Tuesday, October 2, 2012

IT Cost Transparency

In one of my previous blog posts I outlined Virginia Mason Medical Center's (VMMC) supply chain innovations, including their Total Cost approach to inventory. Total Cost inventory management encourages efficiency by pricing inventory transparently on its real itemized process and delivery costs [1].

This week, our articles discuss, in part, the intimidating complexity and cost of IT systems. MIT's "Trouble With Enterprise Software," explains how difficult it can be to assess the true implementation and operation costs of large scale ERP systems [2]. Based on those problems, "Information Technology in a Supply Chain," recommends that businesses be conservative ad only implement as much IT as absolutely necessary.

I chose to look further into how the cost of IT can be evaluated. For my conclusions, I use two McKinsey Quarterly reports, "Managing IT in a Downturn: Beyond Cost Cutting," by James Kaplan, Roger Roberts, and Johnson Sikes and "Unraveling the Mystery of IT costs," by Andrew Appel, Neeru Arora, and Raymond Zenkich. Ultimately, those reports recommend using a form of Total Cost pricing to evaluate and implement major IT systems. As with VMMC, Total Cost IT pricing encourages efficiency and cost effectiveness in any IT implication   

Financial Savings Through IT
Initially, I appreciated Kaplan's article for its explanations of why, given tight corporate budgets, improving IT systems (as opposed to cutting IT) can be a good investment. The chart below (from Kaplan) suggests that while cutting IT by 15% may increase earnings by up to .5%, using IT to improve merchandising  the supply chain, and pricing, can improve earnings by as much as 2%, 4% and 5% respectively [4].

These savings are considered to be "short term" saving, as in the savings can be achieved quickly through basic process optimizations. Larger "long term" savings will also be recorded [4].

What to Consider 
Appel is concerned that many business executives do not fully consider the itemized cost and cost effectiveness of new IT systems. His solution, a practice similar to VMMC's Total Cost methodology, is "cost transparency [5]."  Cost Transparency seeks out, through detailed bills and management reports, all projected and real itemized costs of potential and used IT systems [5].

The goals of such transparency are twofold. First, an executive can use those documents to optimize the usage and quantity of IT services. If an IT system is not cost effective or if other solutions are more cost effective, it should be scrapped or replaced. Second,  IT staff can use those reports to optimize the IT system itself. Products can be evaluated by performance and systems can be adjusted to better control for variables or set more precises process improvements [5].

The chart below (form Appel) is an example of how an itemized bill can be evaluated.

By breaking IT costs down, managers and IT should have a better understanding of their system's performance, how their system is being used, and what potential future costs might be.

Whether ERP or Cloud based systems, any IT solution MUST be analyzed thoroughly before implementation and evaluated thoroughly during and after the process. Failure to do so may result in unplanned costs and sub-optimal system performance. Nonetheless, these articles do not address why such analysis is not often used. Is the problem just that executives are inexperienced with IT implementations or do some companies just not have the financial or human resources to meet those needs? I presume that cost transparency will be cost effective but, in practice, has that been the case?


[1] Hansa, L. "The Evolution of the Toyota Production System." IBS Case Development Centre, No. 604-032-1, 2004.

[2] Rettig, Cynthia. "The Trouble With Enterprise Software." MIT Sloan Management Review, Fall 2007

[3] Chopra and Meindl. "Information Technology in a Supply Chain."  Supply Chain Management (4th Edition, Chapter 16), pgs. 452-464.

[4] Kaplan, James, and Roger Roberts and Johnson Sikes. ""Managing IT in a Downturn: Beyond Cost Cutting." McKinsey Quarterly, September 2008. Internet; Available from https://www.mckinseyquarterly.com/Managing_IT_in_a_downturn_Beyond_cost_cutting_2196

[5]  Appel, Andrew and Neeru Arora, and Raymond Zenkich. "Unraveling the Mystery of IT costs." McKinsey Quarterly, August 2005. Internet; Available from https://www.mckinseyquarterly.com/Unraveling_the_mystery_of_IT_costs_1651

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