Budgeting for Innovation: 5 Budgeting Principles to Make Sure You're Prepared
Budgeting for Innovation in 2016 is shaping up to be a challenging one. In fact, it could be harder to formulate budgets this year than in prior years. Why is that?
As our economy accelerates in a way that benefits property casualty insurers and the digitalization of insurance creates pressure for new technology, most property casualty insurers are now dealing with two opposed forces: modernization and keeping the lights on. This is tough on the expense line and is particularly tough on the human resources front. For many carriers, pursuing these necessary ends means paying for two staffs in several parts of their business and IT operations. Ouch!
For life insurers, low interest rates have compressed margins for a number of years now. It has slowed down the adoption of new technology. Most of the focus has been on better in-force management, particularly in the management of a larger number of closed blocks. Instead of new technology, there has been a period of offshoring maintenance and a tightening of loose ends. Now with the prospect of (modestly) higher interest rates on the horizon, product actuaries have begun developing new products, especially those that buttress the risks for Boomers' who plan to retire within 5 years.
From my perspective, an effective collaboration between IT leaders and their business clients can be generated from the following 5 budgeting principles:
A budget is a forecast, not a business case
Planning for the future should happen year-round
Successful IT leaders should clearly define value
More than ever before, IT leaders should think like risk managers
Standardized, agile, repeatable budget and business case processes always generate higher quality results
1. A Budget Should be a Forecast
IT spending to KTLO (Keep the Lights On) should have a highly predictable pattern and be declining if business volumes are constant. By moving to an operating expense only cost structure, IT leaders will find financial capital for innovation programs by making a clear distinction between the creation of new assets and maintaining the old ones.
To make the forecast overall more predictable, IT leaders can smooth application maintenance costs by structuring frequent small releases that have constant delivery or value capacity. Similarly, for predictable infrastructure cost management, IT leaders can use selective outsourcing and the development of applications whose cost can be made variable to match business demand.
New programs have more risk. For that reason, it is useful to budget for a range of costs and ensure that the business case can withstand the higher cost and the deferral of revenues and savings due to delivery delays.
No one likes surprises. During the operating year, IT leaders should re-forecast the full year every month and explain variances. Ideally this forecast should be a rolling 12-month plan, but most firms still devote far more time to the current fiscal year estimates than the following year so this may not be a viable option.
Lastly, saving money without giving business partners a chance to redirect the funds to another positive use is just as bad as going over the budget without warning. Finance in advance. In this re-forecasting approach, all variances represent an opportunity to change course and maximize the value received for the money spent.
2. Planning for the Future Should Happen Year-round
Don't wait for the start of budget season to think about what you want to do. Meet with your business stakeholders regularly to determine priorities, quality assure that your delivery is as good as what your people say, and educate them on what's possible with newer technologies or techniques.
Build business cases with key stakeholders before budgeting starts so you can enter the process with a full slate of proposals. Then your strategy and line of business leaders can factor IT's contribution in to their own assessment of current project hurdle rate, funds available and ability to execute. Budgets only get smaller. Start with bigger goals for value creation.
3. What Constitutes Value?
A recent study across industries showed that business leaders think that the average IT budget is eight percent of revenue when in fact it is five percent.
The bigger question should always be 'what constitutes value?' Make it clear that IT value is greatly influenced by strategic project selection, timely business requirements, and an agile approach to delivery. In today's world, new opportunities and threats can arise within a 2-year horizon - IT programs needs to deliver inside of that timeframe.
Lastly, the IT leader must be the one who is most aware of new technologies and IT delivery models that can reduce barriers to market entry (for both agents and carriers), provide greater lifetime customer value, or disrupt what the carrier defines as its sales and service model. A budget should have some element of 'investment dollars' that are reserved to evaluate new technologies, pilot new methods for selling and servicing insurance, etc. A modest investment backed by good governance gives the enterprise options to respond timely and effectively to new ideas or new competitors.
4. More than Ever Before, IT leaders Should Think and Act Like Risk Managers
With stronger business continuity programs, access control practices and less expensive, more powerful hardware, many of the traditional risks in IT that affected availability and reputation have been overcome. Today, with state-sponsored cyber-hacking rising dramatically, significantly greater attention has to be paid to focusing on preventing data loss. You'll be spending more here and need to explain what you will get for the money.
Start with creating a risk management position in IT. This person doesn't have to an expert on all risks, but must be able to analyze and leverage the skills, products and processes that mount a more secure defense. Not only does data loss create a public relations nightmare, it also brings into question the base design of applications and infrastructure. Programs in flight have to be re-examined, infrastructure capital spending arises, and so on. A risk manager in IT brings a powerful voice to preventing those problems at a lower cost and with higher confidence. Organizations that only respond to incidents after they occur will find themselves re-forecasting, not budgeting.
5. Standardize your Budget and Business Case Process and your Forecast
After all, you'll be doing the budget annually and the forecast monthly. Standardization increases transparency. A standardized budget process and monthly financial reporting allow you to evaluate performance, hold people accountable and change responsibilities mid-stream without missing a beat on managing and reporting on the spend. It allows those managers to have consistent discussions about money in terms of value instead of only about cost.
Budgets are a reflection of business plans. For IT, a forecasting approach combined with tight management of KTLO expenses and agile delivery of new initiatives can provide a more transparent budget that creates more value.
About the Authors
Russ Bostick and Donn Vucovich are the managing partners of MVP Advisory Group, a management consulting firm focused on developing and executing superior strategies for business and IT.