Beyond ROI

By Jodi Mardesich

The most common measure of a good technology investment is the direct financial return it yields. Tools that measure Return on Investment can help CIOs quantify the gains they have made, both in order to justify past spending to the CEO and other C-level executives, and to protect and expand their budgets for future projects.

With IT budgets continuing to be tight, it's a given that CIOs should make realistic assessments of the risks, the benefits, and the returns on their IT spending before investing scarce capital and human resources into new software and hardware initiatives. Yet 70 percent of CIOs find it difficult to calculate the ROI on projects they have planned, and 73 percent don't calculate the ROI on projects after they're completed, according to CIO Insight magazine.

It's no wonder an industry has sprung up to fill this gap and aid CIOs in evaluating projects and justifying spending. A multitude of vendors offer various software programs and spreadsheet-based tools that allow CIOs to plug in values and crank out results in straight values or percentages. However, these calculations can be tricky and subjective. Often, tools call for generic data instead of company-specific information. Some vendors skew the tools to focus on their own products' strong points. Also, some ultimate benefits of a technology project -- such as an increase in margins or profits for the company -- are obvious and tangible, while other benefits, such as new business development, and customer and partner satisfaction, are difficult to measure.

"ROI is not about calculating a number; anybody can use Excel or a calculator," says Rebecca Wettemann, vice president of research with Nucleus Research. "What's important is understanding where costs are coming from, where you expect benefits, and how you're going to make the benefits outweigh the costs."

While CIOs shouldn't rely on numbers alone, ROI methodologies can help to evaluate how technology projects will affect the company's bottom line, as well as help them communicate those benefits to other peers in the boardroom. There are a variety of ways in which CIOs may present or view the value of IT investments: Return on Investment, Net Present Value, Internal Rate of Review, Total Cost of Ownership, and Payback Period:

• Return on Investment  ROI is the most important measure to use when evaluating technology or projects, according to Nucleus's Wettemann. ROI is the earnings obtained by investing capital in a project. The value of a technology investment can be determined by dividing the project's benefits by its cost, and is usually expressed as a percentage. In relation to technology, some call it "Return on IT." All projects should be subjected to this basic calculation.



• Net Present Value  Because it evaluates investments over time, NPV works well for long-term projects, especially those that generate cash flow, such as an ATM system or retail kiosk, as opposed to an upgrade to Windows. NPV allows CIOs to consider the time value of money; it's defined as the present value of future cash flows minus the present value of the investment and related future cash outflows. This equation takes into account the cost of capital, interest rates, and investment opportunity. In other words, it's the net result of a multiyear investment in today's dollars. A positive number is a sign of a good investment. An enterprise might be better off financially by putting funds in the bank, drawing interest, rather than implementing something with a negative NPV.



• Internal Rate of Return  By definition, IRR is the discount rate that makes the Net Present Value of a project equal to zero. It essentially calculates the project's effective interest rate. But it assumes a much more traditional, unchanging environment than most people are dealing with today, Wettemann notes, when interest rates didn't change much, or vary from project. "Most people are moving towards modified IRR," she says. Another problem with IRR: it doesn't specify a Payback Period.



• Total Cost of Ownership  TCO -- the summation of all costs associated with a project -- can be applied to technology and non-technology decisions. TCO is a good metric for budgeting purposes, but it can orient decision makers toward choosing the cheapest solution, not the best. TCO should be calculated for a period of at least three years, Wettemann says.



• Payback Period  An excellent measure of risk, Payback Period is a simple metric that determines when a project breaks even. "The shorter my payback period, the lower my risk," Wettemann says. Since technology often becomes obsolete within three years, projects should have a payback of less than that. Calculating payback doesn't give a full view of the project's health, however, and can ultimately be short-sighted. For example, it doesn't take into account profits that come after a project breaks even. While the perfect solution may take three years, shorter-term projects deliver results sooner and can deliver benefits in the interim.

When looking to evaluate projects and investments, CIOs should think beyond the numbers and consider how projects affect the larger business. Ways to achieve greater ROI, according to ROI research and tool company Alinean Research, include:

• Seeing how projects and investments can transform information into value, and improve shareholder value.



• Having a consistent methodology for measuring value, and regularly using it.



• Focusing on projects that help the company achieve competitive advantage and gain market share.



• Outsourcing basic "commodity" IT functions to focus IT intelligence on more strategic initiatives.



• Breaking larger projects into smaller milestones with shorter payback periods -- fewer than 12 months.

The CIO's job has expanded from managing technology projects to envisioning how technology will enable larger business goals of the company. As a result, "the CIO needs to become the CFO of IT," says Thomas Pisello, of Alinean Research. In the current IT environment, in which CIOs must battle security breaches, conform to government regulations, and align with business goals, determining the value of IT investments is crucial to running an efficient and effective IT operation.

Jodi Mardesich writes about business and is a former staff writer for Fortune.