Budgets
Nobody likes writing up budgets. It is a lot less fun than learning a new technology or architecting a new service. But the organization you work for needs to bring in more money than it sends out, or it is in trouble.
In IT, we are usually on the cost side of the ledger. That means that we have to be sensitive to the business cycles of the organization, and we may need to adjust our spending over the course of the year to match the business’s cash flow. Work closely with the finance department to find out what the business needs, and try to structure spending to match what the company needs. If you develop a good working relationship with the finance department, it will pay off both for the business and also for your flexibility in managing your department.
Budgets allow the organization to plan for large expenditures. They can be used to identify where money is being spent, which is useful when planning priorities.
No matter what type of organization you work for, I can guarantee that it wants to spend less money. By identifying where money is being spent, we can start selecting targets for closer examination. The easiest place to start is on the larger budget items.
A lot of times, those costs are viewed as “fixed,” but maybe the situation needs to be looked at closer. If you’re spending a lot of money on hardware support, for example, maybe you should look at whether you can propose an upgrade or consolidation that could result in a net reduction in those costs. (When you’re dealing with older gear, the cost of support can actually be larger than the cost of payments on new or leased equipment on an annualized basis.)
It can help to try to be creative. Perhaps you can look at moving something to the cloud or virtualizing on a smaller number of servers.
The whole process starts with identifying where you are spending your money. When Willie Sutton, the famous bank robber, was asked why he robbed banks, he said “because that’s where the money is.” When we find out where the money is flowing out of the organization, we know which areas to target first.
Usually, we can use the current year’s expenditures as a baseline for our initial budget. There are some obvious problems with this because some costs change year to year. But you have to start somewhere, and at least the current year’s expenditures will give us a list of costs that need to be examined.
Costs should be estimated for as far forward as possible, not just for the current budget cycle. If there will be a significant increase in costs next year (due to warranty expiration or an End of Service Life (EOSL) component, for example), the plans for dealing with that issue should be put in place now.
When projects or changes are proposed, the savings, profits, and costs should all be estimated for the lifetime of the project.
Different types of estimates are expected to have different margins of error:
- Rough order of magnitude (ROM) estimate. This is sometimes referred to as a “ballpark estimate” or a “wild-ass guess” (WAG). These are frequently provided to give management an idea whether to proceed with scoping out a project, before the details of the project have been determined. The expected accuracy of a ROM estimate is usually from 25% below to 75% above the provided estimate.
- Budgetary estimate. This type of estimate is made after the project’s preliminary scope is known, but before the full scope and detailed budget analysis is complete. The purpose of this type of estimate is to provide numbers for long-term budget planning. A budgetary estimate is expected to be within 25% of the final number.
- Definitive estimate. This type of estimate is expected to be accurate to within 10%, and is made after a full budgetary analysis.
Three different ways to perform a budgetary analysis are to
- Estimate by analogy. Use other similar projects as a baseline for cost estimates. These estimates rely on the project manager to understand the approximate costs of differences between the projects.
- Bottom-up estimate. Find the cost for all the components and add the costs together. Assuming that everything is accounted for, this should yield the most accurate result.
- Parametric estimate. These estimates are based on another estimated parameter, frequently lines of code or function points. These estimates can be surprisingly accurate, assuming that the estimate for the lines of code was correct, and that the baseline information is accurate.
It is common for project managers to use a combination of these techniques as a confidence-building measure that the estimates are in the right neighborhood.
The obvious danger of a cost estimate is that human beings are prone to underestimate because we are wired to want to please management. On the one hand, we have to protect against this by being as complete as possible and allowing an adequate cushion for contingencies. On the other hand, inflating cost estimates too far can lead to a job being over bid and lost, or can result in a project being cancelled when the ROI (return on investment) analysis is unfavorable.
Defects are disproportionately expensive. If defects can be eliminated, it helps reduce overall costs. Quality management can be an important part of cost management.
Quality management also applies to cost estimates that are provided to business. The way to improve the quality of those estimates is to track the variance between estimates and reality over time, and use postmortems to identify where the variances come from.
As with most other things you manage, you will get results in areas that you measure. Measure quality, track it, set your team’s goals in terms of quality, and you will be able to improve it.
Negotiating Your Team’s Budget
There are several things you should do to improve your success in negotiating an adequate budget for your team:
- Find out about the organization’s budget cycles and process. Identify the guidelines and deadlines you are expected to follow. Your peers and your boss are good people to find this information from.
- Find out if there are cash flow issues and spending timing issues that you need to be sensitive to.
- Get to know the finance people who are responsible for your team’s budget. Find out from them what their concerns are, and see if there is a better way to communicate your requirements, or to address their requirements.
- What are the real concerns underlying the budget cycle?
- Who are the decision makers? Make sure they understand what you are doing to control costs and improve efficiency.
- Understand every line item of your team’s budget. If you don’t, follow up with your team members who manage that facility. Every expense should be associated with a particular facility that you are responsible for.
- Start gathering the information well in advance of the deadlines. Ask for quotes from your vendors, and assign team members to compare the renewal quotes to the current inventory of facilities you are responsible for. If they discover big savings, keep track of them, and give that staff member credit in a thank you email with your boss cc’d. Keep track of that information for their annual review. If you show your staff that you value cost savings, they will respond.
- As actual numbers and estimates start coming in, compare them to what you expected. Understand the differences.
- Push back on vendors who seem out of line; some vendors view a new manager as an easy mark. Get alternate quotes, and let the vendors know that there is a new sheriff in town.
Organizing the Information You Need
Everything starts with inventories of systems and software. Once you have those in place, estimate the costs associated with each system and each software license.
Then look for low-hanging fruit where reorganization or retirement can have a significant cost savings.
Make sure that your team members understand that they are responsible for keeping their part of the inventory up to date. Also ask them to look for cost savings opportunities by decommissioning old facilities, and make sure that they get credit when they find them. When your staff members look good, it makes you look good. Make it worth their while to make you look good by giving them credit for what they do right.
Tracking Costs and Benefits
The methods your finance team uses to track costs and benefits will be different from organization to organization. Work with your finance team to provide them the information in the format that is most useful for them.
The total cost of a system needs to be estimated for the entire lifetime of the system. If this number is not reported accurately and included in planning, management will not have planned properly for large increases in maintenance or licensing costs that may appear in the out-years.
By looking at the total cost, you also avoid problems with sales reps shifting costs into the out-years of a contract. That may help you look like a hero in the short term, but it will be very costly to the company over the long haul.
When I compare the costs for two solutions, I try to nail down all the hardware, software, support, environmental, training, and intangible costs. The total package for each of the proposed solutions should be compared over the lifetime of the project. (In my experience, five years is a good time window, if the lifetime of the system hasn’t been specified elsewhere.) I frequently find that the solution with the smallest upfront costs is among the more expensive once you consider the support and environmental costs in the fourth and fifth year of the contract.
Cash Flow Analysis
A cash flow analysis looks at the current benefits the organization gets from a system versus the costs of keeping it running. This sort of analysis does not take into account the sunk costs (what has already been spent) involved in bringing the system online.
Tangible costs and benefits are those that are easily counted in monetary terms. Accounting for intangible costs and benefits is obviously much harder. Intangible benefits may be something like prestige, publicity, or ease of use. Some of these can be estimated as dollar amounts, but the analysis will necessarily be more subjective than with tangible costs and benefits.
Depending on the reason why you are running the analysis, intangible costs and benefits may or may not need to be reported or estimated. When you are asked to perform an analysis, try to pin down how intangible costs and benefits should be accounted for.
Direct and Indirect Costs and Benefits
There will also be direct and indirect costs and benefits to account for. An example of an indirect cost would be the electric bill to run air conditioning to the server room. These costs could be significant, and some effort should be made to include them in cost analyses. (One way of estimating the cost is to find out what the annual electric bill is for the data center, and estimate what percentage of the equipment in the data center is associated with a particular system. You can use a somewhat naïve estimate, for example, dividing by the total number of racks in the data center or something similar, but at least you will have a magnitude estimate.)
Sales representatives will usually follow your lead. Make sure they know what will get your business, and make sure that your criteria make sense for the business. Some things I look for from sales reps are
- Accurate, timely information.
- Solid project knowledge (usually from the sales rep’s engineering staff).
- Tries to understand the challenges my organization faces.
- Presents alternatives when appropriate.
- Offers engineering assistance as needed to help size or scope the environment properly.
- Interested in a long-term rather than a short-term relationship.
- Recognizes that a reliable customer who provides references is worth a significant discount.
Some suppliers do not want to provide a quote for five years of support, or cannot provide solid quotes for the costs of expected upgrades three years in the future. In those cases, I try to insist on rider to the purchase contract with “not-to-exceed” pricing in the out-years. I’m not the only one who does this, and most vendors understand what I am after once I raise the issue. Sometimes the sales rep has to escalate the issue to a regional manager to get approval for these riders, but they are not usually a problem once they understand that you are serious about them.
Examine the stability of your suppliers when you make purchases. Check out their financials as if you were buying their stock. In practice, your company is making an investment in the supplier company. If the supplier goes out of business, who is going to provide patches, service, and upgrades? Get a handle on whether the company is stable, and whether they are a likely acquisition target by someone who will abandon the product line you are purchasing.
When you make recommendations for a large purchase, there is a lot of money on the table. Sometimes you will be felt out to see if you would be more sympathetic if some of that money fell into your pocket. Don’t do it. It is illegal. More important, it is wrong.
I know people who have been offered a golf vacation in Bermuda or a new sports car to help a vendor land a seven-figure contract. In these cases, the offers were reported to their management, were discussed between the legal teams for the two companies, and negotiations suddenly involved some extra safeguards and concessions by the vendor.
Your organization has a policy for dealing with gifts from vendors, and a procedure for reporting bribe attempts. If you are put in this position, follow that procedure to the letter. Do not allow your good name and career to be destroyed for a few baubles.
Summary
Budgeting is not something that most technology people like to do. It is one of the tasks that tends to be procrastinated until the last minute. This results in sloppy results, which lead to lots of midyear groveling to get “extra” money for that service contract renewal you forgot about.
The place to start is with an accurate inventory, including systems, software, ongoing projects, and expected projects. Once you have a good understanding for where your money is going, you can both provide accurate estimates for the coming year as well as finding opportunities for saving your organization’s money.
Discussion Questions
- What is the budget cycle for your organization? When do you need to hand in your preliminary budget? When is the final budget approved?
- What method does your organization use to estimate costs and benefits?
- Does your organization use charge-backs? How are they tracked? Is your inventory being charged back to the right departments?
- One tactic for improving budget quality is to “finish” the budget two weeks before it is due, then review it again shortly before submission. What advantages do you see to this tactic?
Further Reading
Harvard Business Essentials. Manager’s Toolkit. Boston, MA: Harvard Business School Press, 2004.
Schwalbe, Kathy. Information Technology Project Management (Chapters 7, 12). Boston, MA: Thompson, 2006.