Private sector IT rates versus Working Capital Fund Rates: Why such a big difference?

Public sector IT organizations that use a working capital fund (WCF) to drive funding based on usage metrics from customer organizations (typically other offices within the agency) have a leg up on other IT organizations across the government that use more traditional fixed cost budget approaches. By attempting to assign IT costs based on usage or demand using numbers of ‘seats’, storage used, web pages hosted, and other metrics, these organizations are often better positioned to provide agency leadership with the basic tools to make better decisions about controlling IT service demand and cost. The approach can simplify and clarify IT costs and more directly and explicitly link demand with the costs associated with supply.

The issue for many customers is however that the cost for service seems incredibly high in many cases relative to private sector offerings. Why, for example, is an organization being charged almost $10 per web page per month for hosting a 1,000 page site internally when the same site could be hosted for less than $100 per month by any number of providers? The same discrepancy often exists across a wide range of services, from e-mail and storage to phone service. With price variances ranging between 50 and 1,000%, there is frequently little rationale for the difference.

One of the most common reasons provided for the big price differences is the costs associated with public sector security and compliance. Security and other requirements do drive costs up, but in reality this does not explain the bulk of the discrepancy. For example, when one organization decided to shop around hosting of an application to other agencies, the organization found it could get better SLAs for hosting in a more secure environment for one-fourth the price they were currently paying their own organization. The response from the internal IT group was to first lower the hosting price by half and when that didn’t work, resort to internal politics to thwart the move. In another case, millions in fees were avoided by an organization by doing its own calculation of total cost of ownership for super computing and working with the IT organization to reconfigure contracts and infrastructure to drive down annual costs.

The reality in many if not most cases stems from the underlying cost structure. The service pricing is typically based on a combination of fixed and variable costs associated with the service being offered. By looking at the cost-basis from this perspective, the real culprits of cost are revealed. First, the fixed cost for these services is often way too high. The salaries, facilities, and associated contracts are frequently out of proportion relative to the number of customers and users they’re allocated across. GS-15s, buildings, and contractor run-rates often result in way too much sunk cost. This is why you frequently see WCF costs go up when someone pulls out of a service or when organizations attempt to reduce consumption for savings – instead of their service costs going down they hardly move as the price is increased to address recovery over a smaller unit/user base. If the fixed cost is $1,000, the IT organization (or CFO shop in some agencies) will allocate $100 per user for 10 users, or $1,000 for 1 user; it doesn’t matter, no decrease in the underlying cost equals little or no decrease in the total price.

On the variable side of the equation, the cost structure, which is frequently tied to vendor/provider contracts, simply isn’t well structured to accommodate one for one pricing relative to usage/user base. Instead of being 100% variable, the contractor often embeds their own additional fixed cost components further raising the overall price for services regardless of demand or usage. In many cases, the fact that the services would be supplied through a WCF to users isn’t even contemplated when structuring external contracts for related services.

In order to fully realize their potential, organizations using WCF models for IT services (or similar charge-back mechanisms) should look to move as much of the total cost of service delivery to external providers (yes, cloud, etc.) and structure those agreements to reflect as much as possible the WCF model. By shifting as much cost as possible to the variable side of the equation and more directly linking external cost and WCF ‘price’, an IT organization can dramatically lower its overall service prices while truly empowering its customer organizations to help control IT investments by better managing service demand.