FULL-COST MATURITY MODEL
|"I definitely would recommend FullCost to any organization where demand outstrips the corporation's ability to pay for it.... It really does align your resources to the strategic goals of the organization."|
| Robert Bender
CIO, SMDC Health System
Clients defend the budget: Experience shows that when an internal service provider submits a budget for deliverables, clients naturally step forward and justify the funding for the projects and services they wish to buy -- that is, clients defend your budget. And they're highly effective at doing so.
With their superior knowledge of their business strategies and how your products and services will help them achieve their objectives, clients make a strong case. With clients' input, corporate executives have the information they need to make better decisions.
If cuts must be made, decisions are based on a better understanding of the needs of the business. In fact, when clients learn the true cost of their requests, they often voluntarily withdraw some of their requirements.
For example, CIO Lew Davison of the Missouri Department of Transportation first submitted a budget for his organization's products and services in a year when tax revenues were down. Initially he was expected to cut his budget by 7 percent, as were all the other departments. But when clients argued that they needed more IT to save money building roads, his budget actually went up 10 percent!
|"My organization had been under-spending on information technology for years. With FullCost, at a time where other budgets were shrinking, my budget actually went up because clients favored the new process and were able to defend their worthwhile investments."|
| Lew Davison, CIO
Missouri Highway and Transportation Department
If an internal service provider gains its funding through an allocation of its costs to business units, the amount of the allocation can be based on utilization. Allocations are fair, and clients understand that a larger allocation means they'll get more service. Ultimately, many clients find themselves arguing for a larger, not a smaller, allocation!
Managed expectations: Once decided, a budget for a department's products and services clearly defines what's funded and what's not. Thus, clients understand what they can expect with the currently planned resources, and what would require incremental funding. Their expectations match available resources.
If clients want more, you can willingly supply it -- at an additional cost. If clients supply additional funding, internal entrepreneurs can expand supply (e.g., hire contractors and vendors) to satisfy incremental demand -- far better than turning clients away.
The result is more than just improved relationships. Clients can better deliver their objectives if they're no longer surprised and disappointed when they depend on getting more than internal service providers have resources to deliver.
Appropriate reinvestment: Internal service providers can build into their costs the appropriate investments in sustainment activities like training, product research, customer relationships, and organizational improvements. They won't see these critical investments displaced by clients demanding more than the budget permits.
Large investments in the organization itself, termed Ventures, are priced as deliverables separate from clients' products and services. These investments are decided on their merits, based on the internal service provider's business proposals. This explicit decision process is far more fiscally sound and reliable than embedding the cost of organizational improvements in clients' projects or hoping for a surplus of unknown size at year-end.
Valid financial metrics: Rates are comparable to outsourcing, on a like-for-like basis. Like vendors' prices, all costs are associated with products and services that customers buy. Rates include a fair share of indirect costs, and are not inflated to fund corporate-good activities which vendors don't have to do.
Proper metrics enhance efficiency through fair, healthy competitive pressure. They also provide a sound basis for deciding when to use vendors (outsourcing) rather than producing products and services internally.
|"My budget is now much more realistic. [FullCost] has made the institution aware of what services we deliver and how much each of those services cost to deliver."|
| Dr. Joyce A. Mitchell, Associate Dean
University of Missouri Health Services
To appreciate the powerful impact of full-cost budgeting on governance processes, consider the business-within-a-business paradigm. From this perspective, every department, indeed every small group, views itself as an entrepreneurial business. Everyone is clearly focused on producing products and services for customers, both within the organization and among the client's business units.
In the traditional paradigm, your budget is considered yours, and it's your job to do the best you can with it to please your internal customers. This old paradigm suggests that you make decisions about priorities (instead of customers deciding what they'll buy from you), and that you're to blame if your budget isn't sufficient to allow you to satisfy all your customers' needs.
The business-within-a-business paradigm suggests a very different way to look at your budget. Think of the money given to you in your budget as a prepaid account -- money put on deposit with you at the beginning of each year by your clients so that they can buy your products and services throughout the year.
In this paradigm, your budget creates a "checkbook" that belongs to your clients. While a portion of it may be yours to pay for investments in your organization (Ventures) and resources set aside for corporate-good services (Subsidies), the bulk of your budget buys products and services that benefit clients.
Thus, client-driven "portfolio management" processes take on a new meaning. A client committee becomes the "purser" responsible for that checkbook. Its job is to evaluate clients' requests and decide which checks to write.
The internal service provider's job is to deliver anything that's funded -- and no more! If there's not enough money in the clients' checkbook, it's the clients' job to either constrain demand or gain incremental funding for you.
A budget that describes the cost of products and services is fundamental to portfolio management. It provides the list of all proposed investments, from which client portfolio managers can then choose which checks to write. It also provides the information they need to know when their checkbook is fully committed -- that is, where the line is to be drawn.
This is required to optimize the return on the entire portfolio, rather than just rank ordering the projects. For example, it may be that priority one -- a very large project -- has excellent returns; but its significant cost means that the organization cannot afford priorities two and three -- two smaller projects which together add up to an even better return. Portfolio managers cannot make such trade-offs unless they know the cost of all products and services.
Note that as new business needs arise during the year, clients have the opportunity to buy more than was planned in the budget process, as long as they can supply the incremental funding. There's no need to miss good investments or postpone them until the next fiscal year. By the way, the purser committee has no power over any sales funded directly by business units, since they don't require any of the funds in its checkbook.
Conversely, this paradigm discourages projects with poor returns. When clients learn the full cost of their requests, they voluntarily withhold demands that they don't feel comfortable defending to corporate executives or to the committee of peers (the purser of the checkbook).
Presenting a budget in terms of the full cost of an organization's products and services changes the conversations an internal service provider has with its clients. It removes many of the sources of conflict, and induces a fact-based budget decision process and makes possible a truly client-driven resource governance process.
In practice, we've found that the benefits of knowing the full cost of products and services go far beyond the financial. Transformational benefits are those that improve the effectiveness of the organization, its culture, and its structure. These include the following:
First and foremost, staff learn that they're in business to produce products and services for customers, that customers decide what they'll buy, and that they must please their customers to stay in business. In the planning process, staff define their product lines (service catalogs), and who their customers are for each. Vague assertions like "for the good of the company" are replaced with clearly defined clients (or consortia of clients), lists of clients for mass-market services, and internal customers within the organization.
Furthermore, in the spirit of customer focus, staff should never have to judge the merits of customers' requests, or be positioned as an obstacle rather than an ally. With knowledge of the full cost of products and services, business leaders (not internal service providers) can make decisions about what to fund and what to cut.
By shifting the job of defending projects and services to clients, and by shifting the job of deciding what to fund and what to cut to executives, a budget for deliverables gets providers out of the "bad guy" role of judging clients' ideas and telling some clients no for lack of budget -- the opposite of customer focus.
Through the process of planning the full cost of products and services, staff gain a clear understanding of the lines of business they run and the specific products and services they sell, encouraging a focus on results rather than effort.
They learn to plan their businesses within a business, forecast revenues, and understand what business they can count on and what their growth opportunities are. They also plan staffing strategies and expenses for the various business scenarios.
Staff also learn to be frugal about their costs (including their unbillable time, the support services they purchase from their peers, and overhead costs), while reinvesting in their businesses where most needed. They proactively set aside time and money for critical reinvestments (unbillable activities such as training, product development, and responding to clients' calls). And they learn to better manage their businesses with key efficiency benchmarks such as billable-time ratios.
Furthermore, the portfolio management processes that can be built on a full-cost model give staff entrepreneurial opportunities to expand their businesses by proposing new ideas to meet new business needs, rather than forcing them to police clients to pre-determined levels of spending. Without the pressure of unlimited demand, staff feel safe putting forward creative new ideas for serving their customers. This entrepreneurial behavior may lead to the discovery of new, high-payoff investment opportunities.
By planning in advance all the resources that will be needed -- not just the prime-contractor group but all the needed subcontractors and support functions -- peers don't surprise one another with demands for help at the last minute. The process induces collaboration to synchronize the delivery of projects and subsequent life-cycle support services.
Since entire projects are funded, all participants on the project team are funded, avoiding the situation where one group's highest priority is another's lowest. Thus, a budget for deliverables and rates based on full cost ensure that the resources are there to support teamwork and complete the job.
The quality of teamwork is also improved when prime contractors and internal subcontractors precisely define their respective deliverables and sub-deliverables. Subcontracting with peer groups for specific deliverables (instead of just for people) clarifies roles and relationships within project teams.
Note the flexibility inherent in this approach to teamwork. When prime contractors buy what they need from peers throughout the organization, business processes are generated and tuned dynamically, and internal alignment of resources with the department's priorities is automatic.
Managers also recognize their peers as customers for support services and departmentwide overhead services. They plan what they need to buy from, and sell to, one another, with a forum for dialog about these indirect costs. No function is left out of the culture of entrepreneurship and teamwork.
Structure: Insights on the organization's structure are gained in the process of defining the lines of business under each manager, necessary to determine the products and services each manager will cost. This has led managers to see opportunities for improving their organizational structure by consolidating fragmented lines of business.
For example, at a healthcare provider in Minnesota, the IT organization had a separate computer server that was managed and used by the applications developers. The operations staff knew that if they could manage this server, they could improve security, reliability, and efficiency. But they'd been unable to convince the developers to let go of "their computer."
In the full-cost planning process, the applications developers were required to develop a business plan and budget for their computer operations function, distinct from their applications engineering line of business. The experience of doing so convinced them that it was indeed an operations function, and they willingly moved it into the data center.
| "We continue to find ways of using FullCost
to better understand and manage our business.
It's made us more efficient and more effective."
| Matt Frymire
CIO, Riverside County, CA
Implementation advantages: Unlike many approaches to changing culture and building teamwork, these positive transformational impacts are largely "free" in that they occur in the course of preparing a budget, something people have to do anyway.
Furthermore, these changes come more easily than some other approaches to cultural and structural change. Since implementing a new budget process seems to be simply a mechanical change, it doesn't engender the same level of political tensions or fears of change.
There are compelling benefits to knowing the full cost, enterprisewide, of every department's products and services. Not only does this produce all the benefits described above (and in Appendix 1) within each department. In addition, there are benefits to the entire corporation when all departments present their budgets in this manner.
Chief among the many benefits is strategic alignment across the entire enterprise. When this discipline is implemented enterprisewide, executives see the cost of, and fund, entire strategies. Knowing the total cost to shareholders/taxpayers/donors, enterprisewide, of proposed strategic initiatives improves planning and decision making.
Furthermore, allocating resources based on each department's participation in strategic initiatives aligns entire corporations in a manner far more explicit than strategic plans alone. This is far better than deciding budgets organization-by-organization, with no explicit process for ensuring that all the pieces of a corporate strategy are included.
Additionally, knowing the full cost of each product and service is invaluable to pricing and product management. Even when pricing is market- rather than cost-based, analysis of full costs is beneficial for these reasons:
* In some cases, such as government contractors or regulated utilities, internal clients are contractually restricted to charging outside customers for internal services at cost plus a percentage markup.
In firms where only a subset of the clients are bound by cost-based external contracts, keeping two sets of books may be required to ensure that all internal clients are treated equally from a budgetary standpoint, and yet external reimbursements are all that's allowed.
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