Service Strategy Financial Management Financial Management GOAL To

Service Strategy Financial Management

Financial Management GOAL: To provide cost effective stewardship of the IT assets and the financial resources used in providing IT services.

Objective Business opportunities Business Financial Management IT IT capabilities The great connector, between desires and abilities!

Enterprise value and benefits of Financial Management The landscape of IT is changing as a strategic business and delivery models evolve rapidly, product development cycles shrink, and disposable designer products become ubiquitous. Much like their business counterparts, IT organizations are increasingly incorporating Financial Management in the pursuit of: • Enhanced decision making • Speed of change • Service Portfolio Management • Financial compliance and control • Operational control • Value capture and creation.

© Crown Copyright 2007 Reproduced under license from OGC Shared imperatives framework: Business and IT

Service Valuation Total cost of delivering the service + Total value to the business of the service Service Valuation is used to help the business and the IT Service Provider agree on the value of the IT Service.

Service Valuation © Crown Copyright 2007 Reproduced under license from OGC Value Potential Customer assets Performance Service level potential performance designed and delivered + Provisioning Value + Unlocked value potential + Desired outcome Service value realization Service Assets

Demand modeling Poorly managed service demand is a source of cost and risk. The tight coupling of service demand capacity (consumption and production) requires Financial Management to quantify funding variations resulting from changes in service demand.

Service Portfolio Management Financial Management is a key input to Service Portfolio Management. By understanding cost structures applied in provisioning of a service, a company can benchmark that service cost against other providers. In this way, companies can use IT Financial information, together with service demand internal service capability information, to make beneficial decisions regarding whether a certain service should be provisioned internally.

Service Provisioning Optimization (SPO) Financial Management provides key inputs for Service Provisioning Optimization. SPO examines the financial inputs and constraints or delivery models to determine if alternatives should be explored relating to how a service can be provisioned differently to make it more competitive in terms of cost or quality.

Planning Confidence Planning provides financial translation and qualification of expected future demand for IT services. Financial Management Planning departs from historical IT planning by focusing on demand supply variances resulting from business strategy, capacity inputs and forecasting, rather than traditional individual line item expenditures or business cost accounts.

Planning Confidence Planning can be categorized into three main areas, each representing financial results that are required for continued visibility and service valuation: Operating and Capital (general & fixed asset ledgers) Demand (need and use of IT services) Regulatory and Environmental (compliance).

Service Investment Analysis Assumptions about the service are a key component of analyzing investments. The objective of Service Investment Analysis is to derive a value indication for the total lifecycle based on 1) value received, and 2) costs incurred during the lifecycle of the service.

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.

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 used, compliance can be easily addressed.

Variable Cost Dynamics (VCD) focuses on analyzing 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.

Methods, Models, Activities & Techniques Traditional Chart of Accounts Service-Orientated Accounting for IT and Identification © Crown Copyright 2007 Reproduced under license from OGC Applying Invoice to Chart of Accounts • Service Valuation • Service Provisioning Models & Analysis • Funding Model Alternatives • Business Impact Analysis (BIA) Salary Server Maintenance Hardware Depreciation TOTAL 60, 00 0 25, 00 0 15, 00 100, 000 0 Service Maintenance Invoice * Service: Collaboration Service A * Cost Type: Hardware * Classifications: > Operational vs. Capital Direct vs. > Indirect > Fixed vs. Variable *Unit Base for Charging serial number 25, 000 Hardware Depreciation * Service: Financial Reporting * Cost Type: Hardware * Classifications: Operational vs. > Capital Direct vs. > Indirect > Fixed vs. Variable *Unit Base for Charging user extension 15, 000 Service Cost Subset: Collaboration Service Total Costs for Collaboration Service 25, 000 Salary 60, 000 * Service: Service Enhancement Project ABC * Cost Type: Labour * Classifications: Operational vs. > Capital > Direct vs. Indirect Fixed vs. > Variable *Unit Base for Charging personnel ID Total Service-Orientated Accounting Entries 100, 000 (Same 100, 000 but service-orientated accounting treatment) Valuing the Collaboration Service Sample Breakdown of Service Cost by Accounting Characteristic Collaboration Service Total Cost Breakdown by Characteristics Hardware 150, 000 Software 25, 000 225, 000 Traditional cost accounting Labour 50, 000 Operational 180, 000 Capital 45, 000 225, 000 Capital structure Direct 51, 000 Indirect 55, 000 225, 000 Benefit structure Fixed 100, 000 Variable 125, 000 225, 000 Variability of costs Subtotal Expenditure Collaboration Service Potential Value Add Utility Optimizations Warranty Enhancement 10, 000 Subtotal Value Add Subtotal: Anticipated Peak Demand Variance Increase (Decease) 225, 000 E$ value of service improvement 10, 000 225, 000 Current Period Funding Base 20% 47, 000 Additional Funding Required 282, 000 Total Service Valuation (future) 282, 000 Future Funding Need Service Cost #1 50, 000 Service, Collaboration Service Annual Maintenance Service Cost #2 - 125, 000 Collaboration Service Software Service Cost #3 25, 000 Collaboration Service Other Characteristics, etc. 200, 000 Total Service Expenditure 225, 000 Server maintenance invoice is aggregated with other service specific invoices

Funding model alternatives Funding addresses the financial impacts from changes to current and future demand for IT services and the way in which IT will retain the funds to continue operations. Each model assumes a different perspective, yet rests on the same financial data, an increased ability to generate the requisite information translates to increased visibility into service costs and perceived value. The model chosen should always take into account and be appropriate for the current business culture and expectations.

Business Impact Analysis (BIA) A BIA seeks to identify a company’s most critical business services through analysis of outage severity translated into a financial value, coupled with operational risk. This information can help shape and enhance operational performance by enabling better decision making regarding prioritization of incident handling, problem management focus, change and release management operations, project priority etc.

Return On Investment (ROI) ROI is a concept for quantifying the value of an investment. Its use and meaning are not always precise. When dealing with financial offers, ROI most likely means Return on Invested Capital (ROIC), a measure of business performance. This is not the case with service management, ROI is used as a measure of the ability to use assets to generate additional value.

Keep it simple In the simplest sense, it is the net profile of an investment divided by the net worth of the assets invested. The resulting % is applied to either additional top-line revenue or the elimination of bottom-line cost.

Tactical Benefits While a service can be directly linked and justified through specific business imperatives, few companies can readily identify the financial return for the specific aspects of service management. It is often an investment that companies must make in advance of any return.

Terms Business Case Pre-Program ROI Post-Program ROI

Business Case A decision support and planning tool that projects the likely consequences of a business action. The consequences can take on qualitative and quantitative dimensions. A financial analysis, for example, is frequently central to a good business case.

Business Objectives The structure of a Business Case varies from organization to organization. What they all have in common is a detailed set of business impact or benefits. Business impact is in turn linked to business objectives. A business objective is the reason for considering a service management initiative in the first place.

Business Impact While most of the Business Case argument relies on cost analysis, there is much more a service management initiative than financials. The scope of possible non-financial business impacts is summarized as: A business impact has no value unless it is linked to a business objective. There does not have to be a one-to-one relationship between business impact and business objective.

Pre-program ROI The term capital budgeting is used to describe how managers plan significant outlays on projects that have long-term implications. A service management initiative may sometimes require capital budgeting.

Capital budgeting Capital Budgeting is the commitment of funds now in order to receive a return in the future in the form of additional cash inflows or reduced cost outflows. Capital budgeting decisions fall into two broad categories: • Screening Decisions • Preference Decisions.

Screening Decisions (NPV) An investment typically occurs early while returns do not occur until some time later. Therefore, the time value of money, or discounted cash flows, should be accounted for. There are two approaches to making capital budgeting decisions using discounted cash flows: • Net Present Value (NPV) • Internal Rate of Return (IRR)

What is an organization’s discount rate? A companies cost of capital is typically considered the minimum required rate of return. This is the average rate of return the company must pay to its long-term shareholders or creditors for use of their funds. Therefore, the cost of capital serves as a minimum screening device.

Other methods There are other methods for making capital budgeting decisions e. g. • Pay-back • Simple Rate of Return. However, Pay-back is not a true measure of the profitability of an investment and Simple Rate of Return does not consider the time value of money.

Intangible benefits Process improvement and automation are common examples of difficult-to-estimate cash flows. The up-front tangible costs are easy to estimate. The intangible benefits, such as lessened risk, greater reliability, quality and speed are much more difficult to estimate. They are very real in impact but still challenging in cash flows.

Preference Decisions (IRR) There are often many opportunities that pass the screening process. The bad news is not all can be acted on. Financial or resource constraints may preclude investing in every opportunity. Preference decisions, sometimes called rationing or ranking decisions, must be made. The competing alternatives are ranked.

Post-program ROI Without proof of value, executives may cease further investment. Therefore, if a service management initiative is initiated with prior ROI analysis, it is recommended that analysis be conducted at an appropriate time after. Program objectives should be clear as they serve to guide the depth and scope of the ROI analysis.

Data Collection The collection of data is vital for a valid and quantifiable ROI results. There are two periods in which to collect data; Pre – Implementation and Post – Implementation. Program objectives should guide the source and nature of data points e. g. • Metrics for quality of service • Costs for service transactions • Questionnaire for customer satisfaction.

Isolate the effects By this stage, the results of the service management program are becoming evident. By isolating the effects, there should be little doubt that the results should be attributed to the program. There are many techniques available e. g. • Forecast Analysis • Impact estimates • Control group.

Data to monetary conversion To calculate ROI, it is essential to convert the impact data to monetary values. Only then can those values be compared to program costs. The challenge is in assigning a value to each unit of data. The technique applied will vary and will often depend on the nature of the data: A quality measure is assigned or calculated and reported as a standard value. Staff reductions or efficiency improvements are reported as a standard value. Improvements in business performance are reported as a standard value. Internal and external experts are used to established the value of a measure.

Determine program costs This requires tracking all the related costs of the ITIL program. It can include: • The planning, design and implementation costs. These are pro-rated over the expected life of the program. • The technology acquisition costs • The education expenses.