Tightening the Belts

Software Magazine, August, 2001 by Ian S. Hayes

Plan ahead to reduce the long-term impact of IT cuts

How QUICKLY TIMES CHANGE! Just yesterday, technology ruled the economy and IT budgets were going nowhere but up. Hopefully the current economic downturn will be short-lived, but in the meantime it is forcing many IT organizations to do something they haven't had to do in a long time--cut budgets.

A first-quarter 2001 survey published by TechRepublic Inc., Louisville, Ky., finds that most responding IT organizations have already cut previously approved capital expenditure budgets. Moreover, 85% report that they will review the need for more significant cuts over the next six months.

When it comes to cutting, the choices are never appealing. Important projects have to be deferred, ramped down or cancelled; hiring must be frozen and consultants released; and in the worse case, staff has to be laid off. Ironically, these cuts have the side effect of exacerbating an already depressed economy.

IT Budget Challenges

Few can argue the long-term benefits IT delivers. However, when economic pressures force short-term thinking, IT feels the impact of corporate budget cuts and deferrals in capital spending. As an overhead function with no means of generating its own revenues, IT's financial well-being is entirely dependent on the well-being of its internal customers. When growth and sales slow, or Wall Street increases the pressure on earnings, IT budgets face reductions. Unfortunately, as every CIO knows, the inherent structure of an IT budget severely limits its flexibility in adapting to shortfalls. IT has never had the luxury of owning budgetary slush funds that it can painlessly cut in times of need.

Few categories found in a typical IT budget are truly discretionary (see "The IT Budget Dilemma," p. 20). Fixed Costs, items such as hardware and software leases, long-term maintenance contracts and office expenses, are effectively untouchable when considering short-term budget reductions. Production Support, which includes operations and application maintenance, is required to keep the business running. While introducing additional efficiencies may provide some cost reduction, most of the activities in this category are nondiscretionary. Development project budgets are partially discretionary, as lower-priority efforts can be deferred or cancelled. However, companies are loath to terminate or delay projects that can provide new sources of revenue or reduce operating expenses. Planned Upgrades, such as migrations to newer hardware or a later version of Microsoft Windows, may be deferrable in situations where the current environment remains functional, but more often than not, they are mandated by pressing bu siness or technical needs. Growth, in terms of New Hires and New Technologies, is discretionary as long as it is not needed to support subsequent phases of a critical development effort. Finally, Miscellaneous items such as travel and education are discretionary in hard times, but they represent a very small percentage of the average IT budget.

In some organizations, untouchable and nondiscretionary activities can account for 80% or more of an overall IT budget. As a result, the CEO's request to chop 10% out of the IT budget means the entire reduction must be taken out of the remaining 20% of the budget, forcing discretionary activities to be cut in half. Within this discretionary category, aside from deferring hardware expenditures, the bulk of hard dollar savings must be gained from personnel reductions.

Four Budget Scenarios

When facing budget constraints, the options available to IT managers depend heavily on the level of cost pressures they face. "Belt-Tightening Options," p. 21., shows four possible budget scenarios. Normal Growth applies to IT organizations lucky enough not to be affected by the current slowdown. Slow Growth applies to IT organizations facing modest cuts in projected growth rather than core activities. These organizations can cope primarily through reductions in discretionary activities. Status Quo refers to those organizations whose budgets are frozen at last year's levels. Since salaries and many other costs rise year over year, by sticking to last year's budget level, these IT organizations face an effective budget cut. In addition to eliminating the growth portions of their budgets, these organizations need to find additional reductions to cover cost increases in nondiscretionary areas. IT organizations facing the need to Cut budgets below previous levels face the toughest challenge. Aside from reducing o r even eliminating discretionary activities, they may also need to reduce nondiscretionary activities.

As they prepare their budgets, IT executives at Cut and Status Quo organizations need to think long and hard about the business effects of their decisions. Many short-term cuts have long-term consequences. Staff reductions can be particularly painful both in terms of morale and the difficulties of hiring replacements when the economy improves. Deferring the move to a more advanced hardware platform or cutting the exploration of a new technology may seriously impede the organization's ability to respond to future competitive pressures. Slowing new development efforts delays the business benefits of those applications. And, by foregoing or reducing capital expenditures, IT executives miss the opportunity to take advantage of attractive terms, such as rock-bottom PC prices, that crop up during tight economic times.