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IT Chargeback

What is IT Chargeback?

IT chargeback is a method of charging internal consumers (e.g., departments, functional units) for the IT services they used. Instead of bundling all IT costs under the IT department, a chargeback program allocates the various costs of delivering IT (e.g., services, hardware, software, maintenance) to the business units that consume them. [1]

In an IT chargeback situation, instead of simply charging all IT costs to one central department, the company charges individual costs to the user groups or centers that most directly consume the goods or services that were purchased. This principle can make things clearer for administrators who have to manage costs and can also help to provide a clearer contrast for various options, such as outsourcing. With so many types of cloud and SaaS services proliferating across the business world, IT chargeback can be a useful way of ordering information and assessing value for cost. IT chargeback is sometimes contrasted with other options for keeping track of costs, such as showback. In showback accounting, costs are presented in a decentralized way, without being actually cross-charged to the different accounts.[2]


The Purpose of IT Chargeback[3]

The need to understand the components of the costs of IT, and to fund the IT organization in the face of unexpected demands from user departments, led to the development of chargeback mechanisms, in which a requesting department gets an internal bill (or "cross-charge") for the costs that are directly associated to the infrastructure, data transfer, application licenses, training, etc., which they generate. The purpose of chargeback includes:

  • Making departments responsible in their usage, e.g., refrain from asking for resources they are not going to use
  • Providing visibility to the head of IT and to senior management on the reasons behind the costs of IT
  • Allowing the IT department to respond to unexpected customer demand by saying "yes, we can do it, but you will have to pay for it" instead of saying "no, we cannot do this because it's not in the budget."

As of 2011, the chargeback mechanisms are often controversial in organizations. Departments rarely pay directly for their own electricity bill, janitorial services, etc. -- these are allocated to departments on the basis of the number of employees or the square footage they occupy. Similarly, departments may expect to pay a fixed allocation for IT and get a flexible set of services that meet their needs in return. While the discussion on such an allocation are always difficult, seeing actual variable charges arrive on a monthly basis for specific levels of usage can create conflict both between IT and its internal customers, and between a department manager and the users who caused resource consumption to increase and therefore costs to rise. The rise of subscription-based computing services (cloud computing) may make chargeback mechanisms more palatable.


Chargeback Methods[4]

A range of approaches have been developed for implementing chargeback in an organization, as summarized in Figure 1. The degree of complexity, degree of difficulty, and cost to implement decreases from the top of the chart [service-based pricing (SBP)], to the bottom [high-level allocation (HLA)]. HLA is the simplest method; it uses a straight division of IT costs based on a generic metric such as headcount. Slightly more effort to implement is low-level allocation (LLA), which bases consumer costs on something more related to IT activity such as the number of users or servers. Direct cost (DC) more closely resembles a time and materials charge but is often tied to headcount as well.

Methods for chargeback allocation
source: Uptime Institute

Measured resource usage (MRU) focuses on the amount of actual resource usage of each department, using metrics such as power (in kilowatts), network bandwidth and terabytes of storage. Tiered flat rate (TFR), negotiated flat rate (NFR), and service based pricing (SBP) are all increasingly sophisticated applications of measuring actual usage by service.


Implementing IT Chargeback[5]

  • Step 1: Selling the chargeback Idea: Chargeback success relies on IT, business units (BUs), and corporate functions (CFs) working together. When IT budgets are centralized and owned by IT, the BUs and CFs don’t see the IT cost. For them, IT feels like a free and unlimited resource. Moving to a model where the BUs and CFs will be charged for the IT products and services they use is a big change requiring collaboration. Imagine receiving a surprise electricity bill when you have never paid for electricity before. Surprise chargeback won’t work and initiating chargeback as a surprise won’t help to establish trust and partnership. The BU and CF budget holders need to understand the reasons and benefits of chargeback—like freeing more IT budget for innovation and better alignment with business needs. There will be detractors, but it will not be a surprise to them when chargeback happens.
  • Step 2: Organizing for chargeback: Many IT organizations don’t have the people or skills needed for an effective chargeback. Finance skills will be important. IT will need to do new things like model the costs of products and services, set rates, and calculate bills. All with the goal of recovering costs. Chargeback also creates the need for product and service owners. People who design, deliver, market, and recover costs for IT products and services to IT’s new paying customers. To organize for chargeback, accountability and responsibility will need to be assigned for (not exhaustive):
    • Defining a portfolio of products and services
    • Calculating the total cost of ownership (TCO) for products and services
    • Marketing products and services
    • Defining and implementing chargeback strategy
    • Recovering costs
  • Step 3: Putting the right systems and processes in place: Can you use spreadsheets for chargeback? Yes. Should you? No. With those questions answered, let's move on to discuss some of the right systems and processes successful organizations use to implement chargeback. The systems and processes will need to do the jobs of (not exhaustive):
    • Defining product and service offerings
    • Tracking actual costs
    • Managing demand
    • Planning rates
    • Calculating bills
    • Transferring money to IT
    • Marketing and selling products and services
    • Sharing chargeback bills and reports with customers
    • The corporate finance system is critical. The corporate finance system must process the chargeback bill (also referred to as the bill of IT) to enable transfer of money to IT.

The systems must be multi-user systems that provide auditing capability and scalability. This is why spreadsheets are not a good choice.

  • Step 4: Baseline the current state: Capture the current state and include:
    • Total IT costs
    • Total cost of ownership for each product or service
    • Total IT cost by BU and CF
    • To capture the current state, the following information is also needed (not exhaustive):
      • Portfolio of products, services, applications, technologies
      • Asset inventories
      • Capacity, usage, and utilization
      • Projects

This is a great opportunity to use and validate the systems and processes from Step 3, above. Store the baseline current state in the systems and use them both for defining and pricing products and services for chargeback.

  • Step 5: Transfer the IT budget to the business: IT needs to transfer its budget to their customers. IT can’t have a full budget and do chargeback. There are many strategies for transferring the budget, including:
    • The big bang – The whole budget all at once.
    • Staged transfer – Break the transfer down into smaller batches.
    • Never 100% – Some organizations choose to keep some IT budget for management, innovation, or more.

Transferring the IT budget is a fundamental change for an organization and requires support and commitment from corporate finance and senior leadership. Some organizations can take advantage of tax optimization opportunities by charging legal foreign entities for IT products and services. We mean real big dollars, like one Digital Fuel customer that has used chargeback to support $90million in annual tax deductions.

  • Step 6: Market and sell products and services: IT is not known for marketing and sales. Chargeback forces the CIO’s organization to market and sell their products and services—and also themselves. When IT has all the budget, they are the only option in town. When BUs and CFs own the budget, they have choice. IT needs to be an attractive option for their customers. Maximize likelihood of BUs and CFs buying from you by clearly defining and communicating:
    • What IT sells
    • What value IT delivers
    • How IT is better than other options
  • Step 7: Continue to learn: An essential component of all implementations is ongoing learning and process improvement.


Guiding Principles and Considerations for a Chargeback Model Design[6]

  • Fairness

► To what degree should chargeback be based on actual consumption versus an estimated allocation?
► What costs should be included/excluded?

  • Influence

► What behaviors, if any, should chargeback drive (e.g. reduced consumption, investment in new products, incentives to move users from old technologies, etc.)?

  • Transparency

► What insight should customers have into how IT manages IT— including which costs are fixed and which are variable?

  • Effort

► How much effort (e.g., data collection, transformation, calculation, reconciliation, and billing) is appropriate and is it in keeping with the value provided?

  • Consistency

► Are IT chargeback methods aligned with cost allocation and profitability measurement used throughout the organization?


Guiding Principles and Considerations for a Chargeback Model Design
source: EY


Building a Chargeback Model[7]

If you are proposing moving to a chargeback system, you will also need to propose what costs should be covered by the chargeback and which will still be funded through a shared services model. Some of this might be dictated by corporate financial guidelines, but here’s a list of costs that may be included, starting with the most obvious:

  • Materials and external costs—all the out of pocket costs associated with the project
  • Creative and production, fully burdened labor
  • Account management/project management/traffic, fully burdened labor
  • Department management and administration
  • Hardware and software costs
  • Overhead (e.g., space and associated facility costs)
  • Training and team events

Your chargeback model may be an internal service organization that is allocating variable costs, or, a self-supporting internal agency that is truly operating with little or no associated corporate funding. Either answer, or something in between, is okay, but you need work with finance and define your model before you start. You also need to track these charges very carefully, evaluate your chargeback strategy for accuracy, and then fine tune your model. There are a few more questions to consider prior to implementing a chargeback model. Again, there are many correct answers, but you need to ask the questions.

  • Rate sheet or hourly charge? Many internal groups provide standardized deliverables. It may be better to develop standard costs for standard work, e.g., a new 3 page brochure will cost X dollars.
  • If charging back based on hours, what rate will you use? You can track hours by function with a rate for each function, or use a blended rate. As a rule of thumb, the more “agency-like” your model, the more appropriate to use actual rates for each function to calculate the total charge. This is especially important if some clients are using an inordinate amount of high-end creative, or require a lot of account manager time.
  • Are you going to provide estimates? This is not necessary in the rate sheet model, but very important if charging based on project hours. This gives the client the ability to compare with outside agency prices and provides you with the opportunity to track estimate to actual metrics.

Finally, how do you implement your new chargeback model? We’ve seen some very good examples where costs were tracked and reported to the client for a full year before actually going to a chargeback plan. This gives you time to improve your costing strategy, provides the client with data for budgeting and gives your finance group the information they need to re-define their financial model. It is also very important to develop a change management communication plan. That plan needs to inform your clients and other key stakeholders of the changes you will be implementing and how it will affect them. This is your opportunity to sell the advantages of your plan to each stakeholder group and get their buy-in. Theoretically a chargeback model should decrease allocated costs to each business unit to free up funds for their new creative services chargeback budget, but you’ll want to speak with your finance department to understand how clients will be affected by this new line item in their budgets.

Implementing a chargeback model can have positive results for many internal creative organizations. If your organization moves to a chargeback model, it’s important to plan the transition, develop accurate rates and communicate changes to your clients. The results can include better service to your clients, more efficient operations and better recognition of the value of your organization.

Below is an illustration of a model for IT Chargeback

A Model for IT Chargeback
A model for IT Chargeback
source: Massachusetts Institute of Technology


Chargeback vs. Unattributed Accounting[8]

All costs are centralized in traditional IT accounting. One central department pays for all IT equipment and activities, typically out of the CTO or CIO’s budget, and these costs are treated as corporate overhead shared evenly by multiple departments. In an IT chargeback accounting model, individual cost centers are charged for their IT service based on use and activity. As a result, all IT costs are “zeroed out” because they have all been assigned to user groups. IT is no longer considered overhead, instead it can be viewed as part of each department’s business and operating expenses (OpEx). With the adoption of IT chargeback, an organization can expect to see significant shifts in awareness, culture, and accountability, including:

  • Increased transparency due to accurate allocation of IT costs and usage. Chargeback allows consumers to see their costs and understand how those costs are determined.
  • Improved IT financial management, as groups become more aware of the cost of their IT usage and business choices. With chargeback, consumers become more interested and invested in the costs of delivering IT as a service.
  • Increased awareness of how IT contributes to the business of the organization. IT is not just overhead but is seen as providing real business value.
  • Responsibility for controlling IT costs shifts to business units, which become accountable for their own use.
  • Alignment of IT operations and expenditures with the business. IT is no longer just an island of overhead costs but becomes integrated into business planning, strategy, and operations.


IT Chargeback - Pros and Cons[9]

IT Chargeback: PROS

Chargeback can be an effective governance mechanism in an organization. It can reveal the resource requirements of running different departments, develop managers into better decision makers, and ultimately improve the performance of the entire organization.

IT chargeback can result to a reduction in resource consumption by cutting off unnecessary demands from users, thus increasing the IT department’s ability of serving a larger clientele, as well as providing a wider variety of services. Furthermore, IT services will be streamlined to customer requirements and IT investment decisions will be more effective. It can also create a marketing mentality among the IT personnel, with them becoming more cost-efficient and customer service oriented. This will eventually raise the credibility of the IT department to a cost-conscious corporate management because all cost allocations will be supported by services requests and usage analysis.

For other business units that avail IT services, IT chargeback will give them the chance to establish priorities. Chargeback may ensure that only the projects with utmost importance are given top priority. It also allows other business units and the IT department to put a value on each of the IT services provided. Furthermore, IT chargeback may allow the potential to improve the relationship between the IT department and other business units by giving both sides the opportunity to learn more about how the other side works and what challenges they are facing. This awareness will lead to better appreciation of the services that either side provides.

Costs will be reduced and there will be a greater, more intimate relationship between IT and other business units. IT chargeback, in general, can provide more accountability and controllability on IT assets and services, as well as timeliness and congruence with the general goals of the organization.


IT Chargeback: CONS
If not properly implemented, however, chargeback may worsen the relationship between IT and other business units, primarily due to concerns about the fairness of applied charges. It may be difficult for users to evaluate the benefit of IT chargeback if the billing and charging process is not clear to them. Seeing the actual cost of each IT service may also discourage IT initiatives among business units, especially if the IT service rates are high and they fail to understand why these rates are high.

To properly implement IT chargeback and reap its numerous benefits, organizations need a reliable usage monitoring system that is capable of easily generating a wide range of simple and readable reports that any user will be able to understand and appreciate.


IT Chargeback Challenges[10]

  • Establishing a fair and practical chargeback policy
  • Partnering with business units for buy-in
  • Collecting usage metrics
  • Allocating IT costs efficiently
  • Pricing IT services
  • Providing detailed billing reports
  • Understanding the cost of an IT chargeback system
  • Recovering IT expenses based on business services


See Also

IT Financial Management (ITFM)
Technology Business Management (TBM)
IT Cost Allocation
IT Cost Optimization
Federal IT Acquisition Reform Act (FITARA)
Total Cost of Ownership (TCO)
Transfer Pricing


References

  1. Defining IT Chargeback Uptime Institute
  2. Explaining IT Chargeback Techopedia
  3. The Purpose of IT Chargeback Wikipedia
  4. Chargeback Methods Kevin Heslin
  5. How can my organization successfully implement IT chargeback? Apptio
  6. Guiding Principles for a Chargeback Model Design Pete Hidalgo
  7. Building a Chargeback Model Cella Consulting
  8. Chargeback vs. Unattributed Accounting UI Journal
  9. Advantages and Disadvantages of IT Chargeback Open IT
  10. IT Chargeback Challenges Help Systems


Further Reading

  • Accounting and Technology: IT Chargeback and its True Costs SEI level
  • Chargeback and Showback Grow in IT’s Quest for Greater Transparency Computer Economics
  • Cloud Computing: Why You Can't Ignore Chargeback cio.com
  • Best Practices: Defining the Right Chargeback Methodology IBM
  • When--and How--to Implement Chargebacks N Dean Meyer