Friday, December 28, 2012

IT Spending Benchmark Debate: Ideally what should be percentage of IT spent of an organization relative to its revenue?

IT spending is an investment, but it is very difficult to quantify the ROI.

A quick search of "IT spends by revenue by industry" gets some interesting data. The Fortune 500 average is slightly above 4%. Most industry IT spending is less than 3% of revenue! The median is 3% to 5%. So ideally, what should be the percentage of IT spending of an organization relative to its revenue? Seriously, the answer to this question depends on the industry, the company, the company's financial state, the company's competition, the company's IT history, and most importantly, the company's strategic plan and the fit of the IT plan to support the company's plan. Also, IT spending benchmark is more complex than such data point, It far too often becomes policy which is either too constraining or too generous.

1. The Purpose to Do IT Spending Benchmarking

CIO must do some benchmarking not only to justify the dollar amounts spent but also to make sure that the company is spending a reasonable portion of its revenue on IT relative to other companies in the industry to be able to keep it in business in the long run.
  • Cost Optimization: Adjustments should be made to these IT spending numbers by shifting the spending figures on a yearly basis after closely evaluating the key IT performance metrics in a micro and macro environment to achieve cost optimization for the business. The bottom line is that the CIO should be able to show that with the multi-million dollar investment in IT that he is proposing, the company will achieve a lower overall expense in the future. IT spending per worker seems to be more consistent but still widely variable. What is always true is that there will be IT spend that can be cut or avoided and there is more value that can be extracted.
  • Objective assessment: Benchmarking is a way of learning from other organizationsComparing to external benchmarks is a healthy exercise and positions the CIO as a critical thinker who assesses the company from both an internal and external perspective. Tangible benefits can also be realized. But it is not to construct measures to beat the internal organization into submission. Sadly such crude measures have led organizations to make decisions that are based on short-term cost savings that lead to higher costs downstream or even worse, loss of competitive position. 
  • Decision validation: Most CEO & CFO are interested in benchmark data to validate and support their decisions. So even if your CEO loves what you are doing for them with your IT dollars, there is still value is analyzing the IT spend benchmarks. It can be a valuable tool for discussing the value of IT with senior management. If your spend is higher than the benchmark, you should be able to articulate why. 
  • Investment justification: It’s about spending the money right, and getting the right results. You should not spend to meet a quota, nor should you avoid spending to stay within a quota. You should spend to make a return. Assuming a proper business case is involved with each IT project, the answer to the question of "how much" becomes "however much makes business sense". If done properly, IT investments save the business money through improved efficiencies and better service. 
  • Merits...
    - ensures you are looking at your #s in a manner consistent with others
    - helps positions IT as transparent
    - provokes thought and challenges the status quo
    - validates your spending levels or forces you to explain why it differs from the norm.
  • Metrics:
- Operational Budget as a Percentage of Revenue
- Operational Budget to Staff
- Operational Budget to IT Staff 
- Track IT spending as a % of revenue on a cash basis: that's OPEX less depreciation + capital outlay.

2. Don’t get Misled by a Too Generic Benchmark

IT spending is an investment. Indeed it is, but the challenge is that, most of the times it is very difficult to quantify the ROI on IT investments; reasons being many - one of them is being absence of pre-defined parameters & statistics against which the benefits to be measures, there are tremendous variations in the percentage of IT dollars to revenue.

  • How to use revenue benchmark objectively? It’s not necessary to ignore the % revenue benchmark, just don't spend a lot of time using them as an investment data point, otherwise, you might follow those %'s right into the ground. Since there is no consistency in accounting practices, "IT Expenditures" can vary from organization to organization, management has a responsibility to employ funds in such a way as to achieve the best possible return on investment. If that is achieved by spending on IT, then do it.
  •  What proportion of IT spending is used to run, grow or transform your business? Also, consider more systematically beyond a generic data point. The amount can further be divided into strategic (future business critical), tactical (efficiency and effectiveness improvement), and operational (work and service capacity) investments and expenditures:  what proportion of IT spending is used to run, grow or transform your business? Doing it can help you weed or prioritize with better results, such as assign an attribute to each project indicating if it's strategic in nature (change in business model), revenue oriented, efficiency / cost oriented, or regulatory / compliance.
  •  What about IT capital projects? In some companies, those are treated as capital expenditures and not as part of the normal IT expenses, though IT has a heavy hand in the process, business would capitalize that expense instead of accounting for it in the normal IT chart of accounts. It’s a commingling of OpEx and CapEx in relation to IT spend compared to revenue. OpEx, with the exception of M&A or massive expansion, could be rationalized as a percentage of revenue year over year, and should be as a metric. However, CAPex defies this principle. Capital expenditures are always driven by ROI. Any CAPex ROI should fall within the first three years or a compelling argument must be made relating to the typical five-year lifecycle.

  • How about Shadow IT Spending: Depending on the industry, IT spending usually runs 3% to 5% of revenue. However, these numbers typically include all IT spending, not just what the IT department may spend. You need to be careful and look not just at the formal IT department budget but also where is shadow IT spending occurring. Is HR system support handled in IT or in the HR department? Is the Sales department buying its own PDAs, iPads, laptops, etc?

  •  It’s “just a number”: this kind of metric is useful for budgeting with new businesses that don't have run rate metrics or mature processes. But it should be remembered that it's "just a number". Actual expenditure should always involve a business case. No matter what the percentage is to Revenue, what should be included in the Expense line for total IT spending. As you can see, the metric differs greatly when you compare apples to oranges. 
Therefore, IT spend as a % of revenue depends on many factors... The answer is entirely situational and depends on too many factors. The real danger is that it detracts from optimizing the investments. The only sensible thing to say is that the information leader should continue to improve the efficiency of OPEX through driving down cost and improving quality and ensure that CAPEX is supported by the organization and directed to yielding business benefits!

3. Further Questions for IT Spending:  "How much should I spend?", to "How much can we make by spending x on this?".

Crude measures such percentage IT spend against revenue is liked by CEOs & CFOs and Business Strategists because they give some semblance of measurement and objectivity. Sadly, these ratios are not precise and the way the figures are constructed based on accounting rules and allocations, make these crude measures dangerous and can often lead to ridiculous and even dangerous decisions being made.

  • Look at the ROI:  Every budget is IT budget now. When business and IT functions are not integrated and thus seen as a cost to the company then this question (IT % of revenue) is always going to occur. If, however, IT and Business are operating in collaboration such that the business knows how much it costs to build and maintain and that they will get the internal charge each month that appears on their budget codes ( TCO costs)
  • Better service for less cost is the continuous improvement agenda here for most organizations. This has to be about focusing on benefits generation, return on investment and contribution to innovation, even when the projects themselves are primarily justified by cost savings rather than revenue enhancement or innovation. 
  • One important consideration is technology spend versus IT spend, with IT spend a subset of technology spend. You really want the technology to spend across the enterprise. Usually, the IT spend does not include head room for innovation and growth, but the technology spend figure should account for these.
  • IT expenditure depends on Business Strategies, Visions, and industries. The maturity of the organization and its' relationship with IT can be another factor. Whether in "Growth" or "Cost-cutting" Strategies, IT expenses (OPX+CPX) fluctuate between 0.5 to 15%. The same applies to how the business views IT: as "Utility" or "Competitive Advantage". The worst case for any CIO is to exist in "Cost-Cutting" or "Utility" environments, It's a constant struggle with the business to justify any expenditure.
  • C-Suite Dialogue: If a CIO is asked the question, rather than answer it mechanically, he/she should take it as an invitation to a dialogue with other C-suite members to explain why the question is nonsensical. Through theses dialogues, perhaps the colleagues will come to understand the contribution that the IT function make and help the Board collectively to make the right decision for the organization
  • Board Room Agenda: If the Board wants to know percentage IT spend/revenue as part of a set of measures to ensure IT service provision is cost-effective and service-improving but looks for investment projects to be justified and governed on the basis of benefit delivery, return on investment and/or contribution to innovation, then the CIO is in a very good shape.
  • IT budgeting should also follow the general business governance principles:
    -Listen to people involved : If every budget is IT budget, then find right people cross-function with deep communication
    -identify suspected key indicators: Always be critical and creative at the same time, to find space can be improved.
    -measure: follow the SMART measure rule, attempt improvement, track, analyze, learn, and repeat. 
Therefore, IT spend benchmark has a couple of dimensions.  If IT is successful at deploying solutions that provide 'true' value to the business, then they may be more apt to spend, the role of technology in the company’s value creation stream plays a major role. This is largely dependent on the nature of the business, the strategic focus, the role IT plays, the accounting rules, and the vision, the mindset, and charm of the CIO! among others. CIO should be as focused on business strategies that create an advantage. In addition, a common yet important practice is to also compare to organizations slightly higher in growth, in order to gauge what decisions you should make, and can justify in the future.Yes, CIO fads and charm does play a huge role in this.


Nice blog! I liked the concept that you have provided here.Thanks you so much for this information.

Interesting in typical splits between IT spend toward maintenance of existing systems infrastructure and spend toward new capabilities. Great blog and will continue to explore if this is covered.

Spot on! I have been advocating this model for years. I will follow you blogs closely.

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