The Hidden Cost of ROIDespite ROI's increasing popularity, several pitfalls must be overcome to achieve long-term business successby Robert Northrop "We must be able to prove a positive ROI for every project." Four years ago, this proclamation could have been a punch line for a Dilbert comic. Today, IT leaders are saturating Internet bandwidth with downloads of return on investment (ROI) calculators and creatively brainstorming ways to quantifiably justify expenditures such as disaster recovery planning or technology training. I believe that ROI, and success metrics in general, are important to the success of any business. However, I fear that the recent reliance on ROI as the primary project justification criterion may be a shortsighted and overzealous reaction to the frivolous spending and general mismanagement that has notoriously plagued IT initiatives within most organizations. I first learned about ROI analysis in college. Overall, the concept is a simple method to determine the benefit of a particular project. Sum the expected cash flows (discounted by the time value of money) and divide by the initial project investment, and the result is the expected return on investment. A value over 100 means the project will provide a positive return; when comparing two similar projects, the project with the highest ROI is the best choice. In practicing these concepts across contrived, textbook problems such as "Should retailer A replace its distribution center sorter?" I too was inspired by ROI and believed that every undertaking should be examined to determine the potential financial returns. The Downside of ROIThe proliferation of ROI as an exclusive tool for evaluating IT projects and the corresponding negative effects have made me question my ubiquitous and exclusive application of ROI justification criteria. Why has ROI become so popular within IT? Requiring projects to have a viable ROI does two things: establishes a formal justification process that helps prevent poor decision making and encourages IT focus on projects that help businesses cut costs. However, when the pendulum of trend begins to swing away from cost cutting and toward business growth, organizations may find themselves scrambling to redress the negative effects of being too ROI-centric. The pitfalls of the current ROI-centric paradigm comprise both tactical and strategic concerns. From a tactical perspective, ROI has two significant shortcomings:
CFOs, financial analysts, and even my college classmates understand the first problem. ROI is conducted on the basis of assumptions. The more viable the assumptions, the better the analysis. In my textbook, the assumptions were usually based on the project being done in isolation with all surrounding environmental factors remaining static. In reality, this vacuum is impossible: Who knows if the true reason that distribution center efficiencies increased were due to the new sorter, change in demand for different products, or stronger coffee in the employee cafeteria? IT projects are usually tightly coupled to such external environmental factors. An even more dramatic IT project differentiator is the high variability of the investment. Everyone has seen the abundance of studies and statistics showing that not only do a significant number of IT projects go over budget (some to an incredibly high degree), but also that a number of these projects are never even completed. The possibility of projects not meeting the expected ROI is affected by the inherent risks of bad assumptions and the concern that the project won't even be executed within reasonable scope of the intended outlay. Besides the classic risks of invalid assumptions and misjudging the investment required, you should also be wary of these ROI pitfalls:
|
 |
Most Popular This Week
IE Weekly Newsletter
Subscribe to the newsletter
| |
| |||||||||||||||||||||||||||||||
