The deciding factor for where and how you invest your money most likely hinges on the answer to this question: How much money will you earn over time (return) on the money you invest now? You want to know the projected return on your investment (ROI), whether it is part of your retirement portfolio, the home you live in, or the car you drive.
It’s no different in the business world. Your IT team might be lured by new hardware, software with unique capabilities, or exciting new personal data devices with features the sales team will love. And you may be convinced that such purchases would be a great boon to the business. But knowing instinctively that a particular IT project will deliver value to the business isn’t enough. As IT continues to move from a cost centre to a revenue-generating business unit, the focus on financial returns has heightened. To get a project funded, you have to present a solid business case that shows tangible benefits and that promises excellent ROI.
Even people without a strong finance background have to do financial analysis in their personal lives. And you may well have this experience when calculating ROI for your IT department. But wouldn’t it be nice if there were a tried-and-true method that takes the guesswork out of ROI calculations and makes it easy to defend your case to the business? Fortunately, there is. This article will outline several effective steps to address ROI analysis that demonstrate the value of your project in terms business leaders understand.
A Short Course in ROI
Let’s start with the basics. ROI measures how much value the business will realise (the benefits) relative to the investment (the cost) over a specified period of time. The results are presented as a percentage, and both benefits and costs (if applicable) are discounted to the present value. The calculation is a simple one that works for any industry: benefits divided by costs. Another way to calculate at ROI is this: total benefit, minus total investment and costs, divided by total investment and costs.
ROI is an attractive tool for evaluating IT investment decisions, because the model is applicable to any type of purchase and can be adjusted according to your company standards and requirements. That is, you can customise the analysis based on the metrics that are critical to your business. For example, as benefits, you can include IT improvements, such as reduced mean time to repair (MTTR) and faster resolution of service desk calls, as well as business metrics, such as additional revenue generated with the new solution, optimised labor resources, risk avoidance, and the quantified value of customer retention. As costs, you might include the purchase price of the software, the cost of solution deployment, the training needed to use it properly, and upgrades.
To be effective, an ROI analysis must be sound and trustworthy. Our simple, 4C framework will help you ensure soundness and trustworthiness by building an analysis that is credible, conservative, customer focused, and comprehensive.
Make It Credible
Would you purchase a home in an expensive neighborhood just because one person says it’s a good investment? Or would you check out local property values, compare similar neighborhoods, and perform your own due-diligence research to see whether something else would better suit your family’s needs? Chances are pretty good that you wouldn’t settle for one opinion on a purchase as important as your home.
Similarly, a credible ROI analysis leverages input from multiple sources. People within your IT organisation know your company well and can provide insight into how the business operates. Outside consultants and trusted vendors complement internal analysts, offering insights into best practices unique to your industry, as well as relating experiences with other companies that have successfully undertaken similar projects. These outside resources can help validate your assumptions and provide relevant industry data. And because of their knowledge of the industry, outside experts can give you a fresh perspective from which to benchmark your company against your competitors.
To ensure credibility, you need to find out the answers to each of these questions:
- How recently was the ROI analytical model developed?
- Was it certified by a third-party research or analyst firm?
- Has the model been benchmarked, tested, and used with other companies in your industry?
- Has the model been calibrated by post-deployment ROI studies of actual results?
Just like a too-good-to-be-true stock tip that promises to make you a fortune in no time at all, recommendations for overly optimistic returns typically fall apart under scrutiny. For example, a promise to reduce IT operating costs by 95 percent while the department retains the same functions and processes isn’t likely to survive a close, critical examination. On the other hand, extensive interactions with hundreds of organisations reveal that conservative ROI models stand up to scrutiny time and again.
Here are some questions whose answers will help ensure a conservative approach to calculating ROI:
- Are the cost reductions or performance improvements backed by documented research or industry standards?
- Are the savings based on realistic costs for your industry and geography?
- Are the benefits phased over time, or are you implying that they will all occur immediately?
- Has project risk been considered?
Being conservative does not mean simply cutting all the benefits and expected improvements in half. It means that you are using a thoughtful, analytical approach that considers realistic costs and benefits backed by industry data and internal research. There is also an important psychological advantage to using a conservative approach to ROI: think how much happier management will be if the actual ROI exceeds your projected ROI, rather than the other way around.
Stay Customer Focused
Your car salesperson may think a luxury sedan is the best vehicle to hold its resale value, but a hybrid might be more your style. Maybe you’re more concerned about the impact on the environment than on the status of a fancy car. Or maybe safety is your key concern, and the sedan doesn’t have the features you want to protect your family. Considering these types of unique concerns is analogous to what you need to do when calculating ROI. The most effective ROI analysis is based on your company’s unique situation.
Answers to the following questions will help you bring customer focus into the equation:
- Did you receive input from the people who will benefit from the new system or technology?
- Or, instead, did you rely on industry averages of companies like yours?
- How precisely does the business case reflect your specific situation?
Your results will be realistic if your analysis is based on the business-critical applications your company uses and the actual business impact of downtime for each application. It should, for example, consider your current maturity level relative to the area where you are making the investment. It is unlikely that you are starting from scratch, so you already have at least some capabilities in the area where the investment will be placed. Consequently, your analysis should reflect the incremental value beyond what you are receiving today. This approach shows what you can realistically expect to achieve given the technology or processes that are in place.
The bottom line is that the more the ROI analysis reflects your environment, the closer the projected benefits will be to actual results. In addition, the intangible benefit of working closely with customers and having ongoing dialogs with them to understand benefits in the longer term will enhance your relationship and trust position with customers.
Take a Comprehensive Approach
When you first started making purchasing and investment decisions, you were not as savvy about your options as you are today. You may not have known what questions to ask before making a decision. With more experience, you now know that you have to be thorough and analyze every contingency before deciding where to place your money. That same kind of comprehensive approach will help you calculate realistic ROI on your IT investments. You can ensure that your analysis is comprehensive by getting satisfactory answers to the following questions:
- What does the ROI model cover?
- Does the model research both IT and business benefits?
- Are all costs and benefits included as applicable for your industry?
- Is it based on third-party research?
- Has it evolved over the years?
- Are your benefit metrics current?
- Does your model include cost savings as well as the business benefits?
Your analysis should reach beyond IT benefits to include expected business benefits the investment can deliver. By closely collaborating with the business, IT can become a change agent as well as a trusted advisor to the business. Situations in which IT proactively seeks solutions to satisfy potential business needs, or cooperates with the business in solving existing business-critical issues, will yield excellent companywide results and tangible business impact. This includes increased gross profit, higher customer satisfaction ratings with the IT services, and IT management becoming an equal partner with business management.
From the cost side, it’s essential to include all major purchase components — software licenses, hardware, maintenance costs, training, and consulting, as well as internal costs. A good guideline is to ensure that the costs and benefits are “mutually exclusive and collectively exhaustive.” Include all potential costs and benefits while avoiding double counting or overlapping of items.
ROI is an integral part of building a business case that assesses the value a project can be expected to deliver. As you build your case, be sure that your analysis stands up to scrutiny: Is it credible? Is it conservative? Is it customer focused? Is it comprehensive? If you can answer yes to all four questions, you’ll end up with a sound and trustworthy analysis that top management can understand and buy into.
Mary Nugent, vice president, software consulting, BMC Software, is an accomplished software technology executive with considerable experience and expertise in information technology. She is responsible for the development of projects around Business Service Management (BSM) for BMC.
Marina Yesakova is a senior strategic marketing manager at BMC Software. She leads the financial justification of IT purchasing decision initiatives by creating financial and statistical models and business cases for BMC customers. Ms. Yesakova holds a BA and MA in Linguistics from the Moscow State University, Russia, and an MBA from Rice University.