The changing face of ROI

You might think that measuring return on investment is one of those things that never changes. You'd be wrong.

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The workhorse measures of financial return haven't really changed, nor has the maths behind them. But as fear of a recession spurs a renewed interest in value - and as the strategic mission of IT shifts from saving money on back-office functions to enhancing revenue - "return on investment" has taken on new meanings and importance.

At consumer products giant Procter & Gamble, ROI used to focus on cost savings. "ROI was about the bottom-line impact of projects," recalls Robert Scott , vice president of information and decision solutions at P&G. "Now we have moved to a phase called 'value creation,' which is a combination of bottom- and top-line ROI."

The "top-line" objective most often is sales, he says, but it could be something else, such as faster movement of cases of Tide, Pampers or Pringles through P&G's US$76-billion supply chain. The new approach, which began in 2004, was important enough to be given a name: Global Business Services -Next Generation.
As companies increasingly try to include intangibles such as customer satisfaction in their return metrics, IT and finance people are finding new ways to deal with uncertainty.

"The biggest change I have seen in five years is what I call the bifurcation of technology between the operational and the strategic," says Steve Andriole, a professor of business technology at Villanova University. "It has phenomenal implications for project prioritisation and ROI. To a great extent, Nick Carr was right - operational technology has been commoditised."

"Operational" projects - such as upgrading a network, replacing PCs or even automating a back-office function - are usually all about cost savings and are subject to fairly straightforward, tried-and-true evaluation metrics, Andriole says.

Of the metrics, and the projects themselves, he says, "IT people have gotten so much better over the past five years. The practice of the discipline has improved through use of business cases, the quantification of metrics, the use of benchmarking data and industry data."

While operational IT projects aim to save money, strategic ones try to make money, Andriole says. An example of the latter might be a project to integrate databases across business units to facilitate cross-selling. The cost of doing that could be relatively easy to estimate, but the benefits would be harder to quantify, he says.

At least the benefits of cross-selling are known qualitatively. But in some cases, the benefits from an IT investment may be dimly perceived or even unknown. For example, Andriole says, "how do you quantify the benefits of open-source vs. proprietary software, or the benefits of Web 2.0? Companies love Web 2.0, and they are deploying it like crazy. What impact is it having on collaboration or communication or business performance or customer service? No one knows."

The basics

Despite the difficulty of developing good estimates, four basic methods for comparing project costs and returns remain in vogue: return on investment , payback period , net present value (NPV) and internal rate of return (IRR). Many more have been developed, and some have briefly been in fashion, but these four metrics have endured for decades. Even so, experts warn, each of them can lure the unwary into pitfalls.

Ian Campbell, CEO of Nucleus Research Inc., is an advocate of keeping things simple. "The worst thing you could do is come up with the next trendy metric," he says. In fact, he maintains, companies really only need two measures, ROI and payback period.

But although he recommends the use of the simplest measures, Campbell does suggest tweaking them with "adjustment factors" to allow for real-world uncertainties. He advocates applying a "believability" discount factor to the estimates that go into investment return calculations -- in other words, reducing the estimated benefits to reflect their uncertainty.

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