Debunking the ROI Myth

No company rushes to bring a product or service to market without having a clue as to whether it will get the desired return and justify the resources it invests in development. Are there no other decision criteria for project selection other than return on investment (ROI)? Most companies will answer in unison and resoundingly: "No!"

The emphasis on net profit has made companies in various industries cautious in evaluating project portfolios. The company focuses on initiatives that can deliver a strong return on investment. In fact, R, O, and I seem to be the only three letters in the alphabet for managers and clients—stakeholders who ultimately determine the fate of a project.

However, if return on investment is to be the single most important, or even single, measure of a project's viability, it must be clearly understood by all stakeholders, from managers to project managers. However, many companies have found that using ROI as the primary measure of project evaluation and selection can backfire. The value of a project is determined by many factors, most of which cannot be measured or even imagined by the return on investment alone.

The challenge facing nearly all companies today is to implement a set of processes and standards for ongoing and future projects that take into account all important value drivers. This of course includes the return on investment. But there are other relevant valid measures beyond this, including real-time collaboration between marketing and production of project outcomes (products or services), the level of visibility into the project across the enterprise, integrated cost management and forecasting tools, and Some form of project portfolio management that aligns projects with corporate strategy and goals.

Ann Tomalavage is president of Malarkey Consulting, where she helps clients develop and plan strategies and cost guidelines. Tomalavig believes that the measurement of a project's return on investment should take into account many factors, including the overall impact on the business. At the sectoral level, the return on investment can be good (or poor) for one sector, but the impact on other sectors can be diametrically opposite depending on the project output. The project review committee must also consider the consequences for the business of not implementing a project.

ROI, the "myth" of project evaluation

Some companies seek immediate returns and often do not pursue long-term investment projects with large budgets. But in the long run, the pursuit of a quick return on investment can be detrimental. "The tendency to approve only low-risk projects with acceptable returns on investment can undermine future goals," says John Baldwin. He is the managing partner of Fountai Group, a consulting firm specializing in project portfolio management.

Industry insiders believe that focusing only on ROI calculations and ignoring qualitative measures will lead companies to abandon investments that will bring significant returns in the future.

Balwyn used a project portfolio management program to categorize potential investment projects by return on investment. Each tier represents a group of investments that have a similar impact on the business. The first level is the project to manage the current business, the second level is the project to expand the current business, and the third level is the project to change the current business. "Management can set different ROIs for different tiers, while accepting the fact that tier 3 projects are more risky, for which the costs and benefits are in the short term," he explained. It can be difficult to quantify, so a pure return on investment cannot be calculated."

Ironically, strategically important projects are often projects with high uncertainty and long payback periods. They are often dwarfed by projects that are easily quantifiable and have clear returns. Unfortunately, if a project is only evaluated at face value, those projects will be rejected, and the company will suffer as a result.

Perhaps the greatest charm of ROI is its greatest "Myth": ROI is some real data, and therefore "objective" "of. But experts say, in fact, the way the return on investment is researched determines the outcome of the research. Even more subjective: Who conducts and publishes a particular ROI analysis often affects the final ROI results.

For example, project sponsors (sponsors) often "step in" to analyze ROI data to get a number they think management needs to see before approving a project. "Anything that brings material benefits drives individuals to manipulate numbers by any means necessary," said Carl Pritchard, president of the Pritchard Management Association. He also points out that a shrewd project advocate can give an acceptable return on investment at first glance, but after careful scrutiny, this data may lack sufficient validity.

In addition, senior executives may mandate the use of complex and unrealistic ROI measures in order to cancel or reject projects that may be valuable but do not help their careers, says Anton S. Steve Andriole said so.

"It is extremely dangerous to focus solely on the numerator and denominator factors (investment and return)," added Mr. Balwin. Management must also consider things beyond these ROI numbers, from data collection methods and sample size, to variables included or not. Otherwise they won't understand what ROI really means.

Combining other assessment tools

Reliable ROI measurement requires careful review of projected costs and benefits through comparative studies, taking into account all possible issues , whether it’s changing market conditions, corporate culture, or the cost of capital. These factors may support or refute ROI results, but they ensure greater precision.

In addition, project managers and stakeholders must never forget or underestimate the effectiveness of using common sense to support a deserving project or to refute a return on investment calculated through an incomplete or dishonest approach.

Finally, the post-completion review is the final judgement on whether the project's return on investment is correct, said Steve Devaux, president of Analytic Project Management, "It is extremely important to re-examine the project to assess its actual costs and benefits. "In addition to being able to identify lessons learned and areas for improvement, project reviews reflect the accuracy of project forecasts, paving the way for better ROI forecasting in the future.

Too much focus on return on investment can affect project managers' behavior and company management's decisions, often negatively, some project leaders have pointed out. During the execution of a project, project team members are often forced to use various methods to improve the return on investment, or to take the job voluntarily. Without a clear understanding of the relationship between the project and the company's goals, what they do can often have negative consequences.

For example, a project team may cut corners to reduce material and labor costs or reduce implementation time. Mr Pritchard, however, believes that these measures could instead increase project risk. Even if these decisions are correct, they cannot be implemented without analyzing their impact on project risk and project value.

"Senior management must clearly explain the value drivers for the project," Mr. DeVox said, "and then the project manager communicates this information to project team members, who must ensure that the value drivers are met. Requirements."

Industry people believe that if the return on investment is only understood by the project manager, but the project team members are not clearly explained how the data is related to the enterprise as a whole, the project may actually be due to Project team members lose value by missing or ignoring opportunities to improve quality.

Just as a business must consider many factors when selecting a project, the question of value must be revisited and assessed during project execution, DeVox said: "These factors should guide the decision as the project is actually going. The value factor considered during the project is ignored by the project team, and the value of the project is likely to disappear."

A project management that completely ignores the return on investment is likely to affect team morale, productivity and creativity, all of which It is the human factor that directly affects the value of the project. "The return on investment is very powerful when used consistently in combination with other optimization and screening tools," Pritchard said, "but when used alone, decisions can be problematic. It has to be combined with other criteria, The total cost and total benefit of the project can be clearly measured for the enterprise."

Five Principles of Project Evaluation

Any project selection process should include a series of evaluation criteria, such as alignment with strategic objectives, resources constraints, etc. But for most top managers, for better or worse, the overriding metric is always return on investment.

However, even the best-intentioned analysis can yield inaccurate ROI figures, leading to poor decisions. Underestimating costs will lead companies to choose market conditions that they should not enter, while exaggerating benefits will lead companies to pursue impossible profits.

Numerous psychological and technical factors can contribute to inaccurate ROI data. But due to imperfect and non-standard procedures, most efforts to analyze the return on investment are inevitably in vain. The following five principles will help improve your ROI goals.

One estimate is not enough. At the beginning of a project, an estimate is not enough. It is very difficult to estimate the project in the early stage, it can only be said to be an unfounded guess. Project cost estimates must be analyzed from multiple perspectives, and it's like lighting a beacon that allows you to get a more meaningful estimate with intuitive insight. At least three estimates should be prepared: one based on general measures compared to projects of similar size completed under similar circumstances; one based on estimates applied to a smaller measurable portion of the project (e.g. Function Points, which is a method of project estimation), estimates derived from more granular measures; one using work plans for comparable, successfully completed projects, based on Bottom-up, activity-based estimates resulting from a detailed job refinement structure.

Takes the entire project into account. The scope of the ROI should cover all costs, even those beyond the project life cycle. Many ROI estimates are simply calculations of how much it would cost to provide a product or asset. But after determining R&D costs, testing costs, and implementation costs, you should also consider other factors such as all maintenance costs over the life of the asset.

Timing is everything. The timing of project spending has a large impact on the return on investment. During the budget period, especially the review period, how project expenditures are allocated may determine the success or failure of the project from its inception. In order to allocate funds properly, a well-resourced, phased project plan needs to be developed.

Consider external factors. Evaluate the impact of external factors. For example, in a software project, advances in source code development languages and methods, technologies, and environments can have a large impact on assumptions about productivity. Other external factors to consider when calculating ROI include geographic location and available resources. Is the project team distributed in various places? Are people with specific skills still available at hypothetical prices during periods of high or low unemployment?

Borrow off-the-shelf assessment tools. ROI analysis may be a relatively new science in the field of projects, but the tools needed to make sound economic assessments already exist. There are many methods of risk measurement, technology assessment in other business areas. These proven methods are a combination of economics, actuarial science, decision theory and portfolio theory, and can often be used to evaluate complex projects.

Originally adapted from The Numbers Game by George Spafford and Aaron Smith at projects@work (http://www.projectsatwork.com, May 15, 2003) with permission. Copyright 2003 by projects@work. Translated by Shao Qingli.