LINQ’s Cost Allocation is an important new capability which establishes an economic baseline for your information ecosystem.
The Problem
Imagine a factory where the Directors have no idea what the Cost of Goods Sold is. Imagine a shop where everything has a price – but the shop owner has no idea what the wholesale cost of each item is. Those businesses would struggle to control profitability.
So, now think about your Information holdings. What does that Business Intelligence Report cost? How much does that Purchase Order cost? What does the Board Report cost to produce? How much does that Service Report cost? It doesn’t really matter how long this list goes on; because you don’t actually know how much any Information Output costs to produce! You know how much that system costs; you know how much that team costs. That’s like knowing how much the conveyors in the factory cost or how much the shelves in the shop cost. Interesting but not actionable.
Your organisation regards information as a critical asset. Easy to say; difficult to explain how when key financial metrics such as cost and value are not available. Cost allocation allows you to see information assets through the same financial lens as any other asset.
Measuring Cost without Allocation
Cost Allocation is a non-trivial calculation since it must factor in the reuse of all data sources involved in the Information Supply Chain for the Information Output. If we were to merely sum all operational costs in the Information Supply Chain, the measured costs would be too high.
In this example, all three Action costs of $100 are being assigned to the single Information Output – the cost of that Information Output appears to be $300:
LINQ’s Cost Allocation addresses the more complex question: how should costs be allocated when reuse occurs:
Let’s look at reuse first.
Allocating Costs by Reuse
Costs are allocated from an Action to the Information Outputs that are being supported by that Action:
In this case, there is a Process that’s supporting five Information Outputs. It doesn’t matter what intermediate nodes might be present, LINQ is just looking at the connection from the Action to the Information Output. The Process costs $10,000 per year, and so those costs get allocated equally across the five Information Outputs: $2,000 each.
Recognising Reuse – Reuse-weighted Cost Allocation
This reuse-based logic can then be applied to the example above:
For some organisations, this connectivity-based valuation will be sufficient. If that is the case, then you should use the reuse-weighted cost allocation model.
Differentiating the importance of Information Outputs
For most organisations, there is a need to recognise that some Information Outputs are more important than others. That could be represented as a description:
That’s description-based approach would be challenging to adopt in a model so LINQ allows users to assign a Business Value Index to represent that importance. Ten (out of ten) is an Information Output that’s critical to the business; zero represents waste:
There’s an implied service level that falls out of those values. The owner of an essential output is going to expect a higher level of service than an important output… than a discretionary output. Logically, the higher the expected service level, the higher the cost that might be expected to cover that service level.
Recognising Value – Value-weighted Cost Allocation
LINQ applies that logic in the Value-weighted Cost Allocation shown here:
The allocation of costs is based on the ratio of the value of the Information Output to the value of the Action. In this case:
That logic then applies to the more complex situation here:
LINQ recommends that organisations use this Value-weighted Cost Allocation model since it is a more sophisticated economic model. Value-weighted Cost Allocation is the default setting in LINQ.
Cost Allocation – So What?
Once you understand the cost of your Information Outputs, you can start asking powerful questions:
- The cost of that Information Output is far higher than its value warrants – should we keep producing it?
- That’s an incredibly valuable output and yet we’re not spending much on it – shall we explore improving the timeliness and quality?
- That report costs a fortune and yet it’s not read by anyone – is it worth doing?
- Will this proposed new system reduce my Information Output costs?
Resources
We’d like you to give LINQ a test drive so please sign up for a Trial Account here.
You’ll want to learn to use Cost Allocation. Check out the YouTube videos here.
Cost Allocation is ‘Infonomics’ in Action. Want to learn more about Infonomics? Check out this blog post.