decisions will need to be made regarding various issues. This section discusses the more common points of contention that all IT centres will need to address.

Direct versus indirect costs are those that are either: 1) clearly directly attributable to a specific service, versus 2) indirect costs that are shared among multiple services. These costs should be approached logically to first determine which line items are sensible to maintain, given the data available and the level of effort required. For example, hardware maintenance service components can be numerous and detailed, and it may not be of value to decompose them all for the purpose of assigning each to a line item cost element.

Once the depth and breadth of cost components are appropriately identified, rules or policy to guide how costs are to be spread among multiple services may be required. In the hardware maintenance example, rules can be created so that a percentage of the maintenance is allocated to any related services equally, or allocation rules could be based on some logical unit of consumption. Perceived equality of consumption often drives such decisions.

Labour costs are another key expenditure requiring a decision to be made. This decision is similar to that of ‘direct versus indirect’ above, compounded by the complexity and accuracy of time tracking systems. If the capability to account for resources allocated across services is not available, then rules and assumptions must be created for allocation of these costs. In its simplest form, organizing personnel costs across financial centres based on a service orientation is a viable method for aligning personnel costs to services. Similarly, administration costs for all IT Services can be collected at a macro level within a financial centre, and rules created for allocation of this cost amongst multiple services.

Variable cost elements include expenditures that are not fixed, but which vary depending on things such as the number of users or the number of running instances. Decisions need to be made based on the ability to pinpoint services or service components that cause increases in variability, since this variability can be a major source of price sensitivity. Pricing variability over time can cause the need for rules to allow for predictability. Associating a cost with a highly variable service requires the ability to track specific consumption of that service over time in order to establish ranges. Predictability of that cost can be addressed through:

 Tiers – identifying price breaks where plateaus occur within a provider so that customers are encouraged to obtain scale efficiencies familiar to the provider.

 Maximum cost – prescribing the cost of the service based on the maximum level of variability. This would then most likely cause overcharging, but the business may prefer ‘rebates’ versus additional costs.

 Average cost – this involves setting the cost of the service based on historical averaging of the variability. It would leave some amount of over- or under-charge to be addressed at the end of the planning cycle.

Translation from cost account data to service value is only possible once costs are attributed to services rather than, or in addition to, traditional cost accounts. The example shown in Figure 5.3 illustrates the FM translation of traditional cost account data into service account information, and ultimately into the valuation of the service. This metamorphosis provides a powerful layer of visibility to the cost structures of services.

Figure 5.3 Translation of cost account data to service account information

In this example, detailed service-oriented cost entries are captured and applied in order to establish the underlying cost baseline for the service (the first component of service valuation). Once this baseline has been established, monetary conversion of the value of any anticipated marginal enhancement to the utility and warranty of a customer’s existing service assets occurs in order for the total potential value of the service to be determined.

After determining the fixed and variable costs for each service, steps should be taken to determine the variable cost drivers and range of variability for a service. This drives any additional amount that should be added to the calculation of potential service value in order to allow for absorption of consumption variability. Determining the perceived or requisite value to add to the calculation is also dependent on the operating model chosen since this takes into account culture, organization, and strategic direction.

Pricing the perceived value portion of a service involves resolving a grey area between historical costs, perceived value-added, and planned demand variances. Through this exercise, depending on the level of cost visibility present, even if actual costs are not recovered, the goal of providing cost visibility and value is demonstrated.

5.1.3.2 Service provisioning models and analysis

As companies analyse their current methods for providing services there are some basic alternatives to be considered that assist in framing the discussion and the analysis. There are distinct advantages to the various provisioning servicemodels available, and while there are non-financial aspects to consider, such as service quality and transition readiness, this section will only address the financial analysis of the presented models.

The Managed Services provisioning model is the more traditional variant commonly known in the industry. In its simplest form, it is where a business unit requiring a service funds the provision of that service for itself. The service provider attempts to calculate the cost of the service in terms of development, infrastructure, manpower etc. so that the business and the service provider can plan for funding accordingly. In this simple example, the service is managed through the customer-specific application of service-related hardware, software and manpower, and the business unit pays for the entire service.

This is typically the most expensive service provisioning model because the resources used to provide the service are completely dedicated to the service of a single entity. If the consumer does not utilize the service and related resources to the fullest extent technically possible, then unused capacity and the opportunity to provide additional services using the same capacity and resources is lost.

The model for Shared Services targets the provisioning of multiple services to one or more business units through use of shared infrastructure and resources (Figure 5.4). This concept is also widely applied throughout industry and represents significant cost savings to practitioners over the managed services model through the increased utilization of existing resources.

Figure 5.4 Shared services

Utility-based Provisioning maximizes the combination of services being provisioned over the same infrastructure so that even more services are provisioned utilizing the same resources found in the Shared Services model. This is accomplished by providing services on a utility basis, dependent on how much, how often, and at what times the customer needs them. (N.B. The term ‘utility’ is used here with a very specific meaning, different from the meaning used in the rest of the publication.) Examples of such services would include an accounting application with primary usage at the end of each month, a reporting service that receives heavy usage only around the 1st and 15th of each month, or a production-related service used only in every other production cycle as production line outputs are changed.

This service provisioning model is the most cost-effective and the most elusive in that it requires a level of knowledge and capability missing from many IT organizations today. These cost savings are achieved primarily through leveraging a deeper understanding of technology architectures and customer needs in order to compile a service combination and architecture that enables maximum utilization of existing resources.

On-shore, Off-shore or Near-shore? The advent of off-shore service provisioning and its related success is not new. However, companies are still finding that what represents an off-shore opportunity for one firm may not necessarily be an opportunity for another. Many service elements discussed in this publication (and others discussed in the Service design, Service Transition and Service Operations publications) are combined in an analysis of what mix of on-shore, near-shore and off-shore service provisioning is right for a specific company at a specific time.