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ROI Overview

Published
  • March 25 2004, 1:00am EST

Editor's note: This is the introductory article to the Eye on ROI monthly column for DMReview.com written by Dawna Paton and Dale Troppito, managing partners of The Gantry Group. DM Review welcomes the new columnists and thinks you'll enjoy their thoughts all aspects of return on investment. Look for the column in the fourth week of each month.

Return on investment (ROI) has been a line item in technology procurement for a long time. But in the past 18 months the term has jumped from vernacular to vogue, spawning a cottage industry of specialists for hire and commodity-oriented, do-it-yourself tools. The only thing missing - and it's of crucial importance - is the establishment (and adherence to) best practice standards for ROI assessment.

This is the mission and passion of the Gantry Group. Our new monthly column, Eye on ROI, will focus on definition and implementation of ROI best practices, the benefits of use and pitfalls to avoid. We will also report on ROI assessments of various IT solutions based on our research. The objective of this column is to provide our readers with practical tips on how to use ROI analysis, optimize ROI accuracy and demystify some of the misconceptions about how ROI is measured and tracked.

Why should it matter if there are standards for ROI assessment? The simple answer is that without best practices, vendors, enterprises and consultants risk developing ROI models that churn out meaningless data that are more misleading and deceiving than informative. The end result of a rudderless discipline is that uninformed ROI claims become the new competitive marketing sport! But hyped claims quickly evaporate with real-world implementations. And ROI then falls into disrepute. Once that happens, vendors will return to baseless claims and customers will be deferring or defending their purchases. ROI is a vitally important tool. If we create best practices for ROI that vendors follow and customers trust, it will impact everything from vendor competitiveness to corporate IT spending.

Here is a set of best practices standards that guide consistent, methodical development of ROI assessment tools:

  • ROI models should be aligned with and support the same strategic goals that companies use to measure their success. Today's IT solutions are evaluated based on how well they help a company achieve its strategic objectives. Therefore the ROI of an IT investment should be based on the impact it has on key business performance metrics.
  • ROI value drivers should connect directly to the bottom line and measure hard - not soft - ROI. Soft ROI, such as "increases employee productivity by 20 percent" does not have a direct connection to the bottom line. Hard ROI tells the customer how that 20 percent productivity increase will translate to a measurable economic return such as cost savings or revenue increase.
  • In order to be valid and accurate, ROI studies should identify and analyze the appropriate and complete business processes, down to the individual workflows that will be affected by the technology investment. Value is measured by capturing the impact of an IT solution on operational business processes.
  • An ROI calculator is not credible until it is market validated, which means capturing data before and after solution implementation using confirmation from deployed customers based on real experience with the technology.
  • An ROI calculator is most effective when it can accurately forecast the impact from a technology investment. This ability to predict expected ROI must be based on prior data sampling. That way the "after implementation" data estimates are based on the actual experience of real customers.
  • An ROI calculator should be scalable and reflect the impact of an IT investment in a variety of size and growth conditions.
  • In order to be believable, ROI must be evaluated and certified by an objective third party.

In today's business climate IT solutions are no longer purchased because they are "fashionable." Now, more than likely, the CFO is involved with an economic business justification required for any purchase decision to be made. The economic business justification should include not just the payback horizon (time to recover your investment) but also the degree to which an IT investment will help companies meet their corporate objectives.
As an enterprise buyer of IT solutions, it is vitally important to assess the potential ROI of an IT investment using believable, objective modeling tools. This means that IT vendors who offer ROI calculators to demonstrate proof of ROI must be using tools that are unbiased and based on the ROI experiences of their deployed customers. If a vendor has built their own ROI model in house, you are correct to be skeptical about its objectivity. Here are some questions to ask of IT vendors regarding their ROI modeling tools:

  1. Has the model been developed or certified by an outside, objective third-party firm?
  2. How generic or solution specific is the model? Is it based on input that really reflects your business processes or is it one size fits all?
  3. How does the salesperson estimate the quantitative post-implementation results for your company? Are they basing your expected ROI benefits on the actual before-and-after experiences of real reference customers who have deployment experience with the solution you are evaluating?
  4. Does the model include any subjective factors such as "risk" or probability? If so, what are these based on?
  5. How tangible is the output of the model? Are the metrics based on expected bottom line impact or are they ambiguous and difficult to quantify?

Calculating ROI is not rocket science and there are established algorithms for its determination. The trick is in identifying the discrete drivers of ROI and being able to distinguish between those drivers that can and cannot be measured. Any IT vendor should be able to explain the methodology behind any ROI tool they use to substantiate claims. The more questions that enterprise customers ask about such tools, the more likely it is that IT vendors will adopt ROI best practices.
Ultimately the enterprise customer benefits greatly from having access to a sound, accurate ROI calculator tool. If an IT investment is being considered, ROI assessment can provide guidance for optimal implementation scheduling, pricing option selection (i.e., license vs. annual subscription), and even what specific features or modules to buy. For customers already deployed with an IT vendor, use of their ROI calculator can provide insight into business justification for continuing the annual subscription and/or investment for the IT solution. The ROI tool becomes central to an enterprise's annual exercise to analyze delivered bottom-line value. In addition, it can reveal ways to improve the ROI from an IT investment. Next month, we'll explain how and where ROI calculators are most useful and how enterprises can use them to economic advantage.

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