Get the ducks in a row, please
To purchase even needed software, you must still address ROI
By Frank O. Smith, senior contributing editor -- Manufacturing Business Technology, 1/1/2005 12:00:00 AM
It's a buyer's market for business applications today. At the same time, there aren't many people who doubt that IT solutions, rightly applied, deliver significant productivity benefits. Yet the hyperbole of the bubble era lingers on as a slightly sour taste in people's mouths. That means it's not only harder to sell software—it's also harder to buy software, even if, as the champion in your company for its purchase, you're convinced it will deliver a significant business benefit.
This sea change means that to secure corporate funds for your project, return-on-investment (ROI) must be substantiated upfront. Responsibility falls jointly on vendor and project leader to pass muster with parsimonious CFOs, whose power has grown proportionately as spending has fallen from pre-millennium heights.
A word to the wise: if a project doesn't address a corporate strategic need and deliver ROI: fa'get about it!
Industry experts peg corporate IT spending at about 50 percent of total capital spending, with about half of that spent on software. That's a lot of money and a lot of projects. But senior management wants to be guaranteed of some tangible return.
In a 2004 survey of 580 enterprise customers and 220 IT vendors conducted by Washington-based Kotler Marketing Group, 75 percent of responding users say their organizations now require quantitative substantiation of ROI for IT investments of $100,000 or more. This despite the fact that respondents widely acknowledged how extremely difficult it is to peg ROI upfront.
Who this burden of proof should fall on is equally muddied. More than half the user respondents say software vendors should do more to make a strong business case to management. About 79 percent say they include some vendor-provided ROI analysis in their own work some of the time. Yet 80 percent of responding vendors say they thought customers were increasingly skeptical of their claims regarding ROI. A bit of historic reflection reveals ample reason for both perspectives—there's sufficient guilt to go around.
"The dot-com era was the height of foolery," says Dawna Paton, managing partner of Concord, Mass.-based Gantry Group, a strategic marketing consultancy. "The motivation for buying wasn't based on an analysis of a company's strategic objectives. Everybody knew that not paying attention to revenue was a poor way to run a company. But there was a suspension of disbelief that was pervasive and ubiquitous. Once the bubble burst in 2000, followed by 9/11 in 2001, high-tech spending slowed."
Jim Johnson, chairman of The Standish Group, West Yarmouth, Mass., offers a similar observation. "During the dot-com days, we had very few ROI projects," he says. "We were talking to the walls. People didn't want to hear about it. I remember one guy talking about 'eyeballing' it. I told him eyeballs don't pay the bills. He said, 'Jim, you're just not with it'."
How times have changed. The need to develop a strong business case for IT investments, excepting long-proven enterprise applications for things like financials or human resources, has spawned a cottage industry of third-party firms like Gantry Group, The Standish Group, Nucleus Research, and Mainstay Partners—not to mention the participation of more traditional industry analyst firms.
Methodology questions
To this day there is no universal consensus as to the most correct way to project ROI—this despite the fact that by definition ROI is a numbers-based discipline defined most simply as net financial benefits minus total costs.
Viewed broadly, some of the most frequently used methods include:
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Looking at IT investments like a financial investment portfolio, where projected yields rise like cream to the top in competition with the entire portfolio of possible projects. But unique, strategically important benefits can wind up undervalued.
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Total cost of ownership (TCO) looks at a solution's efficacy over its entire life. Often used for a quick initial assessment, it too is said to sometimes undervalue strategic benefit. Invaluable for budgeting, TCO should be seen as only one component of a more comprehensive ROI picture.
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Strict credit-and-debit methodologies assess major tangible and intangible benefits, costs, and risks, but certain projects ought to fall outside strict balance-sheet approaches when it comes to ascertaining worthiness.
"If you go strictly on ROI projections for everything, great things won't get done," says Johnson. "You want a good number of projects that have strong baseline benefits, such as cost savings. But you need certain projects to push the envelope. You need some high flyers that can take you to the edge and change the dynamics of your business."
Whatever the approach, making the case for alignment with strategic business objectives is key.
"This is the single most important factor," says Andrew Bartels, research analyst at Cambridge, Mass.-based Forrester Research. "Make sure you use a standard methodology, one approved and supported by the CFO." And be consistent, Bartels adds. "Using different methodologies for different projects will give you different results."
Bartels says Forrester assesses costs that fall into four general buckets: software license and maintenance fees; hardware costs; process costs (e.g., retraining, process redesign); and motivation costs. Calculating the cost side of ROI is typically easier than calculating the benefits.
"Much of the benefit of IT is indirect," says Ian Campbell, chairman of Wellesley, Mass.-based Nucleus Research, "so that many companies favor projects that only deliver direct benefits you can touch, like costs savings from reduced headcount. But even those benefits often are based on assumptions that don't hold up."
Indirect benefits derive from factors more difficult to quantify. "It's something I can't easily measure, though in theory it might be measurable," Campbell says. He cites the example of wireless, handheld devices used by aircraft maintenance workers to access specifications and work instructions while deep in the bowels of an airplane.
"Rather than climbing down and going over to a PC, they use a device to access diagrams. But how can I definitively say that convenience and gain trump the cost of the solution?" asks Campbell.
Different companies handle direct and indirect benefits differently, Gantry Group's Paton stresses. "If the impact can't be dropped direct to the bottom line, it's misleading to include it. When Gantry creates a calculator for a customer, if we can't figure how it hits the bottom line, we won't use it," she says.
Who knows?
Then there is the broader issue of ROI data genesis. The Standish Group says it has gathered 20 years worth of data to create a database of 50,000 case studies, and has a patented "normalization methodology" that sources hundreds of ROI tables.
In contrast, Nucleus Research stresses its unique accreditation by the National Association of State Boards of Accounting. "Our assessments aren't opinions," Campbell says. He also underscores, "There's no such thing as an 'average' ROI. ROI is a specific measurement of the magnitude of change in your operations, not somebody else's."
Finally, which party should do the ROI calculation—the user, vendor, or a third party?
"When it comes to fully understanding how our applications meet the challenges of a particular customer, nobody knows this better than ourselves," says Bob Greene, VP, Oracle Corp., which has a spreadsheet-based ROI calculator that helps a prospect establish the business case for an application. It also has what it calls a Solution Value Assessment tool used in consulting engagements, "which gives you some idea of values on a broad horizon without the rigor of an ROI assessment that brings everything down to dollars and cents," says Greene.
Product data management vendor Synchronicity, now part of product life-cycle management vendor MatrixOne since being acquired mid-2004, attempted to develop its own ROI calculator for its Developer Suite, used by semiconductor chip designers.
"The first model was overly complicated," says Brad Hafer, a company VP. "Then we made it too simple." The vendor ultimately hired Gantry to come up with what Hafer terms a "middle-of-the-road" qualitative approach, based on in-depth interviews with numerous customers. The project helped Synchronicity itself gain a better understanding of what value customers got from its solution.
Says Gantry's Paton, "Vendors don't always know where customers get value. They often think they do, but just as often they aren't right." As for vendor-generated ROI calculators, "They just aren't as credible. As a buyer, I'd value something I created myself, or one I hired someone to help me with."
Sadly, every undertaking has an implicit bias, including "objective" ROI assessments. Though it may be impossible to eliminate bias—whether that of invested project members, vendors, or third-party providers—IT projects are facing tougher muster, requiring ROI projections that must be convincing beyond reasonable doubt. Whichever approach you select, the devil will forever be in the details.
Synchronicity Developer Suite ROI scorecard
Year 1
| Increased revenues: | $1,164,399 |
| Development cost savings: | $426,927 |
| Avoided re-spin costs: | $54,238 |
| Total benefit: | $1,645,564 |
| Total investment: | $295,120* |
| ROI ($): | $1,350,444 |
| ROI benefit (%): | 458 |
| Payback period (months): | 4.6 |
| * includes cost of Developer Suite software, maintenance, support, and engineer time for rollout and training. | |
| Source: Gantry Group | |
