Archives ||  About Us ||  Advertise ||  Feedback ||  Subscribe-
-
Issue of June 2003 
-
[an error occurred while processing this directive]
  -  
 
 Home > IS2003
 Print Friendly Page ||  Email this story

ROI
The ever-elusive ROI

CIOs pay more attention to the intangibles when measuring the success of a particular IT initiative. But is this the right approach?

CIOs are faced with the perennial question: How do you measure the success of an IT investment? Should the benefits be measured in pure financial terms? Or do companies need to look at the intangibles as well?

In our July 2002 issue of Network Magazine ("Realizing ROI on IT"), we had asked prominent CIOs from different industry verticals, how do they justify or measure success of an IT investment. And we ended up with a very mixed bag. Some believed that calculating the ROI on IT investment is futile, since technology has crossed the line from being just an enabling tool and is very much interwoven with business processes. Others were of the opinion that given the sluggish business environment it was absolutely necessary to justify every penny that was put into IT. Then there were the moderates who felt that one needs to look at both—financial metrics as well as intangibles—when calculating the ROI.

Click on image for larger view

What's the real scenario?
We asked 300 CIOs if they considered non-financial parameters important when evaluating the success of a particular technology. Almost 62 percent CIOs say that one needs to look at non-financial parameters. The reasoning: Financial measurement metrics may not be able to provide the complete picture.

So what parameters do CIOs consider important to measure the success of their company's IT investment?
Almost 45 percent of the CIOs believe that 'Customer satisfaction/Value' plays a key role in measuring the success of an IT investment. This is an important development, since companies are clearly focused on improving customer service. The interesting part is that CIOs are trying to map success of an IT initiative directly to 'Custo-mer satisfaction/ Value' gained. Here the customers are both internal (emp-loyees, suppliers, distributors) as well as external. Busi-nesses are trying to create a harmonious environment wherein the emp-loyees, suppliers, distributors, and the end-customer can benefit by usage of IT.

This is followed by Reduced cost, Project is completed on time, and Increase revenue/profits. Cost reduction—one of the main reasons why companies invest in IT—comes second only to customer service. Companies, given their customer-centric approach, are focused on retaining existing customers and acquiring new ones. The logic: a satisfied customer will automatically translate into increased revenues/profits.

CIOs think that parameters like 'ROI,' 'TCO,' or 'Reduced headcount' play a considerably lesser role in determining the success of an IT investment.

Who all are involved in measuring the IT performance? 60 percent of the CIOs said functional heads play an important part when measuring IT performance. This is followed by the CEO (57 percent). Interestingly, the CIO—one who is responsible for implementation—does not play a significant role in measuring IT success.

Determining ROI
As per the survey, Internal Rate of Return (IRR), Net Present Value (NPV), and Economic Value Added (EVA) are the most common methods used for determining the ROI. Of these, IRR is the most prevalent—nearly 26 percent CIOs apply this method.

Calculating the ROI for an ERP implementation may involve juggling with multiple variables; one has to consider the cost savings in terms of reduced inventory, faster production processes, or better inter-departmental communication. On the other hand, ROI on an enterprise-wide VoIP application would be as simple as calculating the cost savings by making voice calls over the existing data network instead of the telecom network.

32 percent of the CIOs do not employ any financial technique to determine the ROI. These CIOs rely entirely on the intangible benefits gained from an IT implementation instead of calculating it in pure money terms.

Of these, nearly 36 percent feel the right time frame for accessing the ROI is six months after implementation.

The right approach
The survey clearly points to the fact that most CIOs focus more on the intangibles than the money returns when it comes to measuring the success of a technology implementation. The question is: Is this the right approach?

Given that IT is firmly woven with various business processes, it's understandable that one needs to consider the issue of not being in business, or being unable to compete in the market if basic IT infrastructure/automation is not in place. But one needs to look at the financial part as well.

A certain level of financial discipline will help an organization manage its existing IT infrastructure better. ROI calculation will bring about this discipline.

The right approach would be to give equal importance to both: ROI techniques as well as the intangible benefits when measuring the success of an IT investment.

Research Snapshots
  • 62 percent CIOs believe one needs to consider non-financial parameters when evaluating the success of an IT investment.
  • The top three parameters for measuring the success of an IT implementation are 'Customer satisfaction/Value' (45 percent), 'Reduced cost' (39 percent), and 'Project is completed on time' (37 percent).
  • Parameters like 'ROI', 'TCO', or 'Reduced headcount' play a considerably lesser role in determining the success of an IT investment.
  • Functional heads play an important role in measuring IT success.
  • Internal Rate of Return (IRR) is the most prevalent method used for calculating ROI.
  • 32 percent of CIOs do not employ any financial metrics to determine ROI.
“It’s not always feasible to calculate ROI”

Ajit Inamdar, Vice President, Finance & Accounts, Garware Polyester Ltd., is of the opinion that since IT provides both tangible and intangible benefits, it may not always be feasible to calculate ROI on IT investment

Given that IT is a vital business enabler, is it necessary to calculate ROI on technology investments in the first place?
It is not always necessary to calculate ROI on technology investments. This is because investments in IT provide a number of benefits, which are both tangible and intangible. And it also provides a valuable capability to a company of carrying out change management. In such a case it's not possible to look for ROI on technology investments.

Besides, companies will lose business and market share if they don't use technology, due to lack of relevant information.

In a CFO's eyes, how does IT help in change management?
Here's a typical example of large companies in India before the days of computerization. The companies were running rather successfully at that time. Soon, the economy opened up, and competition suddenly sprung up from other national and international companies.

Standing at the threshold of this new economy, Indian companies had to concentrate on aspects like quality of products, accessibility, time to market, and service to customers. They also had to introduce systematic processes and transparency of operations. But these issues were never addressed by the companies before.

So the companies knew they had to change, but were worried about how they could change the traditional flow of operations and management, that had existed in their organizations for years.

The solution was IT. The companies had to deploy robust LANs, WANs, enterprise application packages that automated systems and organized data transactions, and round-the-clock management of operations to stay in competition. So, every time a company uses a hardware or software product, it is actually introducing a change.

A change for the better. Against this background of Business Processes Reengineering (BPR) and change management, how do you measure ROI? The user company is making a vital transition to a more informed state for immediate and future benefits.

But traditionally, doesn't the CFO understand only figures?
First let's change the definition of a CFO. A CFO is a business integrator. He's not only a financial officer. As a business integrator he has to set up a bridge between the past and future—old technology and the new. He has to bridge management vision and the realities of a business.

If a CIO promises 35 percent ROI, a CFO can insist on 50 percent. If the CIO promises 50 percent, the CFO may insist on 100 percent (return within one year). The CFO doesn't really have a benchmark to judge ROI, so there's no point in putting a few mundane figures on a sheet.

Is it possible to quantify payback?
A traditional model for quantifying payback says you must look for results like reduction of inventory, savings in manpower, and reduction of delivery time. But a CFO doesn't factor in all this.

This is because the store manager has to bring down inventory by 15-20 percent every year anyway. It's a part of his duty to continuously bring down the inventory level. The HR and Logistics teams should also perform their duties with a natural eye on efficiency.

The CFO may look at other benefits like better cash flow and faster documentation. Better cash flow can happen because the CFO can check the status of outstanding debtors (companies that owe money) at the press of a key. Faster documentation is necessary when the company has applied for export benefits and the necessary documents like the balance sheets, sales history, and other records need to be extracted in a hurry.

If the CFO checks for ROI, how does he/she know that the IT deployment project has failed?
The failure of an IT project like ERP, CRM, and SCM will automatically be reflected in the Profit and Loss (P&L) account. There should be a notable change in figures.

For example, material consumption in a company is 40 percent of the sales price. By natural improvement it may go down to 38 percent or even 37 percent. But after deployment of IT, if the figure goes up to 50 percent, it means that the use of technology has failed. But if it goes down to 30 percent, the technology has succeeded.

“Core IT investment need not be checked for ROI”

Sudhin Goswami, Senior Vice President, Finance & Accounts, UTI Bank opines that core IT investments need not be scrutinized for ROI. However, for non-core IT projects, ROI needs to be calculated

IT is considered a vital business enabler in banking. Is it necessary to calculate ROI on technology investments in the first place?
If an investment in any area in an organization will help satisfy the business needs and objectives, the investment will not be questioned. It is not always necessary to calculate ROI on that investment. So if an IT investment aims to fulfill business strategies, there is no need to look for ROI in the IT investment.

In an organization like a bank, certain resources are absolutely necessary. When a new person joins the team, a desktop workstation has to be provided for him/her. In a bank, there are Government regulatory requirements, that state the minimum amount of required infrastructure like backup, storage, and applications, that the company must have. Calculation of ROI for this is unnecessary.

Other than these core investments, there may be support projects. In these cases, an organization may need to calculate the ROI. The company may have to put numbers to the expected benefits, and look at payback periods.

What if IT infrastructure expenditure is very high in some organizations?
Organizations where IT expenditure is high can select a group of people to form a steering committee. The members may be business heads of different departments, and will include the CIO and the CFO. The group will take an overall organization perspective, and not just a CFO's or CIO's point of view.

The IT solutions and its benefits may be discussed, and aspects like scalability to handle future growth are mapped. The CIO will have a paramount view of the technology, and the committee will discuss the business implications of the solution. This will help make the decision.

Is there a standard model with which ROI on technology-related expenses can be calculated?
There are standard models available like NPV. These models will need the organization to look at aspects like expenditure, cost of acquisition, income, and discount the cost of capital.

But in India, most companies are at a stage where almost all large IT projects are core to the company. The companies need to use IT to perform better. So most IT investments now have a lot of practical value.

So you don't favor calculation of ROI on core projects?
If the IT solution is well aligned with business needs and automates the core business tasks of the company, there's no need to look for ROI. Investments, without which the business will keep running, may need to be evaluated.

For example, investment in storage components may be debatable, whether the company needs it now or later. But a simple discussion with the CIO regarding its benefits can clear the matter.

However the cash flow of the company is important. The CFO needs to see whether the investment is calibrated with the cash flow situation of the company. A cash squeeze situation can be an inhibiting factor, especially since cash flow is measured in hard numbers.

How will the CFO evaluate the success of an IT investment?
An experienced CFO will use a set of financial indicators and track the figures on the various reports like balance sheets and P&L accounts. The CFO can identify the problems and ask the CIO about the recommended action to be taken.

The CFO and CIO need to work in close coordination. None should work in an ivory tower.

 
     
- <Back to Top>-  

© Copyright 2001: Indian Express Newspapers (Bombay) Limited (Mumbai, India). All rights reserved throughout the world.
This entire site is compiled in Mumbai by the Business Publications Division (BPD) of the Indian Express Newspapers (Bombay) Limited. Site managed by BPD.