Managing IT Vendor Costs

What is IT vendor cost management? Why is IT vendor cost management important?

IT vendor cost management entails controlling both what you but and how much you pay – it requires working with IT vendors and evaluating your spend so that you buy only what you need, and do so at the most efficient costs. As companies increasingly rely on vendors for operational expenses, costs can quickly escalate without proper oversight. This makes it imperative to manage vendor costs efficiently to prevent unnecessary expenditures and maintain financial health.

IT spend on innovation can be justified as investment, but spend on operations should be minimized – at most companies, 60% of IT spend is going to be on operational expenses. Spend on operational expenses like core infrastructure, file sharing, etc. should be ruthlessly evaluated for efficiencies.

What are the key elements of effective vendor cost management?

First, evaluate your situation:

• Understand the total cost of technology – by tracking both innovation projects and operational expenses, companies can gain insights into their overall technology spending and identify areas for optimization. 
• Focus on internal capabilities for managing vendor costs – by building expertise within the organization, companies can avoid excessive reliance on external consultants and maintain control over their vendor relationships. The more you move things outside of your infrastructure, the fewer economies of scale that you get.

Then, find efficiencies:

• Move beyond cost reduction – understand the value provided by vendors and ensure that contracts align with business needs. While some external firms may promise significant cost savings through vendor audits, companies should be cautious about relinquishing control over vendor relationships. 
• Make timely payments and understand financial consequences – while it may seem obvious, timely payments are crucial, especially in an era where late payments may incur penalties or service interruptions. Understanding the financial implications of late payments, such as interest charges or service disruptions, is vital for maintaining healthy vendor relationships and avoiding financial strain.

Who should be in charge of IT vendor cost management? Who should be involved in IT Vendor Management?

Key Parties	Role
The Chief Information Officer (CIO) or Chief Technology Officer (CTO)	Oversees all contracts, and should be directly involved in contract negotiations, especially for significant agreements. They bring technical expertise and strategic insight to the negotiation process and can ensure that the contract aligns with the organization’s technology goals and requirements.
Head of IT Infrastructure	Usually plays a key role in contract negotiations, particularly for infrastructure-related services. They understand the technical aspects of the services being procured and can provide valuable input during negotiations.
Finance Representative	Should be involved in contract negotiations to ensure that the financial terms are favorable and align with the organization’s budgetary constraints. They can help assess the financial implications of the contract and negotiate pricing and payment terms.
Legal Counsel	Should review and advise on the contract to ensure that it protects the organization’s interests and complies with applicable laws and regulations. They can identify potential legal risks and liabilities and negotiate contract terms to mitigate them.
Vendor Management Team	While not typically directly involved in contract negotiations, the vendor management team should be consulted to provide insights into the vendor’s performance, reputation, and past relationships with the organization. They can also help assess the vendor’s capabilities and suitability for the proposed contract.

Designate someone within the technology team as the point of contact – this individual may not handle all financial aspects, but they serve as the primary lead for vendor interactions and contract oversight. Who the person is and why they are chosen can vary; the most important thing is that one person has a pulse on everything that is going on. 

Maintain flexibility in team structure – while having a dedicated tech owner is preferred, variations exist in team structures. Finance may employ individuals with tech finance expertise to manage payments, or tech departments may establish their finance arm reporting to the finance department. Regardless of structure, clarity in responsibilities and communication channels is paramount.

Establishing strong partnerships with legal and finance teams is essential –. Legal ensures visibility into all contracts to prevent unforeseen costs, while finance monitors spending to align with budget expectations. This collaboration ensures transparency and financial accountability. Ensure that the designated team possesses the necessary expertise—whether it’s a finance specialist familiar with tech costs or a tech expert versed in finance.

How should you aggregate and track vendor spend data, especially if there are many different buyers within your organization?

Consolidate all vendor spend data into a centralized system – regardless of the department making the purchase. At the end of each month, a thorough review of all technology-related expenses should be conducted, ensuring visibility into every aspect of technology spending within the organization.

Adopt an inclusive approach to tracking vendor spend – and monitor all technology-related expenditures, even those incurred by departments outside of the traditional IT domain. Whether it’s marketing tools, advertising services, or individual cell phone expenses, all technology-related costs should be captured and reviewed.

Facilitate collaborative review sessions between the technology team and finance department – any discrepancies or unexpected spikes in spending can be addressed promptly, with relevant stakeholders invited to provide insights into the nature of the expenses and whether they align with expectations. 

If expenditures exceed expectations, focus on optimization and cost trimming – this process involves open communication between buyers and a willingness to adjust spending patterns to align with budgetary constraints and organizational priorities.

How do you know if you’re spending too much with your vendors?

Leverage your own experience and keep records – draw on past experiences to understand what major players in the industry pay for similar services. Keeping a personal record of past vendor contracts and costs can serve as a valuable resource for future negotiations. Documenting general cost trends and unit prices over one’s career can inform negotiations and foster better decision-making. You can tap into the collective knowledge of technology leaders within your organization.

When experience is lacking, look for industry benchmarking – researching industry standards and benchmarks for pricing offers another avenue for developing knowledge on vendor costs. Examining reports, case studies, and discussions within the industry can shed light on typical pricing structures and help set reasonable expectations.

Engage cost-saving experts – collaborating with cost-saving firms staffed by experts from renowned companies can provide valuable insights into optimizing vendor costs. These professionals bring firsthand knowledge of pricing dynamics and can offer strategies for negotiating favorable terms with vendors.

Require transparent pricing from vendors – establishing transparent relationships with vendors is crucial for gaining insight into pricing structures. Contracts should include provisions requiring vendors to disclose cost breakdowns and justify pricing decisions, ensuring accountability and facilitating informed decision-making.

How much should you spend on IT as a percentage of revenue?

IT spend depends on industry, ranging from 5%-10%+ of revenue – in industries like manufacturing, technology budgets typically range from 5% to 7% of total revenue. However, in e-commerce, where technology plays a more significant role, budgets may extend to 9% to 11%. While these benchmarks serve as guidelines, companies must also consider their unique circumstances and business objectives when evaluating technology spending. 

Note: it’s particularly tricky to provide good IT spend benchmarks for SaaS –  in the B2B SaaS space, providing a good IT spend benchmark requires a nuanced understanding of the company’s infrastructure and business model. Additionally, unlike traditional industries where technology costs may scale linearly with revenue, SaaS companies often face fixed infrastructure costs regardless of customer numbers. SaaS IT is like owning a bus: the bus has a fixed cost, whether you transport one person or fifty from point A to point B. With one person, you’re operating at a loss; with fifty, you’re profitable. Scaling up is feasible, but scaling down is constrained by the fixed infrastructure

Since contracts are so difficult to compare, what are some key considerations in managing vendor contracts and pricing strategies?

Dissect complex pricing structures – it is essential to grasp the nuances of each agreement. Whether it’s the per-user cost, platform fees, or module-specific charges, dissecting these elements is crucial for effective cost management.

Know that vendors frequently adjust their pricing strategies over time – which complicates cost calculations for buyers. From changes in module offerings to alterations in pricing models, staying abreast of these shifts is imperative for making informed decisions.

Evaluate cost models and their impact on your business – Assessing different cost models, such as percentage of revenue or transaction-based fees, requires nuance. While some models offer simplicity, like Salesforce’s percentage-of-revenue approach, others may disproportionately impact businesses with varying transaction volumes or average order values.

Align vendor selection with pricing models and business needs – while preferred vendors may offer optimal solutions, alternative providers with more favorable pricing structures could be a better fit for your specific circumstances. Prioritizing agreements that align with your business model ensures cost efficiency and avoids unnecessary expenditures.

Advocate for pricing models that best serve your business interests – highlighting discrepancies in pricing fairness, particularly concerning high transaction volumes or low average order values, can prompt discussions with vendors to secure more equitable terms.

Regularly reassess vendor relationships and pricing structures – continuously monitor market trends, pricing benchmarks, and industry developments to ensure your vendor management strategy remains aligned with your business objectives.

What are key metrics for contract-agnostic cost management?

Metric:	What it allows:		How to use:
Standardized Cost Metrics	Transcend contractual complexities with standardized cost metrics		Focus on fundamental cost elements such as floor space, shipping expenses, and labor costs for consistent evaluation of vendor performance and cost efficiency.
Universal Cost Units	Meaningful comparisons across diverse contracts and pricing models		Convert disparate pricing structures into common units, such as cost per unit shipped or cost per square foot of storage, to streamline cost analysis and decision-making processes.
Customized Cost Translation	Develop customized tools to translate varied contract terms into standardized cost metrics		Create spreadsheets or documents that reconcile different pricing methodologies and align them with the organization’s cost measurement criteria.
Comparative Cost Analysis	Overcome vendors’ intentionally complicated pricing structures		Translate contract terms into comparable cost metrics so you can effectively evaluate vendor offerings and identify cost-saving opportunities.

How do you evaluate your need and consumption of vendor services to ensure you’re only buying what you need?

Implement licensing guardrails to prevent unnecessary costs – limit user additions without proper approval. For example, when procuring software licenses, ensure that the contract specifies a maximum number of users and requires approval for any additional users beyond that threshold.

Conduct regular audits of usage and associated costs – ensure alignment with expected expenditures. Review usage patterns and expenses at the end of each billing cycle to identify any discrepancies or unexpected increases in costs, prompting further investigation.

Develop and enforce user access policies to manage user accounts – upon employee departures or role changes, promptly revoke access to systems and applications to prevent unnecessary licensing costs and mitigate security risks associated with inactive accounts.

Utilize automated tools to streamline user account management – ensure adherence to access policies. Implement automated workflows for account provisioning and de-provisioning to minimize manual intervention and reduce the risk of oversight or delays in removing access.

What are common areas in which companies end up with extraneous vendor spend?

Cloud Hosting
Common Areas of Waste	Paying for underutilized or unused cloud resources can double your cloud spend without providing any added value.
Ways to Optimize Spend	Centralized DevOps Team Ownership – assign accountability for cloud spend to this team. They should have visibility and control over cloud resources and be responsible for optimizing usage and costs. Regular Monitoring and Analysis – implement analysis processes to identify unused cloud resources. Utilize tools (like AWS) and metrics to track CPU usage, server activity, and resource allocation. Proactive Resource Management – encourage proactive resource management by regularly reviewing cloud infrastructure and identifying opportunities to scale down or decommission unused resources. Foster a Culture of Accountability – make developers and teams aware of their responsibility for cloud spend. Educate them on the impact of resource wastage and encourage efficient usage practices. Incentivize Cost Reduction – offer rewards or bonuses based on the percentage of cost savings achieved within a specified timeframe, motivating them to identify and implement optimization strategies internally. Integration with Budgeting Process – align cloud spending with organizational goals and financial targets. Ensure that cloud expenditures are reviewed and approved as part of the overall budget planning cycle.
Using Amazon Web Services (AWS) to Reduce Cloud Spend	Utilize AWS Cost Estimation Tools – leverage the cost estimation tools provided by AWS to analyze your cloud spend. These tools offer insights into usage patterns, resource allocation, and potential cost-saving opportunities. Engage with Account Representatives – build a relationship with your AWS account representatives and seek their guidance on optimizing cloud spend. Account reps can provide valuable recommendations and insights tailored to your specific usage patterns and business needs. Consolidate and Optimize Resources – review your AWS infrastructure to identify opportunities for resource consolidation and optimization. Look for redundant or underutilized resources that can be consolidated or resized to better match workload requirements. Monitor and Manage Reserved Instances – monitor your usage of AWS Reserved Instances (RIs) to ensure that you’re maximizing cost savings. Evaluate your RI utilization reports and consider modifying or exchanging RIs to better align with your evolving workload demands. Implement Cost Allocation Tags – utilize AWS Cost Allocation Tags to categorize and track spending across different teams, projects, or departments. Cost allocation tags provide granular visibility into cloud spend and help identify areas for optimization. Explore Spot Instances – consider utilizing AWS Spot Instances for non-critical workloads or applications with flexible scheduling requirements. Spot Instances can offer significant cost savings compared to On-Demand or Reserved Instances. Evaluate Third-Party Tools – while AWS provides robust cost estimation and optimization tools, consider evaluating third-party solutions if additional features or insights are needed. However, be mindful that AWS tools may already offer comparable or equivalent functionality.

Overlapping/Redundant Tools
Common Areas of Waste	HR and Marketing departments tend to be less aware of overlapping tools.
Ways to Optimize Spend	Conduct Audits – identify redundant tools and services being used across departments. Look for instances where multiple tools are performing similar functions or overlapping in functionality. Evaluate Total Cost of Ownership – consider not only the direct costs of subscriptions but also indirect costs such as training, support, and integration efforts of overlapping services Compare Functionality and Features – determine which tool best meets the organization’s needs. Look for areas where consolidation can be achieved without sacrificing functionality. Create a Comparative Matrix – highlight the costs and features of each tool side by side. Clearly illustrate the potential cost savings and benefits of consolidating to a single solution. Set Cost-Saving Targets – challenge departments to justify the continued use of overlapping services if cost savings can be achieved through rationalization. Promote Adoption of Centralized Solutions – adopt centralized solutions that address the majority of departmental needs. Provide training and support to facilitate a smooth transition to the consolidated platform. Monitor Usage and Compliance – implement governance mechanisms to prevent the proliferation of shadow IT and unauthorized tool usage.

Paying for more product than you need
Common Areas of Waste	IT Equipment (computers, desktops, etc.) Contractors updating their base product Failing to scale down during slow periods of the year
Ways to Optimize Spend	Equipment Rotation Strategy – implementing a rotation strategy for equipment helps ensure that resources are utilized efficiently over time. By replacing devices on a regular schedule, such as every four years, organizations can avoid sudden spikes in replacement costs and encourage users to take better care of their devices. Ownership Incentives – offering employees the option to purchase their devices for a nominal fee at the end of the rotation period incentivizes them to take better care of the equipment.  Consistent Budgeting – establishing a consistent budget for equipment replacement allows organizations to plan and allocate resources effectively. By spreading out replacement costs evenly over time, companies can avoid unexpected financial burdens associated with large-scale upgrades. Contractor Management – be vigilant when managing contractors and external service providers to prevent unnecessary spending. Avoid situations where contractors have the ability to hire additional resources without proper oversight, which can lead to inflated costs and inefficiencies. Cloud Auto-Scaling – Configure cloud auto-scaling solutions to scale both up and down based on demand. Failure to scale down resources during periods of low activity can result in unnecessary costs and underutilization of cloud resources.

What tactics can help you negotiate more favorable agreements when you sign up with new vendors and renew with older ones?

Maintain a balance between cordiality and assertiveness – establishing a positive rapport with vendors can create a more cooperative atmosphere during negotiations. While you don’t need to be overly friendly, being polite and respectful can go a long way in building a mutually beneficial relationship.

Know your alternative products and services – this gives you leverage and allows you to negotiate from a position of strength. Vendors are more likely to offer competitive pricing and terms if they know you have other options.

Highlight the value of your relationship – emphasize the value your company brings to the vendor and vice versa. Highlight any past successes or positive experiences working together. 

Approach negotiations with the mindset of finding mutually beneficial solutions – instead of viewing it as a zero-sum game where one party wins at the expense of the other, strive to reach agreements that satisfy both parties’ needs and objectives.

Be transparent about your company’s needs, budget constraints, and priorities – this helps build trust and encourages open communication between you and the vendor. Avoid playing games or withholding information, as it can hinder the negotiation process.

Be prepared to make concessions during negotiations – remember to also be clear about what you expect in return. Whether it’s lower pricing, extended payment terms, or additional services, clearly communicate your requirements and negotiate for concessions that align with your company’s goals.

Consider the overall value proposition offered by the vendor – instead of solely focusing on price, evaluate factors such as product quality, customer support, reliability, and long-term partnership potential when making your decision.

How can you leverage long-term or high-volume vendor relationships to your cost advantage?

Leverage your position to negotiate favorable terms – this could include discounted pricing, extended payment terms, or additional services at no extra cost. Be clear about your requirements and seek concessions that align with your organization’s goals.

Be cautious when signing long-term contracts – especially those with stair-step pricing or automatic renewal clauses. Avoid locking your organization into agreements that may not be flexible enough to accommodate changing needs or growth patterns.

Consider signing shorter-term contracts to maintain control – push back against vendors pushing for longer contract durations and negotiate terms that work best for your organization. One to two years is the absolute longest you should agree to at one time. 

Conduct regular performance reviews of your vendor relationships – assess their effectiveness and identify areas for improvement or renegotiation. Use data and metrics to evaluate vendor performance and ensure they’re meeting their obligations. Don’t hesitate to explore other options if you believe there are better alternatives available.

What are the most important things to get right?

Understand the costs associated with IT vendors and negotiating favorable terms – avoid overpaying for services and regularly review contracts to ensure they align with your organization’s budget and needs. Effective negotiation skills are essential for securing favorable contracts with vendors. 

Building strong relationships with vendors – this can be beneficial for negotiating better terms, resolving issues, and obtaining support when needed. Communication and transparency are key to maintaining positive vendor relationships.

Assess and manage risks associated with IT vendors – do this to prevent potential disruptions or security breaches. Conduct due diligence on vendors before entering into agreements and establish contingency plans for mitigating risks. Ensure that vendor contracts comply with regulatory requirements and industry standards and establish governance processes.

Regularly monitor vendor performance – to ensure they are meeting their obligations and delivering value to your organization. Use metrics and key performance indicators to evaluate vendor performance and address any issues promptly.

Prioritize strategic alignment – Align vendor management activities with your organization’s strategic objectives and long-term goals. Evaluate vendors based on their ability to support your strategic initiatives and contribute to your organization’s success.