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5.4.1 Scope of Charging
5.4.2 Charging policies
5.4.3 Leading practice
5.4.4 Deciding Chargeable Items
5.4.5 Variable costs and charges
5.4.6 Pricing
5.4.7 The internal market
5.4.8 Differential charging
5.4.9 Pricing flexibility
5.4.10 Billing
5.4.11 Conditions for Charging to
be effective
5.4.12 Case Studies
The concept of Charging for incurred internal costs is not new but is often seen as too bureaucratic and too difficult to implement fairly.
The Charging systems described should enable an organisation to:
Such a system controls IT Service costs and influences the proper use of IT Resources, so that these scarce resources are used in the manner that best reflects business need.
To calculate the charge for providing IT Services internally, or between (or to) subsidiaries, an organisation must decide, prior to implementation, what it is hoping to achieve. One key factor is to analyse the motivational aspects of Charging, considering both the effects upon the provider and the Customer of the service. The objective is to optimise the behaviour of both parties in achieving the organisation's aims.
Traditional, centrally funded, IT Service organisations are under pressure from many sides. They are expected to reduce overall costs while maintaining or improving service in an increasingly complex Environment. Business divisions may make unrealistic, competing and unjustifiable demands on the fixed resource available. Within the organisation, staff may feel trapped into a slave Role with little opportunity to manage workload or to develop new skills.
Charging for IT Services is seen as a method of:
'Customers will only value what they have to pay for': the corollary is that once Customers have to pay, they will demand value for their money.
To implement charging requires a management commitment to resolving the issues that this brings to the organisation as a whole. Unless the IT Service organisation has the support of the whole company in introducing Charging, it will fail. It has to be simple, fair and realistic:
The image of the IT Service organisation is likely to Change; they may be seen initially as demanding money without providing the required service, as having become bureaucratic and focused on trivial accounting. To limit this Risk, IT organisations considering the implementation of charging should
Four factors govern the requirements of a Charging system in the organisation. For example, full commercial Charging requires that costs can be forecast and collated in a manner that provides profitable revenues in the chosen marketplace. In a simple environment, the aims of a Charging system may be solely to make costs more visible and to cause Customers to pay more attention to them. The four factors are as follows:
1) Level of recovery of expenditure required If the IT organisation opts for full recovery of all costs, then it is opting to function as an autonomous unit, financially self-sufficient. This then requires that costs can be forecast and a Charging system selected that is rational, easily understood and very accurate (although not necessarily based on Business unit Charging).
2) Desire to influence Customer and User behaviour Customers and Users are encouraged to make more efficient use of IT resources through levying charges that vary with usage. This can be applied to:
There is a conflict between the aim of simple, fixed charges referred to in Paragraph 5.1.2, and the levying of variable charges (which makes the Customer's task of Budgeting more difficult). Leading practice would be to help the Customer identify where poor Process or lack of knowledge was increasing the costs of providing their service and work with them to reduce this excess cost to zero over a number of years.
3) Ability to recovery according to usage Recovering costs according to usage requires that the selected Chargeable Items have a reasonable correlation with the amount of resources required to produce them, thereby promoting the perception of a fair pricing and Charging structure.
4) Control of the internal market Introducing market-priced services requires an efficient and effective IT Infrastructure Management with Capacity properly managed, costs well controlled, and services delivered according to expectations.
Pitching services at market price in turn leads to being able to provide quality services consistently, and at reasonable prices, thereby establishing a professional Interface with Customers. Ideally, the Charging is based on business deliverables, recognisable to the Customers e.g. business transactions, monthly reports.
Charging Customers by resource usage, particularly where they have no control over that usage, is one of the most hotly debated topics. Most organisations which seek to charge for service, particularly those who are Charging internal business divisions or departments, levy the charges as a method of forcing sound IT Service procurement discipline in both Customers and suppliers (the latter usually being the in-house IT organisation).
In this situation, the business division benefit from being able to evaluate the best options for the supply of IT Service while the in-house IT organisation benefits by the increased awareness of costs resulting in greater efforts by the Customer to reduce or remove inefficient use of IT.
The actual charges made are usually negotiated annually, with the Customer forecasting service quantity and quality requirements and the IT organisation attempting to balance the requirements from all of its Customers with a corporate strategy to provide the lowest cost core services and to support the IT-enabled directions that the businesses and the organisation need to take.
In order to prevent over-Capacity and under-Charging, or under-Capacity which results in over-budget or insufficient service to meet business needs, the majority of organisations separate the provision of core services from the more optional and variable services, such as installing, moving, adding and changing hardware and software Infrastructure components. This excludes applying 'fixes' to hardware and software, which should be seen as part of the cost of providing the agreed IT Services (defined in the Service Level Agreements).
Additional Capacity is often made available through the use of contractors or third-party service agents. The role of a modern IT organisation can often include being an 'honest broker' by assisting the Customers in the selection of the most suitable Service provider and reducing costs by 'bulk-buying' on behalf of all Customers.
It is still necessary to fully understand the Cost Model for the in-house IT organisation if the core charges are to be fairly assessed and most Customers need to see this broken down by Chargeable Item in order to perform full comparisons with alternative suppliers of service. Any comparison should take into account the different environment and scope of services provided by external suppliers.
One of the greatest dangers for an IT organisation beginning to apply charges to internal divisions or departments is that, in the absence of a breakdown by element of service, the service provided appears more expensive than Outsourcing or Third-party suppliers. This is often due to levels of service being offered that could not be duplicated by an external organisation. It is therefore critical that the level of service being provided is discussed with Customers at the same time as proposals to introduce Charging.
The key decisions for Charging are the choice of what to charge for (Chargeable Items) and how much to charge for them. Chargeable Items should be understandable and controllable by the Customer. Suitable Chargeable Items would be PCs connected to the network or number of batch enquiry jobs submitted. The Customer can then manage their budget by controlling their demand for these items.
The more closely the Chargeable Items relate to the organisation's business deliverables the better the interface to the Customers. Only a lack of information should force Charging to be directly based on resource usage; this lack of information must be overcome and it is important that in the analysis phase, steps are taken to ensure the future Availability of information.
| Example Airlines sell tickets for a journey; they do not issue a bill covering usage of plane, fuel, food, proportional crew costs and so on. The flight or journey is the chosen Chargeable Item. |
Often, business deliverables are not suitable as Chargeable Items because they require too detailed a measurement of the resources consumed. For example a Customer may require a service to produce sales analyses but calculating the individual cost of one analysis or even of many types of analysis could add to the total costs unacceptably. In such cases, a structure may have to be established in which the service is charged for as a whole.
Another example is work performed by a statistical analysis program that on one occasion may run through very quickly and on another, consume vast amounts of resource. Although over a period of time, Charging by the business deliverable (the report) may collect the appropriate money for resources consumed, more accurate Charging for the resource-intensive runs may influence the Customer to alter the way in which the program runs enabling a more effective use of IT.
Often, business deliverables cannot be easily attributed to single processes or applications. Programs are rarely written to produce single logical business deliverables: often many Customers utilise portions of a multitude of programs, each of which contributes to the production of parts of many business deliverables. Batch systems in particular are characterised by this trait and identifying the costs of running a large suite of batch jobs may not be possible.
Where a Customer requires charges to be variable, dependent upon usage, the Chargeable Items have to be more specific to that Customer and easily attributable to that Customer. The more freedom the Customer has to define their own service, the more detailed the Charging structure required.
Other costs that are known to vary, for instance computer consumables or overtime hours, have to be managed carefully. In the budget, it may be necessary to estimate the likely annual total and manage the cost by checking monthly that the usage is in proportion to the period measured.
The Customer wants an estimate of the likely charges and possible upper and lower limits, in order that they can budget. If a service depends upon staff costs and the effort required cannot be predicted accurately, the charge calculation might be in the form of:
e.g. first 1000 hours @ £60 /hour, subsequent hours @ £100/hour (reflecting the need to pay contractors).
When estimating Costs-by-Customer or Costs-by-service for a new or Changed service, the potential variation from estimate could be large. For example if a major project is due to be implemented, a large variable cost may be the overtime necessary to install equipment outside normal working hours or additional processor time to re-run work.
Often, apparently variable costs do not decrease with decreasing usage, for example decreased usage of a mainframe server may not result in any decreased costs, unless licence, maintenance or hardware charges can be reduced.
Hence, IT Finance Management must be cautious in identifying a cost as variable if this figure is to be used in calculating Costs-by-Customer or Costs-by-service. At the very least, it needs to be re-checked whenever there is a Change to the system or its usage.
Pricing is just one element of the marketing quartet 'product, pricing, promotion, place'. Deciding upon the appropriate charge/price is, therefore, not merely a question of cost recovery but also of its Impact upon the demand for the product. If an organisation charges for its product in an open marketplace (i.e. no constraints upon the businesses to buy the service) there must be clear understanding of whether the product (i.e. IT Service) is attractive to the marketplace.
The pricing of any product or service involves:
Achieving an anticipated rate of return figures greatly in many managers' considerations. For the IT Service Management, selling services to internal divisions, the price to be charged is often based on what has to be charged to recover costs, with any cost above market prices explained through the benefits of internal spend, the assumed flexibility of internal organisations or the value-added aspects of working for a common organisation.
Whatever pricing decision is taken it is essential for IT Services Management to first know the actual costs of providing the service.
Examples of pricing methods include:
Cost The cost can be defined in several ways, for example:
Cost plus There are a number of cost-plus pricing models. The basic form is:
Price = cost + x%
The mark-up (x%) can either be set by the organisation as a standard Target Return, comparable with returns on other business investments, or varied by the IT organisation to meet strategic business needs e.g. encouraging the use of strategic applications but discouraging the use of legacy applications.
Cost plus may be used for large one-off original projects where the costs cannot be easily predicted. The contract protects the supplier.
Going rate The price is comparable with other internal departments within the organisation or with similar organisations.
Market price The price is the same as that charged by external suppliers. Care should be exercised in asking external suppliers to quote prices - they may well disguise a discount to gain the business.
Fixed price The IT organisation sets a price based upon negotiation with the Customer for a set period, based upon a predicted consumption.
However the prices are determined, it is essential that they are visible to Customers so that they can tailor their budget forecasts and Service Level Requirements to match the likely costs.
Tied Customers In many IT organisations, Customers are tied to using the internal IT Services. Where the IT organisation is intending to operate as an independent business unit, the stages usually followed are:
Where no direct charge is levied, Customers do not take account of the cost of producing a service and tend to treat it as free. As a consequence they may be extravagant and uneconomical in their use of IT Services.
Untied Customers In an untied situation Charging becomes particularly important because it enables Customers to choose between using the in-house IT Services organisation or outside suppliers, based on the relative quality and price of services offered.
If IT provision is to be untied (i.e. Customers can buy in from other sources), the IT providers should operate on a commercial basis with the aim of recovering full cost, including return on capital employed. When Customers are first freed from being tied to internal IT Services, it is not uncommon to find some organisations subsidising the cost of the internal IT Services, to discourage Customers from switching suppliers. In practice, subsidising IT Services should be discouraged, since prices appear to be unrealistically low.
Charging at full cost entails recovering all revenue spend costs associated with providing an IT Service (including a share of overheads), insurance premium, depreciation of fixed assets and interest on capital employed. It is important that the charge for each service provided by an IT Services organisation should, wherever possible, be charged out at full cost.
Cross-subsidisation between different Customers of the same service should be avoided whenever practicable. Where surpluses and deficits accumulated by a number of services are pooled so that they break-even in total, the effect is to subsidise the cost of one service with the income from another. Such cross-subsidies may lead to a department being criticised for taxing one group of Customers for the benefit of another group.
An IT organisation might not charge out a particular service at full cost when:
Setting different charges for different usage of the same or similar services enables an organisation to reward some usage patterns over others. For instance the use of Differential Charging to increase charges for batch work during peak daytime processing periods may encourage changes in Customer behaviour which reduce overall costs, often without the IT organisation being blamed for poor value of service. This can result in smoothing demand for Capacity and reducing the overall Capacity required.
However, if Customers are not tied to the IT organisation, great care has to be taken in applying differential charges that are not seen in the open market or cannot be justified on a business basis. For instance, trying to discourage the use of daytime development work on a mainframe because of the impact on the Service Levels of the production service, may cause a Customer to move their development workload, decreasing the revenues for the IT organisation without reducing their need for Capacity (i.e. revenue drops, costs stay constant).
IT Finance Management in a Profit Centre may wish to set prices for an annual period to guarantee revenues. However, where new resource requirements are committed to meet the needs of particular Customers it may be necessary to build into any contract for the provision of such services a clause to permit Changes to the Capacity available during the contract period. This reduces the risk of having excess Capacity. The alternative is to be able to sell excess Capacity to other Customers, but it is rare for this to be effective, as other Customers' budgets will also have been fixed.
IT Finance Management in a Profit Centre may wish to consider the stability and duration of a Customer requirement for IT Services and seek regular updated forecasts if demand is likely to change. This may be particularly important if there are large peaks and troughs in Customer demand especially when these are not synchronised to the Availability of additional Capacity. It may be that the management should consider setting specific prices for particular times of usage; but this depends upon size, circumstance, and objectives of the Profit Centre.
Three objectives are key to Billing:
Bills Charging information is passed to Customers to make them aware of the cost of the resources used by their business. This can be done by :
Often the first two options above lead ultimately to the introduction of Full Charging. Whichever approach is followed, the presentation of the information to the Customer must be simple, understandable and honest.
Notional Charging is useful when a Charging system is being introduced for the first time. Notional Charging allows the IT Services organisation to gain experience and time to correct errors in the Charging formulae or cost recovery plans and familiarises Customers with the concept of being charged for using IT resources. Notional Charging is not recommended for long-term use unless the organisation does not intend to move to a real Charging system, because the incentive to become cost conscious is lessened when money does not change hands.
Billing cycle If Full Charging is introduced, the organisation may also expect the IT organisation to manage cash flow. If a bill is only paid annually, the organisation may have to account for the gap between revenues and expenditure in the same way that a separate company would have to manage its cash flow.
In the simplest example, an IT organisation which pays licence fees annually in advance, has monthly Operational expenditure and some Capital expenditure but does not bill its Customers until the end of the year would operate at a loss throughout the year and only break-even when all bills are paid. This is recognisable to businesses as a cash flow Problem, which requires funding. For most organisations, the budgets are agreed and monitored monthly by the Finance department, which takes care of any cash flow issues for the organisation as a whole and can include those of the IT organisation.
In the simplified example in Table 5.9, the overall cost of implementing a service has to be borne within the Financial year ending August 31 but the Customer only begins paying once installation is complete.
|
Expenditure |
January |
February |
March |
April |
May |
June |
July |
August |
|
Software |
£20,000 |
|||||||
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Development |
£10,000 |
£10,000 |
£5,000 |
£2,000 |
||||
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Testing |
£10,000 |
|||||||
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Hardware |
£30,000 |
|||||||
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Installation |
£5,000 |
£2,500 |
||||||
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Support |
£2,000 |
£5,000 |
£4,000 |
£1,000 |
£1,000 |
|||
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Total |
£20,000 |
£10,000 |
£45,000 |
£19,500 |
£7,000 |
£4,000 |
£1,000 |
£1,000 |
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Charge |
£26,875 |
£26,875 |
£26,875 |
£26,875 |
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Revenue-expenditure |
-£20,000 |
-£30,000 |
-£75,200 |
-£95,002 |
-£75,882 |
-£53,965 |
-£28,858 |
-£3,530 |
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Cumulative cashflow |
-£20,000 |
-£30,000 |
-£75,502 |
-£95,757 |
-£76,840 |
-£54,733 |
-£29,405 |
-£3,824 |
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Interest @ 1% |
£200 |
£302 |
£755 |
£958 |
£768 |
£547 |
£294 |
Table 5.9 - The effects of interest on late billing
The result of interest applied to the cash flow is to show a £3,824 shortfall in recovery. Even if the Finance department takes responsibility for managing this, they often want to see the Cash Flow profile to aid their planning.
In considering whether it is worth investing time and resources in setting up a Charging system, regard should be given as to whether Customers:
If demand is not sensitive to pricing, Charging is effective only as a mechanism for funding IT Service provision: alternative arrangements such as inter-departmental reviews must take place to verify and assure the Cost effectiveness of IT Service provision (see also Paragraph 5.7.11).
Any considerations, however, must take into account the fact that Customers' perception of IT is constantly changing and that they increasingly expect their IT Services supplier to be a thoroughly professional organisation, whether in-house or external.
The intent of this Section is to provide the reader with a few examples of how Charging may become a real hindrance for an organisation if the initial strategy is not clearly defined or the implementation imperfect.
A company has an underground parking lot. This parking lot is for the use of all employees but is over-subscribed. The company decides to introduce Cost Accounting and calculates that the £200,000 yearly cost of the car parking facility will have to recovered by an internal charge to each department of £50/month for each car park pass issued.
The company parking lot is:
A hotel nearby provides parking facilities:
Because the hotel has the space free during working hours, it need only recover costs of administration plus any profit it wishes to make. It decides to charge £30/month for business car parking. The result of this is that the internal parking lot is only used at 20% of its Capacity while the hotel parking lot is full.
Using the external hotel parking facility costs less to the department manager but more overall to the organisation, as it has to pay the costs of the building and would usually prefer to minimise external spend. They cannot reduce their overall costs, as the company parking is an integral part of the offices and grounds.
The company agreed that it should subsidise parking to reduce the charge to £40/month while also banning managers from purchasing outside services when suitable internal services are available.
Do not allow businesses to buy external services when suitable internal services are available.
Avoid higher internal prices than the market prices.
One company is charging £860 a year for the provision of an Infrastructure to which Users' workstations are connected. This Infrastructure is available 24 hours a day, monitored 16 hours a day and includes a number of facilities such as office automation tools, shared printers, e-mail, external gateways (faxes, Internet, access to large servers).
Some small departments (from 5 to 20 Users) were used to very simple peer-to-peer Infrastructure that suited their needs. Moving to the new, more expensive common Infrastructure did not appear to provide any benefits and even seemed to add to overheads.
Several of these departments conducted a study and found that it would be less expensive for them to continue with their dedicated Infrastructure and just have one shared workstation connected to the common Infrastructure for e-mail purposes.
The charges were adjusted by reducing the standard charge and adding an additional charge for those requiring the additional facilities. The standard charges were raised above true cost, under the direction of the organisation management, to encourage Customers to adopt the systems that were felt to be strategic and to wean them from outdated systems.
A small, dedicated Infrastructure tailored to specific needs is always cheaper than a company wide Infrastructure.
However, several small, dedicated Infrastructures always cost much more than a global one and are also unlikely to meet strategic aims.
A company provided its Users with a dedicated, outsourced Service Desk facility. The vendor charged the company on a per-call basis, the price varying in bands, depending upon the total number of calls during the month. The charging policy was to recharge all IT spending to the business on the basis of true cost.
Once the Service Desk was in place, Customers realised that they could reduce their costs by not placing Service Desk calls. Some business managers instructed their Users not to use the Service Desk, or to route all issues through a single, local support person.
Decreasing the total number of calls decreased the calculated charges to the Customer but did not reduce overall price of the service by the same amount. It also resulted in:
The charging method was changed to one in which a fixed fee per User was negotiated, based upon an estimated call rate taken from previous years' volumes and business predictions. This charge was reviewed quarterly to check that call levels were within agreed thresholds.
Some cost should be fixed and should not depend on actual usage.
In the same Service Desk context as the previous example, business managers may be tempted to set up their own Service Desk facility by appointing staff dedicated to this. It may cost less to the business department than a centralised desk and allows the business to direct the efforts of the staff toward the Incidents and Problems that concern them. However, the total cost to the organisation of allowing one or more businesses to do this is:
This results in an under-used central facility and an increase in hidden costs of IT as the business Service Desks are not accounted for in the IT budget and probably not fully costed by the businesses.
The organisation forced all business units to measure effectiveness and introduce cost analysis. This demonstrated that the internal Service Desk and support services were actually costing more in total than would be the case if the central facility were correctly used.
If the businesses are allowed to develop private Infrastructure or services, it may result in:
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