Rethinking ROI: How IT value measures up

by Stephen E. Lipka

August 28, 2008 —

In the world of IT, ROI is king. But should it be? How many approved IT projects have you seen with projected returns that -- in spite of the vetted calculations -- you just didn't believe? And how many projects that were rejected because ROI couldn't be calculated or proved, would have turned your company into a well-oiled machine? ROI can be a great tool, but it's not the only mechanism for judging value.

Let's look at some situations that arise when managing information technology and see how well ROI works in each instance.

The Broad View of IT Value

Figure 1: Achieving IT Value

The company sets its business objectives (e.g., expand business to two new continents).
IT sets its own objectives consistent with its mission and with the business objectives (e.g., increase international usability of applications).
IT designs its projects and services with the intent of achieving its objectives (e.g., three proposed projects for language extension, geographic address localization, and mapping).
The outcome is changed operations and the concomitant benefits.
The changed operations drive achievement of the business objectives and the IT objectives.

"Information Technology" -- both the technology itself and the department or team organized to apply it -- is a means to achieve business objectives. Its value is derived from how well it achieves this objective. (Figure 1 illustrates how IT value is achieved.)

Achieving business objectives is a long-term matter if they’ve been set appropriately, and continuous progress towards the objectives often takes the cumulative effect of many projects.

Where is ROI in this picture? If it exists at all, it’s in a project. (It may not exist for some projects, such as foundation infrastructure or technology platform work, for example).

So what's the value of IT? It's in the achievement of its financial and customer benefit objectives (increased usability and use in foreign countries, in this example), and it's in the indirect achievement of the business objectives (increased international revenue). It's not in the ROI calculation of any one project (extend applications to Spanish)

ROI may be illustrative, but it's not a measure of IT value.

Making Project Choices

There are always more projects than there is budget flexibility, so how does an organization choose? The snap answer is 'pick the projects with the highest ROI for the money' -- but not so fast. Would you choose to build and support what you thought was a killer iPhone application, potentially a lucrative business, if your company offers only outsourced support services? Probably not. Would you choose a project, all other things being equal, if another project delivered results faster? Probably not. Would you choose a project, all other things being equal, if another project could drive achievement of two strategic objectives, not one? Again, probably not.

On the other hand, would you settle on a project that had no ROI but allowed you to pass your Sarbanes Oxley audit? Would you pick a project that yielded no new revenue, but prevented erosion of revenue from a competitor? Would you pick a business-continuity project if no such plans were in place, even though you may never get any benefit from it? Probably yes for all, because the business impact is potentially significant.

Good governance suggests that there be a sensible, understood, and predictable scheme for choosing projects. This requires a scoring scheme agreed to by all who have a say in IT's work. The scheme can have any number of factors -- ROI/impact, number of objective served, time to impact, etc. Pick your factors and the weighting of each. Certainly ROI fits into the scoring scheme, but it’s not the only factor.

Judging Project ROI

One way to balance your portfolio of projects and services is to classify them by whether they’re about running the business, transforming the business, or growing the business. The ROI calculations are different, and among them, have differing levels of credibility.

Running the business includes all IT activities that support day-to-day operations of the business and all IT improvements that don't fit into the other two categories.

Projects in this group are often motivated by cost savings or compliance. For the latter, there is no ROI calculation, or it's the potential cost of not doing the project. Cost savings calculations are usually straightforward -- you can compare the projected cost reduction with the amortized investment. Examples include hosting or server consolidation, outsourcing support, or replacing printed invoices with emailed invoices. The "optimism" of each assumption, in the author's experience, is easily judged, largely because the facts are available (assuming vendor proposals are credible). But, as car manufacturers caution about EPA estimates, 'Your mileage may vary.'

Growing the business includes work focused on increasing revenue, fueling organic growth, increasing demand, or supporting a new line of business.

Here, you can compare the projected revenue growth with the amortized investment. Examples include building an e-commerce channel to supplement the sales force, building a new ecommerce site in another language to capture another market, or offering a new low-cost self-service plan. Too often such projections are wildly optimistic. To be credible, they must be vetted by an experienced and knowledgeable group and may require some market research or research into past industry experience with similar work. There may be fewer facts on which to base the proposed benefits.

Transforming the business includes work that transforms the way the company does business through faster or less work-intensive business processes or that supports new business models.

Projects in this group are motivated in the belief that IT can be an innovative and disruptive force, driving business to change for the better. Often, these projects drive business process changes. Frankly, who knows the outcome with certainty? CRM is a perfect example. How can you calculate the benefits of knowing your customers better or of the personalized touch you can now offer them? How can you calculate the benefits of management's increased ability to understand in near real time where that new value proposition is failing and succeeding?

Because transformations almost always have unintended consequences -- good and bad -- it's impossible to predict all the outcomes. For example:

A change in process and its supporting system seek to reduce processing cost and "red tape." It may happen to increase customer satisfaction enough to increase revenue.
A contracts workflow system can be motivated by the desire to reduce physical paperwork and eliminate mailroom delays. What happens when parties in the workflow realize that their decisions and rationale can be more easily scrutinized than before, when it was all buried in paper? Will they take more time?
An integrated CRM-finance system is motivated by the desire to speed the order process and put in place the infrastructure needed for significant growth. What happens when management visibility ends excessive discounts the sales reps have been giving to make the quarterly numbers? Will revenues drop due to loss in unit volume, or will revenues increase over time due to less discounting, with a side benefit of leveling peaks and valleys?

In summary, ROI projections can be highly credible for run the business IT projects. They will be will be less so for grow the business projects. ROI calculations can be illustrative examples for various scenarios in transformation projects, but they’re not definitive.

It's That Vision Thing

Vision is the ability to see possibilities -- possibilities far in the future or possibilities arising from proper alignment of strategy, resources, and external forces. Vision requires a holistic view, taking into consideration all the 'moving parts,' all the effects the parts and forces have on each other, and all the delayed and indirect effects involved. Vision requires intuition, and visionaries often go on faith -- faith that even though they can't necessarily quantify the enabling mechanics and the outcomes, the result will be great.

Calculating the expected return on an investment requires a different kind of thinking. It requires choosing and quantifying a manageable number of variables and assumptions. It requires quantifying the relationships and validating the computations based on experience and research.

ROI analyses can only be developed when there are a limited number of assumptions, variables, and relationships. And bullet-proof analyses become exponentially difficult and expensive as the assumptions, variables, and relationships grow in number, by virtue of the research and experience needed to validate them.

Broad visions have too many un-provable calculations to be judged by ROI analysis. So take bold steps based on broad visions. Building a bulletproof case may kill your vision or your market leadership.

There are cases where ROI can be a valid and valuable tool for assessing the value of a project. But it's not the only measure by which to score the value of a project, and it's not a measure of IT's value to the organization. Beware the use of ROI as the primary criterion for IT work.

Stephen Lipka PhD, CMC is a Principal of Avatar Strategic Partners, where he guides clients to higher profits through better use of information technology. His career spans 33 years in management, consulting, and product development. He can be reached at slipka@consult-avatar.com