Hitting home with ROI
We’ve established that ROI is a measurement used to evaluate (IT) initiatives in terms of financial value to an organisation and should be used to help justify those same initiatives. But it’s important to note that the concept of ROI and the measurement of ROI vary from company to company and from executive to executive. This is because there are different criteria by which to measure ROI, and there are many ways to quantify it. In its simplest form, though, ROI is the ratio of present value of expected benefits over the present value of expected costs. Therefore:
ROI = (PV OF EXPECTED BENEFITS / PV OF EXPECTED COST) * 100
You may say, “Hold it. Some IT investments are nearly impossible to quantify.” I agree, but there’s always a way. A typical example is a business intelligence (BI) project. Even intangible benefits can be quantified with some creativity, and it is important to find a way to do this. Again, the financial person on your project can help.
Going back to projects that can be quantified, a basic rule of thumb is that projects with an ROI of less than 100 percent should not be undertaken unless there are compelling reasons to do so and strong executive sponsorship for the project. Anything over 100 percent has a better chance of passing the CFO’s scrutiny. Also, an important point to consider is the project’s expected payback. When the expected benefit exceeds expected costs, and that benefit is expected to be realised within the first year of the project implementation, the more likely the project is to proceed.
Caution
The best way enterprises can improve their ROI is by not inflating benefit expectations.
During the development phase, there may not be any measurable benefits. However, if a project goes live earlier, it stands to reason that project costs are reduced and revenue is increased. However, project managers should also understand that simply "crashing" or reducing the development phase by adding more resources (i.e., developers) will not bring about a better ROI, because more resources will add to the investment. So, you should carefully analyse the cost/benefit with the ROI expert on your team.
Figure A illustrates the concept of ROI within a project environment. It shows how project managers work with an ROI database and determine the ROI prior to the start of a project. The project review team documents the projected costs, potential savings, and risks. Make sure that someone who has a good financial background assists with the accuracy and logic of the ROI calculation. The results are then finalised and submitted to the executive team for approval and a go/no-go decision. If the project is of strategic value, the project manager may present such findings to the executive team.
ROI in a project environment
Here are the steps you need to take for projects that fall into the (1) ERP, (2) CRM, (3) wireless, (4) legacy systems upgrade, (5) managed services, or (6) outsourcing categories:
Step 1: Determine the full scope of your project and baseline it.
Step 2: Estimate the resource costs to be used on the project.
Step 3: Use an ROI template/cost accountant to assist with the accuracy of the calculation.
Step 4: Submit to the executive team for review.
Factors affecting ROI
Since ROI may not factor in all risk or intangible rewards, it is prudent to list some of those risks and intangibles that may impact an IT project as a separate item on your document. Here are examples of factors that impact any ROI:
- Lack of resources—Developers or testers may not be available or may not have the proper skill sets, requiring additional funding from the company.
- Dissatisfied client—The client or users may be dissatisfied with the IT solution you delivered and reject it until it’s corrected. You may need to add code, burning up more time, testing, and money. Or, the solution may not be compatible with current or future operating systems, platforms, or other applications.
- Unsatisfactory executive commitment—The executive team may not be fully committed to the project (e.g., dissatisfaction with the proposed project budget).
- Vendor delays—Sometimes, vendors may be unable to deliver hardware or software when you need it, impacting your release date and potential revenue.
Understanding ROI will help you sell and manage your projects better from a financial perspective. In the future, project managers will likely place a greater priority on determining the ROI of a project. Available ROI calculators are somewhat fuzzy and difficult to pin down. Project managers should strive to understand ROI calculations. If you cannot get suitable training, get a financial person on your team to analyse ROI for you. Project organisations, boutique firms, educational institutions, and presenters should also begin addressing ROI prior to each project start. ValueIT ProjectROI is one commercial tool that I’ve found useful for calculating and assessing the ROI for any new project or proposal, thereby allowing you to align your IT budget accordingly. But that comes at a price. There are also free ROI tools available online.
How’s your ROI?
How do you calculate ROI on IT projects? Do you find Jason’s tips helpful? Do you have questions about calculating ROI? E-mail your comments to builder@zdnet.com.au.
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