How and why to strategically finance IT projects. (State of the Art).
In today's technological environment, the strengths and weaknesses of an organization are, to a large extent, dependent upon the technological capacity of the organization. Organizations that are able to build and maintain technological capacity will have new and exciting opportunities open to them. By the same token, those that fail to develop technological capacity are likely to face substantial threats stemming from organizational inefficiencies and obsolescence.
Unfortunately, the desire of the administrator to achieve a high state of technological capacity is offset by the ability to fund projects at the desired level. In such an environment, it becomes imperative for the administrator to carefully orchestrate a strategic plan for technology financing. While financial strategies for technology are often similar to other financing strategies, there are some unique considerations that must be kept in mind.
Before embarking on specific financing strategies, it is important to understand the basic cost profile of information technology. Information technology costs are of two basic types, capital expenditures and operating expenditures. Strategic financing options for IT projects will generally result in the modification of either the operating cost structure or the capital cost structure. One of the most common strategies is to spread the large initial capital costs over the life of the project, resulting in capital costs that look and behave like operating costs.
IT life cycles tend to be substantially shorter than those of other large capital projects. Whereas buildings and bridges tend to have life spans of 30 to 40 years, information technology projects will seldom exceed five to 10 years. The proliferation of new and improved technologies quickly obsoletes existing technologies by providing equipment that is faster and smaller and that utilizes fewer operational resources. In such an environment, even though the existing technology is still functional, it becomes cost effective to replace the existing technology with the newer more efficient technology. This results in a short life span for most information technology. Because it is generally advisable to finance capital projects past the end of their life spans, some financial options, such as the 30-year long bond, may not be appropriate.
Several strategies exist for the administrator attempting to determine how a particular IT project should be financed. While many of these strategies are not new they often have some new twists because of the unique nature of information technology. Still other strategies are new and deserve consideration.
General Fund Financing. As the price of IT drops, the ability to finance smaller systems from the general fund will continue to increase. For a large government, it is not unreasonable to seek general fund financing for smaller systems with limited users. These systems are often utilized by small offices or even individuals and can greatly increase productivity when implemented. When considering general fund financing, a system with a short life is most appropriate. Because smaller, less expensive systems such as the personal computer are sold in highly competitive markets, the specifications of these systems improve exponentially and result in quick obsolescence. Even with relatively inexpensive hardware and software, the total cost including implementation and training must be considered before opting to fund an IT project from the general fund.
Enterprise Funds. Another option that occasionally presents itself for IT financing is the use of enterprise funds. Enterprise funds are used to manage
funds for governmental businesses such as power and utility agencies. When these operations do well they are often able to build up substantial resources that can be utilized for other objectives. For example, the City of Tacoma's power utility generated additional revenues by selling excess electricity to California. The city utilized those additional funds to build a fiber-optic communications infrastructure (providing Internet and cable connective) that it was then able to resell to residents. Similarly, the State of Georgia utilized funds from the state lottery to supply IT for all K-12 schools in the state.
Long-Term Loans, Bonds, Certificates of Participation, and Leases. For large, high-cost technology projects with components that have both long and similar life spans, the traditional bond provides an economical means of project financing. The major problem with financing IT with bonds is that the financing may last longer than the technology. Often this problem can be resolved by breaking a large technology project into components with similar life spans and using multiple types of capital financing. For instance, technology infrastructure with a long life span, such as wiring and computer room construction, might be financed through a bond. Equipment that is deemed to have a shorter life span could be financed through certificates of participation or leases. In either case, this type of financing has the impact of spreading the capital expenditures over the life of the technology.
Outsourcing. While outsourcing is not technically a means of financing, it is a much-used means of restructuring information technology financing and thus deserves comment here. First, outsourcing eliminates distractions to core competencies, allowing an organization to focus on its mission. Secondly, outsourcing eliminates the need for substantial up-front costs for hardware and systems development. Often the primary barrier to providing a state of the art IT solution is the capital cost of acquiring the initial hardware and development cost of the system.
However, this form of provisioning does have some significant drawbacks. The major issue is that the contract cost will usually exceed the operating cost of an in-house system. Not only must the initial capital costs--amortized over the length of the contract--be included in the charges, but also a profit must be factored into the contract charge. Another concern is that the organization will not own the IT upon completion of the initial contract, subjecting the organization to re-solving the original technology problem. However, this may actually be a benefit to the organization. If the outsourced technology will be obsolete at the end of the contract, the organization can easily move to newer technology without the burden of a large capital investment in obsolete technology.
The outsourcing solution can be very appealing if off-the-shelf technology exists that can handle an organization's needs. If the organizational needs are complex and technology does not exist that meets the organization's needs, outsourcing may be more expensive than developing the technology in-house, provided resources are available. Even if resources are not readily available, it may still make sense to outsource. For example, the State of Georgia determined that it was more cost effective to hire contractors to develop application software than to develop it in-house. Officials reasoned that even though the contracted costs to develop the software exceeded the costs of in-house development, the state was still better off in the long run because it did not need to retain the full project development staff after the contract was completed.
Commercial Partnerships. In some instances, commercial partnerships may be a way to finance a needed information system. Commercial partnerships can range from sharing physical resources such as a server farm to sharing knowledge and information. One of the most common forms of a commercial partnership is the sharing of knowledge. In this type of partnership, a commercial systems developer may provide free of charge or at a reduced rate a system specified by the governmental organization. In return, the governmental organization provides some combination of design, analysis, or beta testing expertise. There are instances where organizations have been able to negotiate royalties from future sale of the developed system. Naturally, this comes with much risk both in completing the system and in ensuring that governmental functions continue unabated during the partnership period. Once the system is functional, the governmental organization may become a demonstration site for the system.
Resource Marketing. In some respects, resource marketing is similar to a commercial partnership. Here the governmental organization provides some physical resource, service, knowledge, or information for a fee. One primary resource of government is public information. Many states are now selling information such as property records and drivers license information. However, much governmental information is sensitive and only information deemed appropriate for release should be considered as a saleable resource.
Philanthropy. Philanthropy may be another means of financing new IT. Philanthropy can take on many forms with the most obvious being a monetary donation for a system. Yet, other nonmonetary forms of contributions should not be neglected. Some of these forms might be the donation of computer time, communications access, personnel expertise, or software. Many commercial and not-for-profit organizations can be made available to needed governmental projects at below cost or even for free. Often, tax benefits can be realized by the philanthropic organization, resulting in a win-win situation for both organizations.
User Fees. There are two types of fees that can be levied to aid in financing IT--convenience fees and internal service fees. Convenience fees may be levied when technology provides a preferable means for transacting business with governmental agencies. An example of this is the ability of New Yorkers to pay parking fines through the Internet. With the online payment option, they no longer need to mail fines or appear in person at designated locations. Because of the convenience to the citizen, the City of New York is able to levy a convenience fee for the use of this service. These fees can often be used to pay for the development and implementation of the services.
The second type of fee is the internal service charge. Internal service charges are useful when IT is utilized by two or more agencies within a government. With internal service fees, agencies are charged for the amount of processing that they utilize. This often has the added benefit of maximizing efficiency because users tend to waste fewer resources when they are being charged for them. Of course, in the end, this is just a roundabout way of financing the technology through the general fund. Unless the internal service fees are structured to include the cost of capital improvement, IT is still faced with the problem of obtaining the capital portion of the IT costs.
Non-Commercial Partnerships. Another financial strategy that may reduce fixed operating costs and provide scale efficiencies is the use of a non-commercial partnership. Often joint ventures can be structured between two or more cities or between a city and a county to provide information technology services. Communications systems for police and fire are often prime considerations for such ventures. Economies of scale may result when larger systems are purchased, reduced capital outlays may be realized when software is jointly developed, and fixed costs can be reduced when system maintenance for hardware and software is shared. Other non-monetary benefits may also be realized by overlapping jurisdictions through better coordination of their operations.
IT capital costs are not unlike other capital infrastructure costs. When a city builds a city hall it is designed for two purposes. First, it is the place citizens come to transact their business with the government. Secondly, and equally important, it is the symbol of governance for the community. Increasingly, IT is beginning to fulfill both of these roles. Whether the technology is a kiosk, a Web site, or a phone system, technology is often the point at which citizens interact with their government. Thus, efficiency, accuracy, and reliability are high priorities for any system. Technologies can also fulfill a role as the symbol of governance. Indeed, citizens are beginning to make more trips to a government's Web site than to city hall. As citizen interactions with government employees decrease, it becomes more important for the systems with which citizens interface to be impressive. This being said, the lowest cost for technology may not always be the best in the long run. City halls are built for multip le functions; much of today's technology needs to be also.
WILLIAM R. VOORHEES is an assistant professor at the City University of New York's John Jay College of Criminal Justice. E-mail: Wvoorhees@jjay.cuny.edu
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|Title Annotation:||adapted article from the November 2001 issue of the PA Times, American Society for Public Administration; information technology|
|Author:||Voorhees, William R.|
|Publication:||Government Finance Review|
|Article Type:||Brief Article|
|Date:||Apr 1, 2002|
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