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The Dreaded IT Budget Cut: Myth, Reality, Transparency

On the surface, a 10% cut on a $2 billion IT budget seems easily attainable. In reality, it isn't.

Executive and business management rarely have the transparency they need in terms of the technology economics of the IT function. As a result it is easier to specify “cuts” than to make them happen. Therefore there is an urgent need for IT management to provide more exacting and insightful views into the cost structure of IT – what is controllable in the short term and what is not. In short, there are many misconceptions surrounding realities of IT budget cuts.

The Scenario
A financial services company is focusing on managing expenses downward in the face of flat or declining revenue and increasing regulation. A Board and Operating Committee that has reviewed company expenses, has identified IT as being among the top five expenses in the company. Leaders mandate that IT should reduce infrastructure costs, currently at $2.5 billion, by $250 million (10%). Sound familiar?

The Myth
Taking out 10% of IT cost is easy.

The Reality (and “Harsher and Harshest Realities”)
For this company, which is modeled after most financial firms, 63% of infrastructure cost is “non-controllable.” This means that $1.56 billion is locked into depreciation and contracts that cannot be impacted within a one-year timeframe. That leaves 37% of cost ($935 million) that has the potential to be short-term “controllable.” However, the requested $250 million reduction represents 27% of the $935 million -- suddenly the 10% reduction in expense is actually 27%.

[For more on the challenges facing CIOs and pressures on IT budgets, read: Pressures on Bank IT in the Age of Cloud.]

The harsher reality is that of the $935 million of controllable expenses, 85% ($792 million) is usually staff related, and the desired reduction of $250 million is essentially 32% of the staff -- which just cannot be done without incurring a high level of operational risk.

The most extreme and harshest reality is that a closer analysis reveals a “safe” staff reduction level is 10%, which is equivalent to $79.2 million. Furthermore, additional options in other expense categories total only $10.17 million in cuts for a total potential of $89.4 million, assuming a start on such reductions at the absolute start of the year.

What is most evident, net-net from the $250 million original request, is there is a gap of $160.6 million in likely unattainable expense reductions.

The Resolution
IT leadership needs to provide a new form of transparency into the dynamics of the IT cost structure.

While most organizations have focused on chargebacks with unit costs and consumption, the more pressing need has to do with creating a view of the elasticity, control points, and “runway” for the adjustment and tuning of IT costs.

A starting point is the construction of a table or documentation that shows the controllable and non-controllable costs. The value of building one is not the table itself. The value comes from the insights and learnings from the process of creating the table. Doing so forces the issue of the realities of controllable costs and the long tail of financial obligations that have built up over time.

With technology intensity continuing to rise and with technology increasingly itself being the product and channel in financial services, an understanding of a firm’s true technology economics and the levers for its management is equally critical for business management, IT management, and even shareholders.

Dr. Howard A. Rubin is a Professor Emeritus of Computer Science at Hunter College of the City University of New York, a MIT CISR Research Affiliate, a Gartner Senior Advisor, and a former Nolan Norton Research Fellow. He is the founder and CEO of Rubin Worldwide. Dr. Rubin is ... View Full Bio
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IvySchmerken
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IvySchmerken,
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6/30/2014 | 10:04:10 AM
Re: Easier said than done
The sales pitch is that the buyer is being offered a good price if they are willing to lock in the rate for say 3 to 5 years. Then as you said, the market can shift as we saw with trading volume. Firms that invested in fixed cost infrastructure can end up with overcapacity.

I think with technology contracts FSIs would prefer the flexibility. Unless, the vendor says that it will raise its prices and it's better to lock in rate for 5 years. That could be another sales pitch.
KBurger
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KBurger,
User Rank: Author
6/30/2014 | 9:58:56 AM
Re: Easier said than done
Good point, Greg. To accomplish this, though, there needs to be management understanding and a general culture that understands how variable/flexible cost structures work. Again, not a quick fix or cost cutting in and of itself. Not a silver bullet, either.
KBurger
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KBurger,
User Rank: Author
6/30/2014 | 9:57:02 AM
Re: Easier said than done
Yes, and not just in financial services.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
6/30/2014 | 9:43:07 AM
Re: Easier said than done
Flexibility and 'elasticity' are the benefits of pay as you go. It is extremely hard to forecast demand 6 months ahead, let alone 3-5 years ahead of time. With long contracts, sometimes a buyer gets a good deal. But often, the market shifts and the buyer is stuck with unused capacity or they pay for things they never use. 

With a flexibile model, a firm can ramp up or down accordingly.

 
IvySchmerken
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IvySchmerken,
User Rank: Author
6/30/2014 | 9:33:08 AM
Re: Easier said than done
I gather you are indicating that larger players probably won't accept a one or two year contract.  FSIs are probably required to sign up for 3-to=5 year deals which then lock them into contracts and limit their ability to make changes or cut costs. I wonder if this is a motivation to shift over to cloud-based services since they have this 'pay as you go' or 'pay for what you eat' motto?
Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
6/30/2014 | 7:16:58 AM
Re: Easier said than done
Moving away from long-term contracts with high 'maintenance' fees is something all FIs need to do. The fees and hidden costs associated with these longer contracts make up a big portion of the fixed costs that Dr. Rubin is focusing on in this article. However, unwinding from a large enterprise contract with one of the big players (insert name of monolith vendor here), is not easy and takes time.
IvySchmerken
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IvySchmerken,
User Rank: Author
6/29/2014 | 11:00:41 PM
Re: Easier said than done
Kathy, I agree with you completely that cost cutting via the IT budget is not a growth strategy and that companies need to launch new products and increase customer sales to increase revenues. Yet, we often see companies cut expenses to improve the bottom line in the short term before they consider investing in growth strategies.
KBurger
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KBurger,
User Rank: Author
6/29/2014 | 8:19:38 PM
Re: Easier said than done
Ivy, to your point about mandated IT cost reductions -- I think management (not just in financial services) sometimes loses sight of the fact that, at the end of the day, you can't succeed just by cost cutting. You have to grow via new customers, sales, cross-selling, etc. Yes, IT (and other areas) must strive to be as efficient and productive as possible, and there needs to be transparency into spending, deliverables, etc. But cost-cutting is not a growth strategy.
IvySchmerken
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IvySchmerken,
User Rank: Author
6/29/2014 | 6:56:16 PM
Re: Easier said than done
True, one way around these "untouchable" budgets is for financial firms to sign up for flexible contracts for services that terminate in a shorter time frame. Also, if these are managed services, they probably don't have the depreciation constraint that fixed networks and equipment might have. As legacy contracts expire, firms will be freed up to choose more flexible arrangements, leaving them room to cut certain expenses out of their budgets.
Becca L
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Becca L,
User Rank: Author
6/29/2014 | 3:33:36 PM
Re: Easier said than done
This argument immediately reminds me of this youtube video that visually illustrate's the realities of trying to cut $100 million from the federal budget. Similar to Dr Rubin's point, the vast majority of the budget is fixed/untouchable. I imagine this argument can be scaled for nearly any enterprise down to any department level.  https://www.youtube.com/watch?v=cWt8hTayupE
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