Cost Optimization

What Is Cost Optimization?

The most prominent companies in the world generate huge revenue and profits. They can do this partly because they ensure that every cent is costed. Gartner reports that More than 50% of organizations don’t have clear measures of success assigned to their cost management initiatives. Many organizations are wasting resources due to a lack of cost-optimization strategies.

But what is cost optimization? How does it differ from cost reduction? Why is cost optimization important in today’s business environment, and how can you implement the four pillars of cost optimization? We will explore all of these questions, beginning with a definition.

Cost optimization is the act of reducing company spending while maximizing business value. This list includes:

  • Purchasing goods and services at a lower cost.
  • Standardizing and streamlining platforms, applications, processes, and services.
  • Automating IT and business operations.

Companies benefit from strategic cost optimization when they are aware of these aspects of the definition, allowing them to maximize business value realization. But we must establish clarity between cost optimization and cost reduction to explore the differences.

Cost Optimization vs. Cost Reduction

When maximizing business resources, it’s essential to know the difference between cost optimization and cost reduction. Cost reduction is only concerned with how much something costs, while cost optimization considers all requirements and constraints.

Balancing service delivery with the best customer experience is the key when optimizing costs. Supply chain leaders who focus on other business aspects than cost consider processes across the entire supply chain.

Company leaders must strive to redefine significant successes and objectives across departments instead of encouraging workers to focus on a single target. This action spurs employees to collaborate towards a goal. It is also necessary to streamline supply chain systems that promote workplace division.

Even updated software cannot fully integrate all expenses and limitations – leading to a greater distance between departments. So, what relevance does cost optimization have today?

What Is The Business Value Of Cost Optimization Today?

Today, businesses use most new apps on cloud platforms, such as SaaS and PaaS solutions. Because of the specific purpose of these apps, companies maintain subscriptions even if they become unnecessary and unused. This lack of oversight leads to vast amounts of waste and missed opportunities for cost-cutting. Cost optimization becomes effective when companies implement cloud financial management.

Doing so ensures that companies optimize cloud expenditures to extract the highest value from their resources. Doing so ensures that you’re only paying for technology that provides additional value to your business.

To ensure that your company uses cost optimization efficiently, you must be aware of the four pillars of cost optimization.

What Are The Four Pillars Of Cost Optimization?

Companies are more likely to succeed when they take note of the central four pillars of cost optimization. The first of these pillars is right-sizing.

1. Right-Sizing

AWS’s (Amazon Web Service) least expensive service size is the smallest possible one that still meets your application performance requirements.

Though this approach is similar to how we manage the on-prem data center, it still leaves us with many questions: at what point do things become too small? If application requirements or resource demands change, what action does the team take next? What happens if workloads are mistakenly oversized in our on-prem environment, and that same misunderstanding continues into the cloud?

While Amazon provides many different sizing options for their instances, this does not mean there is a one-size-fits-all solution. Choosing the right size can be difficult if you need to understand your applications’ resource requirements fully. Additionally, resource demand fluctuates over time, so companies must consider this when deciding.

2. Reserved Instances

AWS outlines that by utilizing reserved instances, your organization has the potential to achieve up to 75% in cost savings. The general idea is that you agree to pay for a set amount of capacity over time, which then entitles you to a discount. However, determining how much AWS capacity to purchase can take time and effort.

Though it may be alluring to reserve more instances than you initially anticipated to save money, this could backfire if you only need a few. The same risks exist when projecting your needs for an on-prem environment. When you base your analysis on past data, there is a chance of overbuying even with the discount.

3. Elasticity 

AWS defines the third pillar, elasticity, as using services when you need them and having the option to turn them off when you don’t. This benefit is one of the critical advantages of leveraging the public cloud – yet it still requires teams to make decisions using the traditional on-prem methodology.

Suggested actions involve automated scheduling methods, such as turning off non-production workloads at specific times of the day every day and increasing granularity in auto-scaling. How can you be sure that these approaches will accurately predict workload demand or respond quickly enough to changes?

4.Measure/Monitor/Improve Approach

Finally, the fourth and final pillar of cost optimization, according to Alam, is “measure, monitor, and improve” to establish a culture of transparency and accountability surrounding your organization’s cloud deployment. But how do you achieve such a significant cultural shift? By setting KPIs and various metrics to benchmark usage.

No matter which tools you use or how much data you collect, it’s ultimately up to your team’s dedication and expertise that will make or break meeting the goals set for you. However, with AWS and other third-party support teams’ and professional services monitoring your progress regularly, staying on track becomes significantly easier.

5 Core Spending And Cost Reduction Strategies

The specific elements of a cost optimization strategy are central to success. The first of these strategic cost optimization approaches are linking your company objectives with operational approach efficiency.

  • Link company objectives with operational efficiency

This article includes suggestions and best practices for using cost optimization to get the most out of your money. However, it is imperative that you also reflect upon other priorities before you get started.

Reducing company expenditure will, of course, positively affect market growth. However, it’s crucial to remember that IT’s objective is also to promote top-line expansion. In the digital age, IT is usually the leading innovator in reducing lead times and promoting creativity.

Companies constantly seek to grow revenue, so it’s vital to review optimization against that metric. “Optimizing” cost means finding the correct cost, not the lowest.

Relying solely on IT will be beneficial as it suggests that IT is not concerned with meeting the overarching needs of the business. It is essential to get approval from the company for your plans; this can be done by sharing your reasons and justification for the changes. Without support, even the best plans may fail.

Suppose you move away from a transactional relationship and interact more frequently. In that case, you will also be able to optimize your standardized offerings and minimize costly non-standard requests by shaping their infrastructure needs early.

Having a successful and lasting cost optimization requires both parties to agree on priorities.

  • Make your hybrid IT infrastructure more visible

To optimize the cost of IT services, organizations need complete visibility into all the components that go into delivering those services. Unfortunately, it’s common for companies to need more clarity. With hybrid IT – a mix of public cloud and on-prem data center operations – becoming the norm for nearly every organization, gaining insight has never been more critical.

Out of necessity, we launched many public cloud services to support various components across the board. The placement was opportunistic (due to provisioning lead time and cost) rather than part of a larger strategy. Now individual business services are spread out over multiple platforms and service providers.

To gain insight into how your hybrid services are functioning, you need a tool that provides unified visibility and analysis for every aspect of your environment. It helps to base chosen management tools on a thorough hybrid IT strategy. These only monitor elements of the environment or focus on one technology, giving a narrow view.

Being restricted by silos hampers data gathering and slows down analysis.

  • Determine how much each project or product will cost

An optimization program needs to have a never-ending calculation of financial impact to avoid becoming simply technical and losing focus on its primary goal of reducing costs. To calculate cost savings correctly, you first need to figure out the cost structure of your operating environment. By separating the cost into different categories, you can more easily compare various options and ensure that money is always a top priority.

The process of third-party cloud services (IaaS, PaaS, or SaaS) is relatively straightforward: You must base the subscription terms and business agreement on the cost per instance, transaction, or user. This point also applies to setups where a third party has outsourced hosting and operations. In both cases, the agreement may have parameters—like volume-based discounts or term commitments—that it needs to reflect in the structure.

You’ll need to do extra preparations if you have traditional infrastructure stored on-premises in your data center. To find the cost of running a system or resources dedicated to it, you need to include the costs for the following:

  • OS and hypervisor
  • Maintenance and admin effort
  • Dedicated hardware components

To get a more precise estimate, you could add eventual costs for network connectivity via shared resources, facilities (power, cooling space), and software licenses. Out of these three, typically, the big-ticket items are what you should focus on first. But it’s crucial not to get caught up striving for the perfect structure– begin with something basic that can be enhanced by adding new layers later.

Many companies limit their options to a set of usual configurations, where the overall price can be predetermined for each configuration, considering the listed factors.

  • Eliminate inefficiencies safely

Each company aims to avoid over-prioritizing infrastructure, but this is challenging. The first aspect of the challenge is estimating the best resources for new workloads and applications. Despite best efforts, the figure is only partially accurate.

In situations where you get it right immediately, conditions in which you use the applications change over time for several reasons:

  • Workload intensity varies across business seasons.
  • Business changes mean that processes must adapt to satisfy service demand.
  • Base resource allocation on predicted demand outcomes.

Therefore, you must reevaluate and optimize or eliminate overused resources regularly. As you try to locate unnecessary allocations, use enough historical data from each workload to include an entire business cycle in the analysis.

If you want to reduce how much you’re spending on your public cloud, right-sizing is vital. Automating the process should be part of your regular management routine.

On-premise infrastructure generally has a combination of capital and operational expenditures. The impact will be less direct and come with somewhat of a delay. Considering you can’t recover the CapEx component as the sunk cost, you need to look at it optimistically.

The cost of repurposing will depend on if you can successfully reuse the identified excess and replace or postpone other planned investments. The recovery process and new demand for resources may not happen simultaneously, resulting in a delayed bottom-line impact. But that’s no reason not to try. Most modern architectures built on hypervisors and pools of virtual resources usually offer suitable mechanisms for effective resource control and ensuring each investment is the right size.

  • Estimate costs by creating a budget for each project

So far, we have focused on designing a process that corrects non-optimal provisions. By frequently analyzing allocated resources and determining corrective actions, you can considerably reduce the amount of waste.

Without a cost for IT resource usage, there’s a chance a business unit will continue to use more resources than necessary. Doing so harms other areas of the company that also need those resources. To ensure each unit only uses what they need, charge each one according to their consumption.

Public cloud resources make this easy to do.

Charging each cost center for their use is a fundamental part of the framework. This way, business units are held accountable for their choices and can work to optimize their cost. This action will help reduce the total amount spent by all businesses.

For those with data centers not on the cloud, it may be more complex and require new processes:

  • You need the proper instrumentation to monitor customer activity, especially when multiple customers share resources.
  • This action also includes correctly calculating the total depreciation cost for capital investments that cover the resources you utilize.
  • Additionally, if your organization has generally looked at IT as an internal expense, you’ll need a plan to break down cultural barriers toward internal charges.

If you find these requirements negatively impacting your timeline, try to look for ways to boost project efficiency.

Designing a good allocation policy enables business transparency regarding cost and drives better decision-making for the whole company. Implementing this requires minimal extra effort, but it should not be your only measure. The continuous right-sizing efforts described in steps 2-4 should supplement this policy, not replace it entirely.

Gartner's Three Pillars Of Strategic Cost Optimization

Globally renowned thought leader Gartner developed the three pillars of their strategic cost optimization framework to support a business-focused approach to savings plans. The first pillar is defining success.

1. Define Success Clearly 

The issue is the poor design of temporary cost solutions. Gartner reports that just 43% of leaders reach their cost-saving targets within the first twelve months. Even fewer sustain these savings for three years or longer.

According to Gartner’s 2021 data, most organizations utilized multiple success metrics; however, 66% of companies defined the most common obstacle as achieving specific cost savings. Best-in-class organizations manage their costs continuously rather than seeing them as a one-time goal.

Organizations set realistic cost targets and avoid across-the-board cost cuts in favor of strategic divestment. Doing so drives behavior changes that support a climate of cash consciousness and smarter spending across the organization.

What does success look like when setting initial targets for your cost-management journey, such as specific savings goals or increasing productivity metrics? It is helpful to answer this question to define success clearly.

2. Adopt A Consistent Framework 

According to Gartner research, organizations that used a cost management framework before the pandemic were less likely to have their budgets/costs cut. The reason is likely because the framework allows for a shared understanding of which costs you can optimize and which need to remain protected to pursue organizational goals.

Organizations that use a systematic and methodical approach find it simpler to validate their budgets to other interested parties.

Despite the benefits, only 35% of surveyed organizations deploy such frameworks. A framework — whichever you choose — can provide more consistent cost categorizations for budgeting, target setting, and reporting on costs.

3. Leverage Cross-Functional Collaboration

Cross-functional collaboration is critical to keep driving impact (and is more common when a standard framework is in place). Start by identifying instances where functions depend on — or need to collaborate with — their peers to manage their cost drivers and address the areas of poor inter-departmental collaboration.

Best Practises To Optimize Costs

Following best practices allows business value to increase within a structured process. The first of these best practices to optimize costs is to audit cloud costs.

Audit Cloud Costs

When examining your cloud spending, look at the potential areas of improvement and where you may have repeating systems. Businesses often find multiple cloud structures working on similar tasks – like security or administrating tools. There could also be portions of your development in the cloud that need more attention to be successful.

Enable Cross-Functionality

You may have noticed that there’s always a debate about how companies should allocate money between administrators, developers, and users. Even though they might all be correct from their perspective, the employees working on the ground will see where cloud costs need to go. By having cross-functional teams, you’re less likely to spend money in places that aren’t needed and more likely to identify areas needing improvement.

Formulate Processes to Procure And Decommission

Unused or inactive resources within an organization are often due to a lack of effective systems and processes. By reinforcing stricter controls when companies commission resources and ensuring IT departments decommission apps no longer needed, organizations can reduce the chances of unwanted Shadow IT.

Consolidate Idle Resources

Set up resource consolidation for idle systems to increase cost optimization. Systems used yearly don’t need to be kept in the front and center. While these resources may not be suitable for decommissioning, they may not need to utilize as many resources as they are. An example: organizations may want to have a multi-layered system where the most active resources have the highest availability and the least active resources have the lowest levels of availability.

Utilize Integrated Optimization Tools

Azure and AWS both have cost optimization tools, which should be exhausted before searching for a third-party tool. Built-in technologies work perfectly with the infrastructure and don’t come at an additional cost.

Cost Savings & Digital Transformation

One of the most important goals of digital transformation is cost savings. Businesses can free up resources by streamlining processes and automating tasks. Digital transformation can also help companies optimize costs by identifying areas where they are wasting resources.

However, digital transformation is about more than just cost savings. It generates savings by improving efficiency, effectiveness, and customer satisfaction. When implemented correctly, digital transformation helps firms to achieve their goals and create lasting business value.

Related DX Content

Cost optimization involves much change for staff, so you must implement change management theories. Cost optimization is also part of digital transformation strategies.

It is also essential to ensure that you incorporate customer experience into every cost optimization strategy to maintain service quality despite savings.

Updated: November 03, 2022

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