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Issue of July 2002 
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REALISING ROI
A mixed bag of returns
Neeraj B. Bhai

Corporate executives are constantly evaluating the cost versus benefit of different business decisions. Understanding and quantifying each option's costs and benefits is necessary to make an informed decision. When assessing projects, the most commonly accepted financial measure is the calculation of the ROI.

Measuring ROI on technology investments has always been a favorite activity among organizations. Lot of effort is taken in trying to quantify the returns in terms of revenue growth and cost reduction resulting from investments in technology. But it's not possible to calculate the ROI on IT investment very precisely because at times businesses are not able to define quantitatively, the importance of high availability, redundancy, and reliability of technology infrastructure. Many CFOs find the loose relation between technology investments and returns very discomforting.

IDBI Bank Limited

Industry: Banking & Finance
Revenue: Rs 509.31 Crore (Interest earned in 2001)
Employees: 1,208
IT Budget: Rs 20.71 Crore
IT budget as percentage of revenue: 4.07 percent

Although the process of calculating ROI on technology investment is important, it depends on a mixed bag of situations and conditions. But it's not possible to calculate the ROI very precisely because quantitative benefits don't figure very well on paper

It's certainly very pertinent to calculate ROI in the financial industry. Costs have to be controlled and at the same time investments need to be made where the 'bang for the buck' is maximum. There are always areas where the ROI may not be very high but other non-quantifiable factors may exist which may tilt the choice in favor of those investments.

In the area of IT, working out a precise ROI can be a tricky affair. This is mostly because the returns may not always be immediate. The situation becomes even more complex because the distinction between technology and business is fast disappearing. And let us not forget that many technology investments fail to deliver expected returns not because of technology failures but because of poor process design and inadequate user training.

A MIXED BAG
There is no fixed set of tools that one can use when it comes to justifying IT investment. This statement can be better understood by looking at the following examples which represent a variety of technology investment scenarios where the investments are justified:

  • A new set of equipment has been procured and has replaced the old. The new equipment may have been purchased at a high cost and has an expensive AMC (Annual Maintenance Contract). This results in lower running expenses and the new investment pays for itself in a given timeframe.
  • A company has invested in IP Phones and has set up a dedicated VoIP network across its offices. This investment allows the company to save costs by using in-house spare bandwidth capacities instead of using the services of external entities.
  • A company makes investments which aim to exploit new technologies to give itself a first-mover advantage. In this case, quantifiable returns may not be possible, but the clear benefit is that the company is able to enjoy a marketing and publicity edge over its competitors.
  • Most banks have stepped up on efforts to increase its ATM network. Although this needs a rather large investment, the cost is justified when you look at competition. Other banks will offer a larger network and if one bank doesn't do the same, it loses business. In this case the investment is justified due to competitive pressure.
  • A company invests finances to set up a helpdesk infrastructure. This kind of IT investment brings about qualitative improvements in the services being offered by the IT department to its customers (various users in the organization). These improvements are very difficult to quantify in monetary terms.
  • The IT department recommends an investment of a certain amount that promises to increase the efficiency and performance of the network from X to Y percent. In this case, the increase in network uptime is very clearly understood and defined but often the business will not be able to put a quantitative benefit that arises out of this increased uptime.
  • A company considers investing in a new CRM application. Typically, the expected benefits from such investments are framed in terms of improved customer satisfaction leading to increased retention and/or use of a company's products and services, and an improved ability to target customer needs. However, the implementation of a new system is only one element. Having perfect customer information without adequately trained customer service representatives to interpret and act upon that information or having the insights derived from one's CRM system but not providing these insights to one's sales force or product development organization prevents ROI from getting maximized.

It is evident from the above situations that it is not always possible to work out ROI on IT investment in a precise form. One measure of appropriateness of technology investment may come from a comparative study that looks at what other companies of similar size have achieved with their IT investment. But such data may not always be available and will invariably be outdated even if available.

The practice of calculating
By calculating and observing ROTI (Return on Technology Investment) over a period of a few years, one can aim to achieve a better level of IT investment management. And it also helps the IT Department achieve a certain level of transparency that may lead the top management in placing more faith in it.

Unfortunately, the practice of calculating ROTI was not followed as a serious discipline in most organizations until very recently. It is only over the last couple of years or so, that business units in Indian organizations have started demanding justification for investment in technology. This has forced technology departments to be more transparent in the way they make their decisions.

Today, technology departments are required to justify their investments and as far as possible account for the tangible benefits that can be derived out of that investment. At the same time, the CEOs and Business Heads are much more tech-savvy than in the past.

They also have much better appreciation of technology processes than before.

Steps for ROTI
IT investment in a company can take place in various forms and situations. Some of these situations have been discussed earlier in this article. The benefits in some of the situations are obvious and easily measurable, and in some, very difficult to ascertain. It is the responsibility of the IT Heads to examine wherever possible, whether companies can use any appropriate metrics to calculate ROTI.

Such an exercise will invariably require interaction with business units to translate specific benefits into quantifiable measures. Many consulting firms have evolved relevant templates that can help companies measure ROTI in key areas of IT spend. Using such templates as a basis to calculate ROTI, a company can find an appropriate solution metric for itself.

WHOSE BABY IS IT?
Very often the responsibility of ROTI calculation is left to technology departments alone. Calculation of ROTI should be a joint responsibility of the finance department, technology department, and related business units. Also, at times there is a tendency to achieve perfection which, should be avoided. It is best to follow the 80:20 principle so that key technology investment benefits are captured much earlier, before a precise model can emerge.

EASIER CALCULATION
Calculation of ROTI becomes easier if:

  • Technology, business units, and finance units work cohesively on the activity.
  • One makes an attempt to derive benefit from similar work done in other organizations.
  • In case, in-house expertise is not available, it makes sense to engage services of a consulting organization and incorporate best practices from them.

Not all areas of technology investment are amenable to ROTI computation. Investment in R&D, new technologies, and improvement in service levels are generally the areas where precise calculation of ROTI is not possible. While looking at return on technology investment one should keep these facts in mind and set the expectations appropriately. There is a need to approach ROI in a holistic fashion, incorporating people, processes, and technology and then attempting quantification of returns pertaining to the utility of products and services one offers. So, total expected returns may be a better option to look at than just the ROTI.

Neeraj B. Bhai is CTO at IDBI Bank

 
     
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