Return on investment in technology

Due to the harsh competitive realities, there is a question that is being asked over and over in businesses these days: "Why are we spending this money on IT?" Answer that question correctly and you can Invest to drive improved performance. Without a convincing answer to this question, you're stuck with the status quo.

The technical procurement proposal determines whether senior management approves or "shoots" your project. The skills you need to have when deciding whether a project is worth investing in aren't just financial. Finance people are mostly good at discounted cash flow analysis and calculating internal rate of return (IRR), but it's not these details that senior management should focus on when making decisions. What decision makers need to know is whether a software acquisition is feasible—what returns the new software can bring. No matter how sound your analytical arguments are, policymakers need to see data that makes a point and hear a persuasive argument.

Unfortunately, there is no one-size-fits-all decision model when it comes to deciding whether to invest in information technology. For example, spending a month writing a serious business plan in order to decide whether or not to buy a $200 external Zip drive is not worth the effort. The value of the work time spent on this far outweighs the value of the product purchased; simply making the case that "fast backup of files is guaranteed" is enough. Conversely, if you want your company to invest a lot of money in a budgeting and planning app, you have to make a stronger case.

The amount of time and effort needed to demonstrate a project's return on investment (ROI) depends entirely on the situation. You can use a three-level forecasting model to analyze the benefits of choosing an application. You can decide what level of analysis to go to according to your situation, and then choose the appropriate model to analyze the project.

Before we start discussing these ROI analysis models, a word of caution: In some cases, intuition alone is sufficient -- like the example of buying a $200 Zip drive. Over time, people accumulate an invaluable set of experiences that alone can lead to effective decisions. When decision makers are broadly agreed and eager to try what is at stake, knowledge and intuition alone can lead to judgments. Either way, don't underestimate the role data plays in decision-making. Data on cost savings is particularly important in purchasing decisions, so our first analytical model is concerned with that.

Level 1: Cost Analysis Models

When one tries to predict the ROI of a proposed solution, it is most common to focus on calculating the cost savings. Not surprisingly, cost savings is often the most obvious and practical reason to make a business investment.

However, many purchasing recommendations are unconvincing because the underlying assumptions of many purchasing recommendations are not based on data and are not illustrated by data. Do a quick cost calculation on the back of the envelope and wishful thinking about the savings. what's the result? Without the support of top management, the project was not approved. Still, there are ways to show that cost savings are real. In a cost-saving ROI model, the only real reason to make a new investment is that it will cut costs.

How can the new investment save costs and what are your assumptions based on? These two questions are key to cost analysis models and represent two areas that senior executives often grapple with when reviewing investment proposals. The most important and valuable tool in cost-saving investment advice is reliable benchmarking data. After all, it's one thing to know how much your business is spending on a process, and it's another to know how much your business is investing more or less compared to other companies, especially those in your industry.

A common mistake when using benchmarking data is the lack of comparability between the two objects being compared, and such loopholes are quickly discovered when someone else reviews your report. For example, if you estimate how much your company is investing in the planning/budgeting process, and then compare that data to benchmark data, how can you be sure that the reference company is calculating costs the same way as yours? Likewise, how do you know that all the companies being targeted are calculating their costs the same way? One company may only consider the number of finance personnel involved in the planning/budgeting process when costing the planning/budgeting process, while another company may include the number of hours spent by non-finance managers in setting departmental budgets, or Include the number of hours spent by senior executives reviewing the budget plan.

To solve this problem, you must ensure that all companies being compared, including this company, calculate costs the same way. This doesn't have to be a problem. The Buttonwood Group surveyed 225 companies on how much they spent on planning. Respondents completed a questionnaire on the Internet, which contained a series of questions that could be used to estimate the cost of the company being interviewed. Because all respondents answered the same questions, the cost estimates from the survey companies were highly comparable. Now, if a company wants to compare its costs to the mean of all reference objects, it just has to answer the questionnaire and come up with its own costs, and the comparison is accurate.

Armed with carefully collected cost data and reference data, project leaders can begin the next important step: setting cost reduction goals. Is a 10% reduction in cost considered high, and a 40% reduction in cost considered low? With reliable benchmarking data, you can set goals more easily. If a company's costs are higher than the national average for the industry, then a reasonable goal is to bring costs down to the average. If your company's costs are below average, you can aim to reach the level of the top 25% of companies in your industry, or even the top 10% of companies. Goal setting, of course, requires some professional judgment and experience, as well as listening to senior executives.

If benchmarking data is not available, another way to set improvement goals is to determine the cost per user of the system to be purchased, and then calculate how much business capacity must increase at least to offset the cost. Proper research, including comparison with reference data, can help you assess whether the business capability improvement goals you have set are feasible. Once you've identified your goals, you can easily calculate possible cost savings. For example, according to the Buttonwood Group of Companies, the average company costs $1,000 per employee to develop an annual plan. If your company's cost per employee for the job is $1,200, then a reasonable goal is to reduce the cost per employee by $200.

When demonstrating the return on investment of a cost-saving procurement program, it is critical to understand the company's current costs, understand the benchmarking costs against which How far to improve, and set cost savings targets based on that.

Target cost savings = current cost - benchmark cost

Some management teams don't even look at a procurement proposal unless the cost savings exceeds the cost of implementing the project. Such harsh conditions of course kill some projects that do deliver value to shareholders (such as customer profitability analysis programs), but it is also a reality that many finance teams have to face. If you work for such a company, you have no choice but to use a cost analysis model to construct the strongest investment recommendation. Even in more open companies, sometimes the only predictable benefit of a procurement program is cost reduction, and the cost-saving ROI calculation method applies.

Often, your case is more convincing when you can demonstrate that the benefits of the investment go beyond cost savings. Understandably, the first thing most management teams want to hear is how much the investment will save. But if you mistake this cost-saving concern for the management team's lack of interest in the other benefits that the investment can bring, you'd be wrong. For example, when a CEO hears about a technology that will allow her to understand weekly profitability data in various markets, and grasp the details down to the store level, her attitude towards the project changes immediately. This example gives us a simple and useful inspiration: spend more time fleshing out the investment proposal, in addition to cost savings, should also detail other benefits that the investment can bring.

Level 2: Cost-Benefit Models

Cost-benefit analysis models go further than pure cost analysis models. Instead of focusing solely on costs, it gives investors the opportunity to see all the benefits a business can get. In order for an investment proposal to be approved, the cost-benefit model conducts a comprehensive analysis of various factors. Many finance professionals are unfamiliar with this approach, but research into the benefits of the technology to be procured may reveal the most compelling evidence.

Quantifying the benefits of a technology investment is often difficult, but there are some tools that can help. One of the most effective tools is "gap analysis". In short, the method enables a business to determine, based on an internal survey, where the organization is currently and compare it to where it wants to be, with the gap being an opportunity for business improvement.

A gap analysis begins with identifying the performance standards that apply to the process or area being assessed. The next step is to decide which people in the company should be investigated. Try to include people from all aspects of the company into the survey to make the survey more comprehensive. Carrying out a survey can be a very simple task, as long as you send out the Excel file and then organize the results of the survey, but the anonymity of the survey must be guaranteed - only in this way can the respondents answer the questions candidly, you can ask A third party assists with the investigation and collates the results.

Performance gap analysis becomes more persuasive if the project manager can include benchmarking data—perhaps even data from other companies in the same industry—in the gap analysis. Consultancy firms that do extensive benchmarking in the planning, budgeting and performance management areas can provide this information.

There are two ways to estimate the benefits of closing the gap. The first approach is to close each gap exposed in the survey and quantify the benefits of closing each gap. Managers can strive for improving the planning process, helping managers make better decisions, improving goal alignment, and increasing transparency. However, it is nearly impossible to quantify these benefits individually.

Another approach is to fill the gaps and estimate the combined benefits. For example, according to benchmarking data collected by the Buttonwood Group, the combined benefits of improving the planning process by improving the decision-making process, promoting alignment of goals and increasing transparency can increase a company's sales revenue by at least one percentage point.

In a cost-benefit analysis approach, calculating ROI means that you add up the cost savings and other quantifiable benefits and divide by the cost of implementing the project. Usually you have other minutiae factors to consider, but that's it for the basic calculations.

ROI = (cost savings benefits + other quantifiable benefits) / project implementation costs

How do I know if a second level ROI analysis is appropriate? Expanding the ROI analysis to include the benefits of the solution has proven to be an effective approach when the savings are not sufficient to offset the cost of the proposed solution. Finally, if solutions are expected to deliver substantial and significant benefits, including them in your investment advice report will only make it more convincing.

Level 3: Business Case Modeling

A business case is by far the most comprehensive and convincing method for evaluating a project's return on investment, but it also requires the most time. Therefore, you must decide in advance whether you want to prepare a business case for the project. Waiting until the last minute to piece together a business plan is tantamount to hiring a designer to design the house’s blueprint when the house is nearly built.

The process of developing a business case can help you identify why change is necessary and what value it can provide to the organization. Nothing is more powerful and persuasive than a rational business plan when it comes to making an ROI argument. The larger the scale of the project, the more important the business plan becomes.

A business case is a written document in a presentation format (such as PowerPoint) that contains some standard content: a description of the current state of the process, the size of the project, the expected business outcomes, how those outcomes can be achieved, and an analysis of the return on investment . The difference between this approach and the benefit-over-cost ROI model is that the former is more comprehensive, taking into account the needs of all sectors.

To illustrate this approach, let's look at how a financial manager developed a business case for upgrading his company's planning process. He starts with the current state of the business and describes the current planning process without any improvement. Some people cut corners in doing this work and just express their own opinions (rather than objective situations). This is wrong and financial managers should take this opportunity to communicate with senior executives and end users. One way to get a lot of feedback is to conduct a short survey of users. For ease of comparison, it's best to use a standard-format questionnaire that matches existing benchmarking data, so you can see how your business is performing overall compared to others.

From this, you can see which parts of the planning process employees and supervisors love and hate. In our example, the project manager found that the consensus was that the planning process was too long, decision-making dragged, and that the planning process didn't always lead to good decisions. Finance people spend a lot of time processing data, but what they should do (and want to do) is provide decision support. Making annual plans and making monthly forecasts takes too much time for finance staff to react quickly to changes in an important parameter such as price. Finally, the current planning process does not tie the entire enterprise together, and the goals of individual departments compete with each other. Financial managers summarize these findings as the first part of a business plan.

Next, the finance manager sets out to determine the scope of the remediation effort. All significant areas of deficiencies identified by managers during the interview process, as well as all areas with significant performance gaps identified by comparison with benchmark data, should be included in the scope of rectification. In the example above, the remediation extends to reporting to management, slightly beyond the strict planning and budgeting process. After all, what's the use of making a plan if you can't track the execution of the plan?

When preparing a business case, the next step is probably the most important: What do we hope to achieve by implementing this project? To answer this question, a financial manager need only review his findings from executive interviews and company questionnaires. He decided that the goals of corrective measures should be to shorten the decision-making process, improve the quality of decision-making, strengthen the role of the financial department in decision support, shorten the time required for planning and forecasting work, enable enterprises to quickly revise forecasts, and enable enterprises to The goals of each department are aligned.

How valuable are all these improvements? While efficient, high-quality decision-making and the ability to quickly revise forecasts as determinants change are desirable goals, their value to the business is difficult to quantify, at least precisely. In this example, the project team decided to look at these benefits as a group, and because the project improved decision support, they estimated that the improvements as a whole would increase the company's sales by 1 percentage point. If the company's annual sales are $100 million, they expect the project to add $1 million to the company's annual revenue ($5 million over five years).

Going back to the benchmarking analysis the project team did earlier, they also set a goal of reducing the cost of developing an annual plan from $1,500 per capita to $1,000 per capita. Since the company has 800 employees, improvements to the planning process will save the company $2 million over five years.

Achieving these results requires a series of process changes and investment in new technology. Companies need to hire outside experts to design and implement process transformations, but most of the cost will be spent on purchasing software. When calculating the ROI, the consulting team adds up the expected benefits of the project, subtracts the cost, and divides the result by the cost. In this simple example, the projected profitability of the project by the business case is impressive: the projected total project benefit over five years is $7 million ($2 million plus $5 million), and the total project cost of ownership (TCO) over the same period --- Including the maintenance costs of the system during this period - an estimated $4 million, the project leader expects a 75% ROI for the project ($7 million minus $4 million is $3 million, divided by $4 million equals 75% ).

ROI = (Cost Savings Benefit + Revenue Growth Benefit - Total Cost of Ownership) / Total Cost of Ownership

In most cases, if the project ultimately requires senior executive approval, a business must be prepared for the project Program. This method is also suitable for projects that are under suspicion or in dispute. In fact, since demonstrating the return on investment in a business case is about gaining support from senior executives and across the enterprise, it is worth considering this approach if the project requires broad support.

What can we learn from the above three methods? Plan ahead and carefully choose the ROI argumentation model that fits the current situation. In most cases, an all-encompassing business solution will undoubtedly be the first choice, but don't assume it's a panacea, other approaches have their place.

Originally reprinted with permission from Lawrence Serven, Passing the ROI Test: A Three-Tiered Model For Obtaining Project Funding, Business Performance Management Magazine 2003/06. Copyright 2003 by Penton Media, Inc. Translated by Gong Hao.

Lawrence Serven is the Principal Partner of The Buttonwood Group LLP. The Buttonwood Group LLP is a consulting firm that designs and implements business performance management solutions.

Return on investment in technology

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