As tech investors, we often read CIO surveys to understand how and where they are spending their IT budgets. These surveys by research companies typically tell us whether CIOs are going to spend on average 2% more next year or 3% or if they are going to make cuts. They also give us a list of top 10 or 15 CIO spend priorities for the coming 2-3 years. We pore over that information and make extrapolations on which technologies and, by extension, which companies will grow in the future…cybersecurity or agile development tools or AI and data platforms or MDB or CRWD or GTLB or SNOW…
Rarely do we know or understand how CIO budgets are prepared, tracked or adjusted over time. Well, today, let’s take a peek behind the curtain at this less understood world.
I was a senior leader in the Office of the CIO at my last two employers, both of them global Fortune 500 companies. Over the last 19 years of my corporate career, I was actively involved in the IT budgeting and capital management process from a variety of angles.
Based on that experience, here is how things typically work at large enterprises. I do not know how medium and small companies manage their IT budgets, however I suspect that they are somewhat similar, but on a smaller scale and with less people involved. Also, please note, that I am making some generalities and using broad descriptions below, while leaving out some accounting minutia. This is to enhance your understanding as an investor and a reader, without needing an accounting degree or going down unproductive rabbit holes.
Components of a CIO budget
CIO budgets are created based on two types of “work”:
Projects - Specific deliverables that will be completed over the next 12-18 months such as development of a new application, launch of a new product, migration of a legacy system to a new technology etc. These have specific start and end dates and quantifiable cost estimates.
Ongoing operations - A CIO will budget, on an annual basis, for the cost of managing and maintaining their ongoing IT operations (security, data center, backups, disaster recovery, help desk etc.) to support the core business of the company, their employees and their customers.
The cost estimates for the proposed projects and the ongoing operations are then broken down into categories such as:
- Labor
- Hardware
- Software
- Vendor services spend
- Vendor licenses spend
- Travel and expenses
- etc.
This breakdown allows the CFO’s team to map out how these costs could impact the company’s financial accounting books - income statement, balance sheet, cashflow statement etc.
Rolling budgets and forecasts
Enterprise IT budgets are usually created and managed over three timelines:
- Rolling 3 years
- Rolling 18 months
- Monthly
Rolling 3 years
Most large companies manage their business according to 3 to 5 to 7 to even 10 year roadmaps. They closely track macro economic conditions and trends in their markets and forecast their annual top line and bottom line estimates accordingly.
All future budgets are derived from these business roadmap estimates. They extrapolate their operating costs, margins, cashflows, capital spend and earnings for these future years. The CFO is therefore able to tell a CIO what her IT budget is likely to be for each of their future roadmap years. Some industries like retail even have IT spend targets based on a % of their revenues and these are used to further refine the budgets for the future years.
Rolling 18 months
Here is where the rubber meets the road. Let’s understand this against a sample timeline. Note that this timeline might vary by company and by industry.
May 2022 - This is usually the first time a CIO gets a more solid estimate of her next year’s (2023) IT budget. This annual budget total gets refined multiple times over the remaining months of 2022 before the 2023 budget is “finalized”. We shall also see later how enterprise IT budgets are never final.
Jan 2023 - New budget year starts. Let the spending begin.
Feb 2023 - About 6 weeks before the Q1 earnings report is due, IT managers (and CIOs) have to submit their 2+10 budget update i.e. 2 months of actual spend and next 10 months of budgetary forecast. If they need more money than their 2023 annual budget, this is when they make their first such request. These numbers from the CIO and all other business divisions feed into the Q1 earnings report’s actual accounting and into the Q2 and 2023 guidance.
May 2023 - Again about 6 weeks before the Q2 earnings report is due, IT managers have to submit their 5+7 budget update i.e. 5 months of actual spend and next 7 months of budgetary forecast. They can also make the case for additional budgetary funds.
In this cycle, they also get a first inkling of their 2024 IT budget. They have to submit a high level plan for 2024 - A list of projects and project cost estimates, plus IT operational cost estimates. If the CFO tells you that your 2024 budget is likely to be $100M, you better submit project lists and cost estimates that show that you will use all that money and likely much more. Ask for more than what you think you will finally get.
Aug 2023 - Once again , about 6 weeks before the Q3 earnings report is due, IT managers have to submit their 8+4 budget update i.e. 8 months of actuals and 4 months of forecast. Some more tweaking of the 2024 IT budget happens.
Nov 2023 - About 6 weeks before the Q4 earnings report is due, IT managers have to submit their year end budget update. This time they will include 11 months of actuals and 1 month’s forecast to close out the year. By Nov 2023, the CIO and her leadership team know what their 2024 budget will be. They start planning for any project launches and headcount changes. They might even issue RFIs and RFPs for technologies they plan to purchase the following year, especially if they need to get a jump on a project in Jan.
And so the cycle continues year in and year out on an 18 months rolling basis.
I will not get into details on the monthly budget management. It’s more mundane stuff like tracking salaries, IT contractor spend, monthly invoices and payments, vacation time etc. for each month.
Hiring FTEs and contractors
Large enterprises are constantly hiring employees and contract staff to fill gaps in their teams as they crop up. There is constant turnover - employees are retiring or leaving jobs for a variety of reasons or even being let go for performance reasons. So the churn is constant. However there are a few “phenomena” that seem to repeat themselves each year…
Mar 2023 - Most new hiring for the year happens in Feb and March. IT managers know what their budgets are, they put in job requisitions for new FTE (full time employees) additions, they start interviewing candidates and hiring new staff.
Apr 2023 - If IT has not been able to fill their open positions by this time, the CFO starts questioning whether they actually need all those additional FTE headcount. Job requisitions that have been open for more than 12-15 weeks are challenged and could be closed out. IT managers have to justify leaving them open so that they can scope additional candidates and continue the hiring process.
Sept 2023 - Managers and employees come back from their summer vacations and there is a sudden sense of urgency and a related burst of activity. If an IT team is behind on their project spend or their hiring, they better get cracking by now. They try to mitigate the delay or shortfall by quickly bringing in IT contractor staff to fill the open positions so that they can get the projects across the finish line within the designated deadlines. It is also a way to spend IT project budgets quickly before they lose the unspent funding.
New technology or platform selection and spend
When considering a new technology or platform for a project or their operations, most enterprises issue an RFI (Request for Information) followed by an RFP (Request for Proposal). Technology vendors find these RFIs and RFPs on the company’s vendor management website and they respond accordingly.
Depending on the total cost estimate, the IT manager and the Vendor mgmt team will execute a series of steps to receive the vendor proposals, review them, score them, shortlist the ones they like, bring them in for interviews, proof of concept tests, presentations etc. This is usually followed by pricing negotiations, contract negotiations and finally the signing of the contract. Depending on the size and length of the contract, multiple levels of managerial approvals could be required.
E.g. A 10-year, $130M contract once took my team about 6 months to negotiate after we had selected the vendor. It had to be approved by the CEO and then the board of directors before we signed on the dotted line.
Remember CRWD and DDOG telling us that some new enterprise customers in their pipeline were mandating additional levels of approvals?
Other items of note
Unforeseen business events come up all the time e.g. acquisitions, divestitures, new market entries etc. IT spend requests for such one-time, “surprise” projects are made as they manifest themselves. CIOs may be asked to handle it within their existing budget by cutting a lower priority project or the management might approve new funds for this work.
Most enterprises conduct monthly capital committee meetings that oversee these budgets, ensure that project deliverables and spend are on track as well as approve new spend requests.
Often CIOs are given budget cut targets for the quarter. This is why the actuals+forecasts are due about 6-7 weeks in advance of a quarterly earnings report. Most IT leaders deliver these budget cut targets by shrinking their labor costs. Labor is almost always the largest cost category and a better place to make such a cut. Sometimes non-contracted IT spend might get deferred to meet the goal.
Takeaways
So what does all this mean for me as a tech investor?
- IT budgets are usually well understood for the following year about 6 months before the year starts.
- IT budgets are never written in stone, especially for large enterprises. They evolve (grow or shrink) throughout the year.
- There are no holy grails in a CIO’s budget. Everything is up for grabs and could be cut under the right circumstances. In the CFO’s eyes, no vendor or technology is truly mission critical. In fact, a good CIO always plans for redundancies within their operations.
- The larger the new IT spend, the more time (and more approvals) it might take to get to a signed contract.
- Consumption-based IT spend is usually already budgeted for in the CIO’s annual budget. Often they prefer to spend all those funds so that they can secure similar or slightly higher such funds next year.
- IT hiring usually happens in two larger waves…in late Q1 and in late Q3.
- It helps to understand if a technology vendor’s product is considered a one-time project cost or if it is an ongoing IT operational cost. It could start out as a project and then transition to an ongoing cost once it is fully implemented.