Heads are often faced with one of the most important
and confusing question: How to calculate and justify
the ROI on IT investment? Planning the IT budget and
getting it cleared from the senior management just isn't
adequate anymore. Sooner or later the question of calculating
the ROI, either tangible or intangible arises.
Over the last decade, as user awareness has grown, the
need to invest in IT resources has increased significantly.
It's high-level of criticality in an enterprise and
the attached high base cost makes it necessary for the
IT Heads to properly calculate and justify ROI on IT
Industry: Banking & Finance
Revenue: Rs 134.14 Crore (Year ended 31st
IT Budget: Rs 21 Crore
IT budget as percentage of revenue: 15.65
Measurement of technology ROI in an organization
depends on the type of investment one has made
and should be looked at on a case-to-case basis.
There are some complex financial models that allows
you to calculate the ROI. However successful organizations
view IT as an asset and do not search for value
Before attaching a value on technology returns, one
needs to note some important aspects in order to get
a clear picture on ROI:
(a) ROI is best justified when the results are expressed
in monetary terms. The value may be a result of either
reduction in cost or increase in revenue.
(b) IT helps in the process of product development,
allowing the company to stay ahead of competition and
retain or gain market share.
(c) Deploying efficient IT systems adds to customer
(d) A well-designed IT infrastructure can adequately
meet the company's MIS and BI (Business Intelligence)
(e) IT systems can help a company leap-frog to new processes
and totally new business models.
The means to attach a particular value to returns on
IT also depends on the type of investments you have
Here are two examples to explain this: ROI of new feature-rich
software application can be assessed by the effectiveness
of marketing the service that has been enabled by the
technology. A hardware upgrade for meeting a transaction
volume growth can be measured by factoring the loss
of business opportunity if the upgrade was not carried
Assessing the ROI
The assessment of ROI should be made on a case-to-case
basis. Calculating the ROI on IT differs from industry-to-industry,
service-to-service. Let's discuss some instances.
UTI Bank has invested in WAN infrastructure for connecting
various branches to a centralized database. In this
case the results were measured in terms of impact on
business growth. The impact was immediate on two counts:
The cost of hardware and software license per branch
decreased by a factor of 45 percent.
The rate of expansion of the branch network doubled
in 12 months mainly due to the ease with which a branch
could be opened with a few desktops and network connectivity.
49 branches were added in nine months, a healthy growth
compared to 43 branches in the last two years.
UTI Bank has installed over 500 ATMs (Automated Teller
Machines) nationwide. There was IT expenditure on elements
like the ATM switch, software licenses, training, and
other network components. But the deployment opened
up an additional delivery channel for banking operations.
As a result we observed a significant migration of retail
transactions. 85 percent of cash withdrawal transactions
from the branch migrated to the ATM channel. The transaction
cost in ATMs is lower by around 60 percent. This percentage
value may be treated as a payback to the IT Department
and shown as cost recovery or profit earned by the IT
Here, although a direct ROI was not worked out, the
assessment of the values of the investments could be
made by recognizing the following:
(a) An increase in revenue from operations
(b) A steady business growth possible due to branch
expansion in a compressed timeframe
(c) Acquisition of new customers
(d) Fewer requirements for skilled IT manpower to manage
operations at each branch
The perplexing question still remains Is IT a profit
center? To answer the question, I prefer the following
(a) Treat core infrastructure expenditure as the cost
of doing business. The expenses associated with its
maintenance and support can be distributed across all
business units in proportion to the percentage of transaction
supported by the system.
(b) In case of specific projects, in order to meet requirements
of a business group that has to achieve a profit target,
the entire incremental investments, maintenance and
support costs may be allocated.
(c) All major technology-related expenditure which has
an impact on business processes that lead to increase
in efficiency (measured in terms of reduced turn-around
time or employee productivity) may be treated as a separate
class of investments. The recognition of benefit from
IT may be measured by an empirical approach, which is
acceptable to accountants and business groups.
This will enable a residual flow as returns on IT investments,
which can justify similar projects.
There are two main approaches to calculating ROI on
IT: The Simple approach and the Quantitative approach.
The Simple approach is based on classifying IT investments
into different categories, while the Quantitative approach
is based on complex financial models.
The Simple approach
A simple approach to calculate IT investments is to
classify them into different categories. (Refer to table
1 and table 2)
A & B
be absorbed as cost of being in business
C & D
the benefit & plough-back a share of benefit
accrued as return on IT investment
difficult to quantify. Quantitative impact
on strategic decision is long term
There are several quantitative approaches that lets
you calculate the ROI on IT. Here's an overview:
Method: Using an appropriate discount factor we
can arrive at the Net Present Value of the total cash
flow over the estimated period for which we expect returns.
This is represented by:
approach assumes that the predicted benefits will actually
occur. This uncertainty can also be factored by arriving
at three types of NPV-optimistic, probable, and pessimistic
assumptions. A risk-averse approach will imply that
we take the pessimistic projections. This approach does
not take into account the value of options. If an IT
head needs to satisfy more rigorous demands from the
CFO/CEO, he has no choice but to justify the expenditure
by emphasizing on the qualitative benefits and the overall
impact on business growth. He can also submit the total
estimated cost to the CFO/CEO and wait for a favorable
Option Pricing Model: Black and Scholes (1973) developed
a model to value options in finance. This method takes
into account aspects like the returns that would have
been possible if the investments were made in the stock
options, capital market, and the price fluctuations
in market value.
Cox & Rubinstein method: This method is also related
to the Options Pricing Model which takes into account
the current value of call, current value of underlying
asset, value of option at the end of the period if stock
prices rise or fall to an estimated level, and the present
cost of capital. These are essentially financial projections
for returns. Here, the management decides the acceptable
Dwelling into complex financial models, may be necessary
only if the total value of IT investments is proportionately
large for the organization and the risk of failure of
the project to generate returns is almost equivalent
to closure of business. To adopt these methods, one
would presume that the entire exercise or approach is
that of an accountant and not a visionary. I want to
emphasize on the fact that all investment models are
subject to uncertainties. The essential point to be
noted is that successful organizations view IT as an
asset. They do not search for value in IT, they create
V.K. Ramani is President, IT at