New Data on Mid-Market IT Spending Emerges

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When summer vacations wind down in a couple of weeks, IT managers across the land will start powering up their spreadsheets to engage in a time-honored annual ritual: creating next year's IT budget. This rite of autumn has often been a tough one for iSeries owners, as few IT spending studies focus on the medium-size companies that are the heaviest users of the server. Fortunately, a growing number of studies are considering how IT spending among medium-size companies differs from that of small companies and big enterprises. This is making it easier for iSeries owners to benchmark their IT spending against their peers.

Among the studies that tips its hat to the unique qualities of mid-market organizations, one of the best that I have seen this year comes from Forrester Research. A few months ago, the IT analysis firm consolidated all of its current research on IT spending in North America, segmented it by industry and company size, and published a report with some very useful benchmarks. One thing that made the benchmarks so useful was the logic that Forrester packed into them. Here is the essence of that logic.

  • All other things being equal, smaller firms tend to spend a larger percentage of their revenue on IT than larger firms do. Because of their sheer size, large enterprises can realize economies of scale that smaller firms cannot achieve. Compared to small companies, the big boys can negotiate bigger discounts with IT vendors and support their systems with fewer IT professionals per employee. Since economies of scale increase as companies grow, IT spending as a percentage of revenue shrinks as headcounts expand.
  • Spending for ongoing operations and spending on new IT initiatives are two separate categories that should be evaluated independently of each other. When companies evaluate their IT budgets, they too often lump all IT spending together to consider whether it is more or less than a benchmark figure. Such exercises can lead to some very wrongheaded thinking about IT spending. As a rule, companies should keep their spending for ongoing operations as low as possible compared to their peers, as this is an overhead cost. However, companies may spend wildly different amounts on new IT initiatives in any given year depending on the changes taking place in their businesses. With this in mind, companies should benchmark the two forms of IT spending separately.

These two streams of logic are completely in line with IT spending studies of AS/400 owners that I conducted a decade ago. In those studies, I determined that IT spending per employee among the smallest AS/400 owners could be over seven times greater than spending per employee among the largest ones. That is an economy of scale if ever there was one. In addition, I found that when AS/400 owners invested in new IT capabilities in a given year, their spending for that year grew by an average of more than 50% compared to the previous year. It became obvious to me that AS/400 owners needed to benchmark their ongoing expenses and capital investments separately and use different criteria to evaluate the two forms of spending.

With these thoughts in mind, let's look at what Forrester Research's study indicates are appropriate benchmarks for ongoing expenses and capital investments among mid-market organizations. The following table summarizes data from a more-detailed table that the IT analysis firm provides to its clients. The figures reflect spending as a percentage of corporate revenue for 2005.

 

Total IT Spending Versus Spending on Ongoing Operations Among Mid-Market Organizations of Various Sizes (As a Percentage of Corporate Revenues)

Total Spending – 2005
(Includes new IT capabilities)
Spending on Ongoing
Operations – 2005
Industry
100 - 499 Employees
500- 999 Employees
1000-4999 Employees
100 - 499 Employees
500- 999 Employees
1000-4999 Employees
Manufacturing
3.3%
2.8%
2.4%
2.5%
2.2%
1.9%
Retail and Wholesale
3.0%
2.8%
2.4%
2.3%
2.1%
1.8%
Business Services
4.1%
4.1%
3.9%
3.2%
3.2%
3.0%
Media, Entertainment, and Leisure
2.6%
2.5%
2.5%
1.9%
1.9%
1.9%
Utilities and Telecom
2.7%
2.4%
3.5%
2.0%
1.8%
2.6%
Finance and Insurance
8.2%
8.3%
6.9%
5.8%
5.9%
4.9%
Public Sector
6.0%
5.7%
5.3%
4.5%
4.2%
3.9%
Overall
4.2%
4.0%
3.8%
3.1%
3.0%
2.8%

[Source: Forrester Research]

As the bottom line of the table indicates, mid-market organizations dole out about 75% of their total IT spending to support ongoing operations. This includes items such as leases of existing hardware, maintenance contracts, software support, and IT staff costs. By contrast, firms spend an average of 25% on new initiatives. This spending could go to new hardware and software investments, services to deploy new systems, or additional staff to support the systems. Remember, however, that actual spending by firms on new initiatives varies wildly from year to year. This is especially true among smaller firms, where new initiatives may cause IT spending to more than double in a given year. On the other hand, spending by such firms may shrink to less than half their previous-year levels after they complete a significant capital investment.

The moral of these statistics is simple. As you prepare your IT budget for 2006, separate your costs for ongoing operations from new investments. Compare your costs for ongoing operations against benchmark figures for those operations. If you are spending more than your peers, you may be robbing yourself of funds you could use for new initiatives that add business value to your firm and boost its competitive standing. Given the low overall operating costs of the iSeries, this is a predicament that you should be able to avoid.

Lee Kroon is a Senior Industry Analyst for Andrews Consulting Group, a firm that helps mid-sized companies manage business transformation through technology. You can reach him at This email address is being protected from spambots. You need JavaScript enabled to view it..

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