The ROI on IT investments
Sidana, Consultant, PricewaterhouseCoopers, on how to measure the return
on investment in information technology.
Gone are the days when CFOs easily agreed to allocate a certain
percentage of their budget to IT investments. Nowadays, IT executives are required
to justify IT spending stronger than ever. Senior management needs to be convinced
thoroughly, and their crucial buy-in needs to be taken before proceeding with
an IT investment. This is where Return on Investment (ROI) analysis comes into
picture and plays a decisive role. Another area where ROI analysis can be used
is to analyse an investment after it has been made so as to gauge whether IT
rupees are being spent wisely or not.
What is ROI?
Traditionally, ROI is calculated by dividing net profits
(after taxes) by total assets. However, the above formula is not relevant in
the case of IT investments. When IT managers talk about ROI, they are essentially
seeking answers to the following questions:
- What do I get back for the money I am spending?
- How much time will it take before I start reaping the
benefits of the investment I am making?
- Are the benefits tangible and quantifiable?
In other words, ROI analysis evaluates the investment by
comparing the magnitude and timing of expected gains to the investment costs.
How do you measure ROI?
Conventionally, ROI used to measure only financial paybacks
(for example, increase in revenues or decrease in costs) of IT investments.
However, ROI methodologies have evolved with time and now include the non-financial
paybacks as well. These non-financial benefits (also known as intangibles)
include increase in customer satisfaction, increase in employee productivity,
and faster and more accurate availability of information. These new metrics
go beyond the traditional measures that focus on cost analysis and savings.
In fact, many IT professionals believe that these intangibles
are the most important ones although they are very difficult to quantify. The
problem in the case of non-financial measures is dual in nature: what to measure
and how to measure. And the problem is compounded by the fact that IT is inextricably
linked to all aspects of a business. One of the benefits of considering intangibles
is that it helps to connect IT with whats really important to top managementthe
achievement of strategic business goals.
Nowadays, IT executives are required
to justify IT spending stronger than ever. Senior management needs to
be convinced thoroughly, and their crucial buy-in needs to be taken before
proceeding with an IT investment
One of the pre-requisites of any ROI analysis is to understand
the context of the IT investment. This will involve listing the costs and benefits
in each of the following areas: technology infrastructure, business processes
Lets take the example of an ERP investment, the area
where IT executives most often have to justify expenditure. The infrastructure-associated
costs will be the costs of connectivity, hardware, software, etc, whereas the
benefits will be more efficient automation and access to information. The business
process-associated costs will be on things like training, whereas the benefits
will be in areas such as improvement in the efficiency of processes. From an
organisation perspective, the costs will be in terms of time of senior management
and the like, whereas the benefits will be increased integration between departments
and accurate MIS reporting.
The next step is deciding whether to quantify the business
benefits or to let them remain as they are. The answer lies in the nature of
the audience. If the audience is the concerned department staff, they will be
more interested in the performance measures, whereas if the audience consists
of the CEO and CFO, they will be more interested in the rupee impact. Whatever
is the case, the temptation to jump immediately to rupees should be resisted.
The next step is translating performance measures into rupees.
Let us take the example of a new software which is projected to result in an
employee productivity gain of 20 percent. If there are 10 employees there will
be a capacity gain of two employees. This will translate into an annual savings
of the compensation of two employees, excluding the money saved by not having
to hire and train the two new employees.
One of the factors which should
be kept in mind while doing ROI analysis is the timing of the benefits
which accrue from IT investments. For many IT projects, the resulting
value does not occur immediately but rather over a period of time
One of the factors which should be kept in mind while doing
ROI analysis is the timing of the benefits which accrue from IT investments.
For many IT projects, the resulting value does not occur immediately but rather
over a period of time. Some of the other factors include how many people will
be affected (either positively or negatively) by the investment, and how often
the new application/system will be used.
If, for some reason, the ROI turns out to be less than expected,
the following can be used to fix the same:
- Spread costs (like training) over a period of time
- Try to reduce the price by negotiations
- Go for a phased or a step-up approach, spreading your
investments over time.
- ROI metrics can be used to increase the recognition
and acceptability of IT as part of the business by measuring the tangible
and intangible benefits of IT investments.
- The ROI of IT is best articulated and delivered
in what is done with the technology. In other words, what it enables,
not the technology itself.
- ROI analysis ensures that the correct technology
projects are funded, and that the investments deliver the promised returns.
- IT executives should not use ROI as a tool simply
to get approvals from the top management. They should also use ROI analysis
to show the effectiveness of past IT investments.n A good ROI need not
be the only factor for giving a go-ahead for an IT project. There can
be several other aspects involved like governmental compliance, strategic
- At times it might make more sense to calculate
the ROI twice: once for the expected ROI and once for the worst-case
- A systematic approach should be followed towards
valuation of IT projects so that the credibility increases in front
of the senior management.
- Since ROI calculation is based on assumptions,
the assumptions should be given due consideration and be as realistic
- If an IT project is intended to provide a strategic
value, then cost and revenue ROI may take a backseat and soft ROI can
- IT executives need to track results carefully
to be sure the investment is paying off.
- IT managers should proactively communicate to
the stakeholders the value delivered by investing in IT projects.