Once companies understand their technology spending, how can they best control and manage it in order to invest more in growth?
Author: Tom De Waele, Managing Partner, Bain & Company Middle East
As companies deploy new technologies, including automation, AI, cloud hosting, service platforms, and others to make their businesses more digital and efficient, all businesses are becoming technology businesses. In a post-COVID environment, natural forces are accelerating this dynamic and the need to digitize and virtualize. This expansion from physical into digital means that many functions and activities that were traditionally labour-based are now technology-based. Although the tech budget may grow, total costs should decrease. With the demand for technology continuing to grow as new capabilities become available, companies have to find ways to manage spending on technology that runs the business, while investing more in technology that grows and improves the business.
As tech spending increases, it has proliferated across the functions of the business. Across sectors, more than half of spending on information technology comes from other back-end functions or the lines of business themselves. Companies need to take a more sophisticated approach to building an accurate view of spending. Traditional benchmarks, such as IT spending as a percentage of expense or revenue, may be irrelevant and misleading because they are based on the outdated idea that proportionally lower spending on technology leads to better business outcomes.
The critical challenge then becomes: Once companies understand their technology spending, how can they best control and manage it in order to invest more in growth?
Three horizons to reduce base costs
Cost transformation is no longer an event or a limited program of several months. Because the need for technology investment continues to grow, the corresponding need to reduce run costs must also be continuous. Fortunately, the law of experience curves, the growing capabilities of technology to automate processes, and the adoption of Agile and development, security, and operations methodologies all combine to make processes and development more cost-effective. Technology requires new investment, but it also reduces the spending for ongoing operations.
Because cost transformation must be ongoing, executives can think of actions as happening in three waves.
Short-term actions can help recapture 10% to 20% of costs, some of that in the first few months. Many of these are business decisions (hiring freezes, pausing nonstrategic projects, tightening spending), while others are technology decisions (squeezing higher utilization rates from servers and storage). Cost is often measured as quantity x price. In the case of technology spending, the business usually has more control over quantity, by managing consumption and demand for IT services, while the technology team has more control over the price—whether through higher utilization rates or renegotiating with vendors and suppliers. Key to any reduction program is managing demand, without which companies are likely to reduce their capabilities in ways that can impair results.
Companies can wring another 20% to 30% out of costs by replacing costly technology infrastructure with less expensive alternatives. Many of these opportunities increase the variability of costs, which aligns spending more closely with actual demand. Examples include replacing on-premise software with SaaS applications, outsourcing more work, seeking out hosting services with more manageable, variable, on-demand hosting solutions, and refining the operating model to include more Agile development and automation. Changing these models can incur short-term costs, but companies need to balance these against the opportunity to reduce longer-term costs.
The most significant and sustainable cost savings, 30% to 40%, come from fundamentally rethinking and reengineering technology (architecture, services, processes, and even the operating model itself), or by simplifying the business and the associated IT. Modernizing or investing in next-generation architecture, moving more workloads to as-a-service and pay-per-usage platforms, and pushing automation to its full potential are all ways to contract the cost base to make room for growth. Some companies are getting to the next level of productivity by accelerating a DevSecOps operating model across the entire technology function and by enabling more remote work with better communication and collaboration tools.
Diligence, design, and delivery
Successful transformations begin by investing the time to scan the organization, analyze cost drivers, and identify opportunities for cost optimization. Companies will have different criteria for prioritizing these opportunities, but in most cases, they will want to tackle a few easy wins first to build momentum. In either case, the leaders of the cost transformation need to pressure-test the business’ commitment to change, to ensure consensus as they begin to move forward.
With priorities in hand, design and delivery begins. Agile sprints are the best way to manage cross-functional collaboration that gathers user feedback and incorporates it to improve the next version. Project leads set the ambition for baseline costs, and then Agile teams work with the technology organization to develop initiatives that reduce costs. New solutions get tested and refined as the tech organization carries them out.
Across initiatives, leaders will want to define a new normal in cost, reflecting a changed mindset about baseline costs and ensuring that the work remains an ongoing effort. Executing the first initiatives, often in the Reduce category, can help gain traction and gather important feedback for the rollout of more significant Replace and Rethink initiatives. And, of course, teams will need to ensure accountability for hitting targets.
The recovery from the Covid-19 is likely to put new pressures on many organizations as they continue to ramp up operations to meet reviving demand. Many companies took advantage of a decline in activity to invest in new technologies that could help increase their resilience, speed their recovery, and place them in leading positions in the next wave of growth. Now, by gaining better control of their spending on the costs to keep their businesses running, companies can extend their abilities to invest in technology that moves their businesses ahead.