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Issue of July 2002 
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REALISING ROI
The elusive ROI
Harsh Kumar

ROI is a straightforward concept which is widely known and used to estimate the gains in terms of profits or cost savings that accrue from a capital IT investment. When we use this term in the commercial world particularly in the context of IT, we often, though wrongly mean return from financial investment.

In almost all IT projects in addition to the financial investment, there is also investment in terms of time and efforts. Besides the financial returns, often we seek returns in terms of ease-of-use, time savings, speed, accuracy, and deeper analysis.

Hindustan Petroleum Corporation Limited

Industry: Oil and Natural Gas
Revenue: Rs 50,000 Crore
Employees: 12,000
IT Budget: NA
IT budget as percentage of revenue: NA

There are a myriad of mathematical models like NPV and IRR to calculate returns but they may not give you a true picture of ROI. In cases like ERP, SCM, and CRM projects ROI is an elusive element. IT Managers can supplement analytical studies with experience and gut feeling to sniff out a good project that can fetch good returns

Not quantifiable
Most of these costs and benefits are not quantifiable in financial terms. For these reasons, ROI in just financial terms (IRR, NPV, Payback Period, and Discounted Payback Period) does not do justice with IT projects and does not make much sense as single evaluation criterion.

Moreover, we must also remember that for calculating the financial ROI one has to make cash-flow projections into the future, which may be easy in industries where the degree of uncertainty is low, but is extremely difficult if not impossible in the IT industry where the degree of uncertainty is high. The boom and decline of dotcoms is a prime example of high uncertainty. Everyone understands that in IT it is very difficult to make future estimates and consequently it is hazardous (often fatal) to follow conventional analytical methods. Quite often we need to justify projects using means other than pure financial terms.

Evaluating IT projects
By highlighting the problems and difficulties with financial ROI methods and their inherent inadequacies I do not mean that evaluation of IT projects shouldn't be done at all. Evaluation is necessary to judge how often investment in an IT project meets our expectations. For evaluating IT projects we need to look at where and how much one should invest and what 'returns' to expect from that 'investment'.

While evaluating these projects some of the very important aspects to be kept in mind are changes in the decision process, changes in a manager’s concept of decision, and the situation and procedures that have to be implemented to make the project successful. All IT managers, even those who have not gone through the process of implementing an ERP project, are aware of these issues and consider them in their analysis.

Numerous methods
Other than financial techniques there are other methods that can be used to evaluate IT projects. They are Strategic Match Analysis, Value Chain Assessment, Relative Competitive Performance, Management Vision, User Attitude and Utility Assessment, Return on Management, Competitive Analysis, and Management Assessment of Systems Value.

The method you select to judge a project depends on number of factors like the project objectives, decision situation (certainty, risk, incomplete information, uncertainty, and conflict), strategy, structure, planning process, control systems of the organization, and other projects being considered or being implemented. Strategic Match Analysis, Management Vision, and Competitive Analysis are three of the most widely used non-financial techniques for evaluating IT projects.

Strategic Match
Strategic Match Analysis is the study of the extent to which technology investment is in line with the overall business and corporate strategy.

There are certain projects which do not necessarily provide monetary returns but if you don't implement them, you lose business and may even have to eventually wind up. In these cases the extent to which the project objective/benefits (including intangible ones) match the business strategy, offers justification of the project.

ROI isn't every thing
A financial ROI study may tell you about the monetary returns you are likely to receive, but may not highlight the criticality of the project. Any bank which says it will not install ATMs (Automated Teller Machines) because it may not earn money through it will surely lose business. In such cases a simple financial ROI study may not reflect that if ATMs are not installed, the bank will lose customers.

A prime real-life example would be the Indian Railways (I had worked with the Indian Railways earlier). The railways use a computerized reservation system. Since computerization, the number of reservation assistants/clerks employed has increased. Cost data indicates that after computerization the cost of printing a journey ticket is more that the cost of doing it manually. But I am sure that everyone will agree that the benefits computerization has produced are enormous compared to this direct increase in cost.

Earlier, with lesser staff there would be long queues of passengers who had to wait for several hours. Today, a person does not have to stand in queue for more than 30 minutes or so.

The amount of man-hours that the railways save every year is astronomical.

This huge benefit can't be calculated as financial ROI figures for the company. If the railways didn't computerize it would have lost revenue and deprived passengers of comfort. Such projects are often justified using Social Cost-Benefit Analysis.

Zero return
CFOs (Chief Finance Officers) sometimes are reluctant to pass the IT budget because they feel that the returns are not large enough

and don't come soon enough. During a pure financial project appraisal one has to understand and accept that any return which can't be put down in figures on a sheet is often judged as 'zero return'.

So the non-financial benefits are taken in to account in such analysis at zero value only. Such an analysis is obviously wrong and projects like the one above cannot be justified in this manner. We have to look at the methods discussed above to justify the projects.

Opportunities
Even though the economy is slow it should not be a deterrent to companies to look for opportunities in IT infrastructure. In a bid to protect finances one shouldn't sacrifice newer avenues to gain value. ROI, although necessary in some cases is not always the best way to evaluate an IT project.

Ultimately you have leave it to the sixth sense of the 'pilot and his team' (corporate leadership) to 'sniff' out good projects from the mass of the projects put up for approval. Often history alone decides whether the idea/project was 'novel' or a 'blind spot'.

We should analyze situations, examine technology and develop options; work on the options and prepare projects, evaluate these projects using more than one method discussed above. If the situation still remains unclear one can even go by sheer 'gut' feeling. But certainly do not just 'toss a coin' to take the final decision.

Harsh Kumar is Advisor - IT at Hindustan Petroleum Corporation Limited

 
     
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