Why Ignoring These Opportunity Costs Will Destroy Your Balance Sheet

CEOs make tough financial choices every day.   Every capital expense requires a combination of fact finding and polishing the crystal ball.  On the one hand, CEOs need to know the acquisition cost, the operating cost, depreciation cost, useful life and so on for every asset purchased.  On the other hand they need to look into their crystal ball and make some educated guesses and intuitive leaps as to what the future may hold.

Award winning entrepreneur, Bill Douglas helps his customers uncover high opportunity cost that typically get missed. He put it this way. “I see it every day.  C-Level managers get so focused on external drivers and cost cutting; they often overlook the high opportunity cost of a seemingly simple cost reduction.”

Mr. Douglas identified these very expensive cost cutting mistakes:

• Assigning routine computer/network maintenance tasks to professionals that should be working on billable projects.
• Overstaffing of highly paid IT employees for general maintenance and security tasks that their competitors have learned to outsource at reduced cost.
• Tying up working capital in computer hardware and software purchases when they could leverage the assets of a managed services provider and have scalable hardware and software to meet current demand.
• Directing highly paid purchasing staff to waste time trying to save a few bucks on non-strategic consumable items when they should be putting all their energy into reducing the cost of production supplies.

Bill Douglas is the founder and CEO of EssentiaLink and specializes in delivering managed IT and procurement BPO services to Small and Medium Businesses.  EssentiaLink has earned 13 growth awards for providing exceptional services and support.

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Who is monitoring the monitors?

Wikipedia describes Operational Intelligence (OI) as “providing real-time monitoring of business processes and activities as they are executed within computer systems, and in assisting in optimizing these activities and processes by identifying and detecting situations that correspond to interruptions and bottlenecks.”
 
I am reminded of the end of the 1998 movie Enemy of the State. Will Smith plays a lawyer whose life is turned upside down by government corruption,  monitoring and tampering after he unintentionally receives a video showing the assassination of a sitting Senator.  

His wife played by Regina King admonishes him throughout the movie about the perils of excessive government monitoring.   After the drama plays out, a Senator is on TV stating that the offending agency will be monitored more closely. 

Regina’s final line is “ya but who is going to monitor the monitors?”

Herein lies the crux of a common business problem.   Gathering Operational Intelligence (OI) is usually the providence of the IT department.   The question is, how introspective is the gathering of data?  Or in Ms. King’s words, “who is going to monitor the monitors?”

There are many vulnerabilities and sources of waste in most IT departments, including but not limited to:

·         Using highly trained (read highly paid) professionals to monitor and maintain in-house backup systems.

·         Sending tapes filled with confidential data home with employees as an offsite back up plan.

·         Buying blocks of software licenses in anticipation of future need.

·         Using expensive professionals to perform routine server and workstation maintenance that can be inexpensively outsourced.

·         Using billable hours of non-IT professionals to maintain workstations or other routine tasks.

·         Buying and Supporting Microsoft Exchange servers when those same services can be purchased for an insanely low per user, per month fee.

The list goes on, but that is not the point.  The point is, when an IT department is tasked with building Operational Intelligence, exposing IT inefficiencies often is counter intuitive.  Or as Dr. Deming so eloquently put it “a system cannot know itself.”

Unfortunately for many C-level managers, the Information Technology department is a “black box.”  Money and resources are poured in and voila’ out comes some result.   Not being able to see inside the black box makes it very difficult to evaluate operational efficiency.

With the potential savings in capital expense and the ability to have IT operations scale with business cycles, it is important that upper management has useful metrics to measure cost and effectiveness of their IT operations.

For the CEO Information Technology poses a number of challenging questions.

·         How can Information Technology best support current and future business initiatives?

·         How can we get the maximum benefit from IT at the least cost?

·         How does investment in IT stack up against other opportunities?

·         How can IT investment be held accountable to ROI initiatives?

·         How can non-productive IT maintenance expense be minimized?

·         How can capital investment in rapidly depreciating IT assets be minimized?

Answering these and other business specific questions define the relationship between CEOs and their IT departments.   Since most of what goes on in the IT underworld is invisible to CEOs, they often feel held hostage by the very Information Technology that is intended to help them.  Important financial decisions are frequently based on barely understandable jargon presented by department experts with a sense of urgency and intellectual authority.

It does not have to be this way.  It should not be this way.  CEOs should have no less discretion over decisions related to Information Technology than they do any other department or operation.

The first step for the CEO is to expect and have absolute clarity regarding IT operations.  Clarity does not mean stacks of technical documents describing every bit and byte of data, every piece of hardware, memory boards, monitors etc.  Clarity, means having useful reports that speak to their objectives.  These reports should include:

·         Backup reliability reports.  The backup reliability report should clearly outline backup system uptime and results of restoration tests.  It is not enough to believe you have a backup plan; you need to know you can depend upon it.

·         Hardware, software and IT staff utilization. 
This may or may not include slightly technical reporting regarding CPU, memory, storage and other benchmarks that will warn the CEO of impending need to invest money in hardware.  The benchmarks will also tell the CEO when IT resources are underutilized.

·         Security reports that show the effectiveness of hardware, software and procedures at keeping data secure.

This report should highlight the number of attacks fended off by their security systems, how many attacks made it past the first line of defense, how quickly the intruders were eradicated and so on.

·         Downtime/Uptime/Response time reports. 
These reports will show the overall effectiveness of their IT resources.  Anything more than a very small percentage of downtime is abnormal and very costly.  At minimum, down time may seem like a minor annoyance.  But in reality, any downtime is a disruption to the flow of business.   Employees lose track of what they are doing if not the actual files they are working on.  Frustration breeds contempt and lower rates of productivity. 

On the high end, ecommerce businesses with very active business sites have reported that they can lose over a million dollars for an hour of downtime.

The other significant piece of information in this report is the response time.  When events do happen, how quickly did the IT department notice the problem and get it fixed.

·         Periodic cost analysis.
This would be based on the number of users, the amount of hardware and so on.  The cost analysis should include Internal IT department cost, software licensing cost, hardware costs, and any other metric the CEO deems necessary to evaluate the total cost of their IT resources.

Ideally, the CEO will assign a team to determine the true cost of downtime events.   Factors entering into this estimate would include lost productivity cost based on salary and benefits, lost revenue due to missed opportunities, IT resource cost and so on. Many companies however find it equally useful to use a rough estimate of $X / hr.  For the CEO, knowing the cost of downtime enables them to more confidently assess IT expenditures and projects.

When CEOs have enough clarity with respect to information technology, much of the mystique and confusion about IT operations goes away.  Having meaningful measures of IT effectiveness enables them to make more appropriate decisions.   CEOs have the information they need to control the IT operations that once controlled them.

Serial Entrepreneur Tells Secret for Surviving in a Down Economy

Bill Douglas started EssentiaLink at a time when dotcom businesses were dropping like flies. He was not discouraged though. Mr. Douglas knew EssentiaLink was the right business at the right time. 10 years and 13 growth awards later, the company is still going strong and is well positioned to survive this current economic storm.

According to Mr. Douglas, “having the right idea at the right time will get a company started, but if you don’t pay attention to some critical financial data the dream will die. Profit is the primary nutrient to keep a business strong and healthy. But, cash flow is oxygen; no business can survive long without it.”

Cash flow began to strangle EssentiaLink. Customers were signing on and buying more but credit limits with suppliers quickly fell short. To further exacerbate the problem, some large customers were stretching payments out well beyond 45 days. Suppliers, having more at risk, were threatening to cut off supplies if not paid in 30 days. Oxygen was running out.

Something had to be done quickly. After a series of meetings with the entire staff a plan emerged that would quickly improve the company’s cash flow. The cornerstone of the plan was to convert over ½ of EssentiaLink’s Colorado employees into remote workers. This bold plan enabled them to cut their office expenses by 75%.

Next the company had to tackle CAPEX. EssentiaLink had a computer room filled with underutilized equipment, loaded with software that was not being fully utilized. Further, all this equipment and software needed considerable labor to maintain the endless patches, software upgrades, and security measures. Mr. Douglas decided to take his own advice. “For years” he said, “we have been helping our customers reduce their CAPEX and improve cash flow by providing comprehensive managed services for their Information Technology. We looked at our situation and realized we could greatly reduce our costs by strategically outsourcing to service partners.”

EssentiaLink took these steps in early 2008. Had they not done so, surviving the current credit crisis could have been extremely difficult, if not impossible. Mr. Douglas feels that because of these and other steps they have taken, the future looks bright for EssentiaLink.

EssentiaLink got its start by providing customers an outsource method for the acquisition of indirect consumable goods without the high cost or long-term commitment of vendor managed inventory or 3rd party procurement. Their approach was so unique, the process was awarded a patent in 2007. Additionally, to enhance strategic benefits for their customers, EssentiaLink soon added their MaintenanceFreeIT suite of managed services.

Business Process Outsourcing (BPO) is a proven strategy for leaders to keep their businesses focused on core competencies. For EssentiaLink, it has been particularly good. As a BPO provider, their market is growing fast. And, as a consumer of BPO services, EssentiaLink has converted 90% of their CAPEX into variable OPEX that easily adjusts with current market conditions.

“No doubt”, Mr. Douglas says, “there will be tough times and other challenges to face but for most companies, transforming CAPEX into variable OPEX is a sure way improve cash flow and build a strong financial foundation.