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IT Optimization Navigating Fiscal Austerity

Situation – Tight Budgets and Tough Requirements Federal budgets are tight and requirements continue to grow. We are in a period of budget reductions, especially for agencies that have experienced significant budget growth over the past decade. The question is how big the budget cuts will be and how long will they last.

The Office of Management and Budget (OMB) policy efforts (e.g., PortfolioStat, TechStat) may be a “too little, too late” strategy to get Federal agencies to look deeper into IT expense management and take waste out of the system. Whether these and similar policies will achieve meaningful cost savings or simply result in more resources being spent on compliance remains to be seen. Currently, OMB projects that PortfolioStat will result in a $2.5B savings over three years1, which is not a large figure considering the Federal government predicts it will spend over $70B on IT in fiscal year 2013.

The Federal Government faces a situation similar to that of the private sector in the early 2000s. Many corporations experienced rapid growth in the late

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> 1990s. Companies spent tens of millions of dollars on ERP, CRM, and other enterprise IT systems. As the below graphic illustrates, large enterprise systems grew corporate expense budgets at an unprecedented rate in the form of support, maintenance, enhancement, operations, and amortization. The late 1990’s technology and dot com busts, multiple downturns, and a recession caused industry to change their spending habits and drive cost out of their baseline. Some succeeded, many failed, and a few went bankrupt.The question is whether Federal COOs, CFOs, and CIOs will wait for OMB to levy cuts on them or whether Federal executives will act to address the systemic drivers of IT expense so they are ready to respond to the inevitable round of forthcoming budget cuts. In the words of George Bernard Shaw, “The possibilities are numerous once we decide to act and not react.” Acting now could protect agency missions and even redirect additional funds to critical needs. If CFOs and CIOs wait for the inevitable budget mandate, it will be too late to identify waste - and the only thing left to cut will be investment dollars.

1 http://www.whitehouse.gov/blog/2012/10/24/portfoliostat-saving-billions-it-spending, October 24, 2012 2 Strategic IT Portfolio Management—Governing Enterprise Transformation, Jeffrey D. Kaplan, 2005

Operating Expense Growth Drivers2

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Complication – Obvious Answers are not the Right OnesFlattening and declining budgets threaten mission and business effectiveness. The easiest places to cut often offer the greatest return on investment, such as new investments in mission capabilities, business optimization efforts, consolidation, and “get well” projects. This is because these investments are easy to identify, reduce, and avoid; it is more difficult to find, take out, and keep out unnecessary spending.

Common practice is to trim down new investments in response to budget cuts, but this may marginalize the organization’s return on investments by elongating project cycle-time, deferring time-to-results, and introducing additional project risk. Eliminating new investments altogether is worse because new investments are often designed to improve mission and business performance. New initiatives are often more strategic than older ones. Similarly, systemic “get well” efforts are often

targeted because the concept of spending to save may appear unpopular in the face of short-term cost reduction targets. However, these efforts affect long-term spending and may pave the way for a more efficient IT baseline.

Another common practice is to spread budget reductions across programs. This practice is popular because it is easy to do. However, it does not address systemic cost drivers and is often not sustainable in the long run due to escalating operations and maintenance costs (license fees, inflation, volume metrics, etc.). IT costs may appear to be flexible to the layperson, but the vast majority of costs for many organizations are relatively fixed in the short term (e.g., contract obligations, license fees, real estate, salaried employees, deployed workforce). Furthermore, the bulk of the IT budget is spent on supporting, operating and maintaining (O&M), and enhancing the IT systems that have been deployed over the past two or more decades. The average O&M sustainment tail can exceed

three times a system’s installation cost. When budgets are flat or declining, the investment budget may decrease if O&M increases. Hence, the value returned from new investments may be reduced as new capabilities are sacrificed or delayed to accommodate increased operating cost. If new investment is squeezed, the risks to the mission and supporting functions increase.

Unless management takes proactive action to correct the trend, O&M cost is relatively fixed in the short term. The industrial supply base is rarely motivated to decrease operating expense, and so leadership must proactively take action to reduce it. Furthermore, cutting O&M cost often requires a change in human behavior, which is rarely achieved voluntarily and almost always requires top-down guidance, leadership, and management. Guidance sets strategy and policy, leadership overcomes behavioral resistance, and management persists to make sure results are achieved.

Value Erosion3

3 Strategic IT Portfolio Management—Governing Enterprise Transformation, Jeffrey D. Kaplan, 2005

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There is a direct and indirect cost associated with each stand-alone system, application, and technology. Furthermore, many of these assets are underutilized.

5. Gold Plating:

Most people do not buy the most expensive home appliances because mainstream ones meet their needs.

Requirements add sustainment cost to a system. Deferring requirements defers cost. Often, deploying a 60% solution provides the majority of the benefits much faster than waiting for a 100% solution.

6. Weak Standards:

Manufacturers of our personal automobiles make suppliers develop to their standards; doing otherwise would be costly and impede interoperability.

Support costs inflate when contractors offer their favorite tools, operating systems, and development environments. The most efficient approach is to set standards and require contractors to work on one common platform.

7. Improper Analytics:

Anyone can perform analysis; few know how to do it right.

Many organizations make poor decisions because they lack sound analysis; they do not know precisely how much applications and technology cost. Most IT professionals cannot perform financial analysis, and most financial analysts do not understand IT cost drivers. Integrating the two skills is critical to supporting investment decisions.

8. Poor Long-Range Planning:

Have you ever seen your town tear up the same stretch of road multiple times because the utility companies do not coordinate their improvements?

Uncoordinated and unplanned release upgrades are often expensive and inefficient. Establishing one integrated multi-year upgrade release roadmap can prevent wasted overhead and expense.

The Culprits – Seeking out Cost DriversWhile IT cost optimization can be found in many areas, a small number of cost drivers offer the greatest savings. Investigating these cost drivers often uncovers hidden costs that can be eliminated or reduced:

1. Unaffordable Service Levels:

Most homeowners do not pay for instant response when their air conditioner goes out. Why do agencies pay for immediate response when the average desktop computer fails?

Ongoing operations and support is costly. These costs are directly driven by service-level requirements (response time, hours of operation, off-peak response, etc.). Open-ended contract structures also add risk to the government and typically benefit the supplier (CP/LOE, T&M, etc.).

2. Enhancement Slush Funds:

Most homeowners would never give a builder a large allocation and pay them based on effort; yet, this is effectively how most organizations manage IT enhancements.

Enhancement budgets are often buried in O&M and program budgets. Many enhancements can be postponed during periods of fiscal austerity. Open-ended contract structures also add risk to the buyer and typically benefit the supplier (CP/LOE, T&M, etc.).

3. Duplication:

Most people do not have two dishwashers at home just because each spouse likes a different model; why do agencies allow similar duplication in the IT portfolio?

There is a direct cost and indirect cost associated with each application. Similarly, there are costs associated with having different contracts and applications across multiple domains.

4. Proliferation:

We do not have a separate computer for each application we install at home. Why do we allow this at work?

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Working Outside the Box The key to achieving IT cost optimization has little to do with technology. In our experience, agencies “get well” by carrying out a behavioral change management campaign.

A get well campaign requires strong leadership and management. Finding, understanding, and responding to cost drivers is not easy. A persistent, strong leader who stays focused and motivates the staff and a person who pays attention to detail are integral to this undertaking. In addition, moving resources in an organization is difficult to accomplish and requires authority beyond most executives’ control. This means that the most senior management must be engaged in driving this from the top. Budget reductions are rarely achieved by consensus-based decisions.

Most get well campaigns require a cross-functional team, including finance, acquisitions, procurement, logistics, human resources, as well as technical domains such as networks, data center, program management, engineering, and integration. The team needs members who both think outside the box and are grounded in the realities of getting work done. Those overly committed to the current state will resist change rather than enable it.

Few government executives have led a team through a period of budget reduction like the one we face because many of them were promoted through the ranks over the past decade when the budget was growing. They were mostly focused on spending and managing an increasing budget. Many cut their budgets by ten percent or more, but few have experienced budget cuts of this magnitude. Increasing attrition amongst the most tenured government executive only makes this situation worse.

> CIO/CFO Partnership—Good Cop, Bad Cop Many Chief Information Officers (CIOs) are challenged when it comes to cost alignment campaigns and most CIOs have a fiduciary and a service responsibility. On one hand, the CIO is expected to be the caretaker of the IT budget and installed base. On the other, the CIO is expected to run a responsive and agile business service, responding to the needs of the mission and business. This dual role places tremendous strain on the IT function and is further exacerbated when the business and mission are allowed to make their own IT investment decisions. While the CIO can usually manage this duality, this role conflict trickles down to other levels of the IT function, often creating stress in the lower ranks where individuals are not adept at dealing with this dichotomy.

Furthermore, while some CIOs control the IT budget, they do not handle the demand for IT services. Rather, mission and business units control demand for IT systems and services, which is the paramount driver of IT spending.

Enter the Chief Financial Officer (CFO). An optimal working relationship ensues when the CFO works with the Chief Operating Officer (COO) to set fiscal policy for IT investments. The CFO helps to establish enterprise service requirements aligned with budget realities, facilitates the financial due diligence of business cases and acquisitions, and makes sure that a process is in place to evaluate whether the investment business case was realized and the scope was maintained. In essence, the CFO paves the way for the IT function to solve technical problems, provide and operate technical solutions, and secure the enterprise.

• Get:

Taking cost out of the installed baseline needs to be managed as a project. Most organizations make several cost take-out efforts simultaneously; initiatives must be handled as a program with interdependencies in schedules and resources.

• Keep:

Managing costs is a never-ending process. Many of today’s controls were established during a time of increased spending and lack sufficient insight to manage costs during a period of fiscal austerity. As cost drivers are better understood, functions from the full life cycle become more involved in predicting costs and providing support in investment decision making. Sophisticated organizations not only manage project cost, schedule, and performance but also ongoing sustainment costs and resources.

Planning for SuccessBuilding and executing a get-well campaign requires strong leadership, savvy, and logistics. It took most organizations over a decade to amass the current level of annual IT expenditures, and it is going to take a few years to decrease it. A plan must be put into place to scale down spending and keep it under control for the long run.

A robust get well campaign operates along three dimensions:

• Find:

Understanding IT cost drivers at a level of detail to deal with them is an ongoing process (which leads to lessons learned and further analysis). Uncovering costs, understanding cost drivers, and targeting opportunities for improvement is an ongoing process.

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Get Well Campaign Elements

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> How PwC Can HelpPwC helps senior executives define and establish campaigns to drive IT cost and value optimization:

• Methodology:

PwC helps senior executives drive accelerated and sustained improvement by applying proven methods. Our methods fuse technology and operational analytics into business and management tradecraft that results in objective conclusions, through planning, and robust execution.

• Competency:

PwC offers direct access to professionals with federal and commercial experience. Our consultants deliver a blend of competencies necessary to solve difficult technical and organizational problems. Competencies may include acquisition, architecture, behavioral change management, contracting, finance, human capital, logistics, policy, procurement and sourcing, strategy, as well as technology.

• Leadership:

PwC’s technology and business leadership is recognized by industry analysts including IDC, Forrester, and Gartner. We offer access to tenured practitioners, many with advanced degrees; including an integrated network of over 7,000 technology professionals embedded in PwC industry groups worldwide.

• Risk Mitigation:

PwC provides clients with an innovative, insightful, collaborative, and results oriented engagement experience. PwC’s business model may offer clients lower engagement risk in the form of self-managed teams, critical mass, a proven track record, broad and deep past performance, and a learning culture.

For more information, please contact:

Jeff Kaplan Principal (202) 756-1711 jeff.kaplan@us.pwc.com

Simona Lovin Director (703) 918-1083 simona.m.lovin@us.pwc.com

Greg Dupier Director (703) 610-7467 gregory.m.dupier@us.pwc.com

© 2013 PwC. All rights reserved. “PwC” and “PwC US” refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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