Beware of Unintended Consequences With On Demand

The Issue: Companies are embracing on-demand, pay-as-you-use pricing as a way to cut IT costs, but equating Service-Level Agreements (SLAs) with on-demand pricing can have negative consequences.

Companies are buying into the promised savings of on-demand, pay-as-you-use pricing for server and mainframe usage, storage usage, and help desk support. As demand rises, these companies are prepared to pay more for immediate access to additional capacity, and as demand falls, pay less for the reduced capacity.

However, IT-to-business unit chargeback mechanisms and service levels must be based on business strategies and not just be a regurgitation of pay-as-you-use pricing. Companies that fail to base service levels on business requirements will have to deal with the following and other problems:

• Costs growing without bounds
• Counterproductive behavior
• Loss of control over consolidation and unification

Pay-as-you-use pricing tempts companies with visions of capacity that continues to grow as their needs grow without having to make an upfront investment in excess capacity. However, along with increasing capacity come rising charges, and not every resource needs to grow without bounds.

Consider the following examples:

• Wasteful e-mail capacity--Most companies place a limit on the amount of storage allocated to each user for retaining e-mail. If the on-demand contract is structured to allow for continuous increases in storage to meet needs, users may no longer be required to limit the amount of e-mail retained, and companies may find that they are paying ever-increasing storage bills. Retaining excessive amounts of e-mail does little for the business and may hurt it if users lose the incentive to organize and manage information.
• Service with marginal benefits--Pay-as-you-use pricing coupled with ever-increasing service levels can lead to requests for service that give back weak benefits. For example, increased capacity for the fast turnaround on custom report requests may tempt managers to order more and more marginally useful reports. Rather than working with IT to create a reasonable number of reports that target critical business issues, managers may get reports covering every piece of data possible, clouding their ability to tackle important business factors.

Pay-as-you-use pricing when directly mapped to IT chargebacks for business units may lead cost-conscious business managers to endorse counterproductive behavior. Business managers may direct their personnel not to use IT services in an attempt to minimize their chargebacks for IT.

Consider these examples:

• One company’s contract for on demand services included pay-as-you-use pricing for help desk calls. For many companies, the majority of help desk calls are related to users forgetting their passwords and needing their passwords reset. For managers without a strong sense of security, the temptation to lower help desk call costs by circumventing corporate password security guidelines may be an overwhelming temptation.
• A manager doing department budgeting and planning using Microsoft Office tools in order to escape chargebacks associated with running the on-demand-supported ERP system may be able to plan and budget without access to corporate-wide data, but the company loses the benefits of being able to quickly roll up and evaluate all departmental financial information.

Pay-as-you-use pricing may result in IT losing leverage over managers running legacy systems and refusing to accept retiring the legacy system and moving to a consolidated standardized system. If the outsourcer is willing to support the legacy application on a pay-as-you-use model and only the department using the application sees the incremental costs, IT may not be able to drive that department to accept consolidation and retire the application.

The company loses in two ways:

• It continues to incur costs associated with the legacy application that may be out of line with other application support costs because of the need for the outsourcing partner to supply underutilized skills to support obsolete technology.
• It loses the benefits application consolidation brings to financial reporting and business analysis.

Companies should not view pay-as-you-use pricing as a substitute for evaluating the Total Cost of Ownership (TCO) versus outsourcing technology nor for defining SLAs between IT and the business units.

IT must do the following:

• Align IT with business strategies and goals. Regular meetings between IT management and business unit management at the executive and line management level are essential. The results of this interaction should be an agreed-to set of services provided by IT supporting business benefit.
• Establish service levels between IT and the business units that map to the corporate strategy and goals. As much as possible, the SLAs should be in business terms, and the metrics used to validate the SLAs should map to business processes, not technology infrastructure. For example, an SLA that defines metrics for processing order entry transactions is much more business-friendly than one in terms of server availability.
• Make the decision whether to provide the services with in-house resources, traditional outsourcing, or an on-demand model. The decision should be based on TCO comparisons for the three models as well as intangibles, such as risk and time to market.
• If the decision is to go with on demand, develop contract and SLAs with the on-demand service that supports the services and SLAs offered by IT for the business units. IT needs to make sure the on-demand service supports the business strategies set out. IT should not let pay-as-you-use pricing enhance the business goals of the service provider at the cost of supporting its business goals.
• Develop baseline usage models and budgeting models to help IT and business units budget appropriately for the ups and downs associated with pay-as-you-use pricing. When IT supports the help desk in-house, it budgets for a set number of resources for the year. Those resources are available for the entire year. If demand increases because of improved service levels in a pay-as-you-use model, an adequate budget may not exist for the entire year, and groups may be forced to scramble for additional funding in the fourth quarter.

AMR Research originally published this article on 31 July 2003.