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2010

This is Part 5 in a series where we have been reviewing comments made  by Jacob Varghese in a 2003 article in which he essentially claims that  it does not make sense to try to measure or compare IT initiative based  on ROI (return on investment) calculations. In preceding portions we  have noted that Varghese called upon Ross and Beath to help him say more  about how and why ROI might not be a good way to make determinations regarding IT investments:

 

"In  'New Approaches to IT Investment,' Jeanne W. Ross and Cynthia M. Beath  break all IT investments along two dimensions: (1) strategic objectives  (short-term profitability vs. long-term growth) and (2) technological  scope (shared infrastructure vs. business solutions)…. Based on those  two dimensions, all IT investments can be broken into one of the  following four categories:

 

"Transformational:  IT investments that aim to remove the infrastructural barriers to  long-term growth across the organization (for example, integrated CRM,  enterprise information portals, or end-to-end processing). Given the  organization-wide impact and the imperative that such investments must  be in line with organizational strategy, the CEO must own these  investment decisions. The success of these projects should be his  responsibility.

 

"Renewal:  The aim of renewal IT investments (such as legacy modernization and  platform conversion) is to improve the service levels of the existing  shared infrastructure or reduce the cost of support and maintenance. The  ownership of such projects should lie with the CIO, since the  boundaries of these projects are well defined and benefits accrued can  be quantified up front. Moreover, it is the CIO's responsibility to  ensure the service levels from the shared IT infrastructure are  constantly improved.

 

"Process Improvements:  The end objective of IT investments that focus on short-term  profitability or incremental process improvements might be to speed time  to market, lower the cost of operations, or to differentiate  services/product offerings. The ownership of such investments should lie  with the business unit head, functional head, or the process owner,  depending on how the organization is structured.

 

"Experiments:  New technological trends that present significant opportunities for  long-term growth should be the focus of IT experiments that use pilot  programs to validate the technology's promise and impact. There is no  fixed home for these projects. In one the industry, they might reside  within the R&D organizations, in another, the enterprise  architecture teams of MIS departments might take responsibility."  (Varghese 2003)

 

I have previously concurred that  there is, of course, legitimacy surrounding each of these  classifications, but I wanted to take a closer look at each since it is  my firm belief that business organizations really should be  seeking ongoing improvement and, for for-profit organizations, real  improvement should lead to making more money. In Part 3 we discussed  "Transformational" IT projects. In this portion, we will try to cover,  in a more brief way, the other three Ross and Beath categories for IT  projects.

 

Process improvement IT projects

Ross and Beath tell us that "process improvement" IT projects  are those "that focus on short-term profitability or incremental process  improvements [such as] to speed time to market, lower the cost of  operations, or to differentiate services/product offerings."

 

The Ross and Beath examples for IT "process improvement" projects are most enlightening. They are:

 

  • Accelerating time to market
  • Lowering the cost of operations
  • Differentiating of service or product offerings

Now, allow me to restate these in the context of the three key metrics that we have been using repeatedly in this series:

 

Example Project

Key Metric Predicted Effect

Accelerating time to market

Assuming  the enterprise's products or services have a market and the firm is  doing a reasonably good job of selling the products prior to the  "process improvement" project under consideration, then accelerating time to market should lead to increasing Throughput.  All that needs to be done by the executive team is to figure out how  they will leverage accelerated TTM (time to market) in order to increase  Throughput, and then put numbers (estimates) to the question of how much they believe that Throughput can be increased as a result of the improvement.

Lowering the cost of operations

This is a simple exercise in reducing Operating Expenses. The question to be answered by your executive team is just how much Operating Expenses can be reduced without jeopardizing support for increasing Throughput (from other initiatives that are hopefully underway already).

Differentiating of service or product offerings

This should essentially be a ditto of what I said above in the "Accelerating time to market." After all,  what is the point of investing in increasing the differentiation of your  firm's products or services if doing so does not, in fact, lead to increasing Throughput. Still, managers will need to set their minds to calculations of how and how much the new differentiators will add to Throughput.

 

 

Experimental IT projects

In their article, Ross and Beath describe "experiment" IT  projects as those that test "[n]ew technological trends that present  significant opportunities for long-term growth" in "pilot programs to  validate the technology's promise and impact." Since this is purely  experimental, it would seem that it would be impossible to calculate  their potential effects on T, OE or I.

 

However, I  believe that it would be possible to apply a simple method called  "profit expectation" to determine the value of potential benefits that might flow from experimental technologies. Under such an application, the standard ROI formula would be modified to the following:

 

ROI = ((a% * delta-T) – (b% * delta-OE)) / (c% * delta-I)

where

a% = estimated expectation (as percent) of achieving calculated delta-T,

T = Throughput, b% = estimated expectation (as percent) of actualizing delta-OE,

OE = Operating Expenses, c% = estimated expectation (as percent) of required delta-I,

and I = Investment

 

It  would seem to me that these kinds of R&D projects would not be  considered alongside other immediately accessible improvement projects.  Therefore, an alternative approach for R&D should be considered.  For example, perhaps before investing more than some preset and  relatively small amount in any R&D project, the promoters of the  project must present an ROI calculation to a review committee based on  the formula above. It is up to the backers of the project to "sell" the  committee on the validity of their calculations and estimates for a%, b% and c%.

 

Furthermore,  it seems reasonable that as R&D projects move forward and more  is learned, the values used in the ROI formula will change. Certainty  should increase with each incremental review, but the ROI value will  move up or down over time. By reviewing projects on a regular basis –  weekly, monthly, quarterly, as may be reasonable for the type of  organization – your executive team can maintain a clear and consistent  drive toward increasing ROI through the firm's R&D efforts.

 

The bottom line

We must again be reminded: the bottom line is "the  bottom-line." Do not succumb to accepting the concept that it is not  possible to calculate ROI for so-called "process improvement" or  "experimental" IT projects. There are ways to help your organization  stay focused on real improvement – improvement that is most likely to  have a positive effect on your enterprise's bottom line.

 

©2010 Richard D. Cushing

Works Cited

Varghese, Jacob. "ROI Is Not a Formula, It is a Responsibility." Journal of Business Strategy, May/June 2003: 21-23.

We have been reviewing comments made by Jacob Varghese in a 2003  article. In our Part 3 we noted that he had more to say about how and  why ROI (return on investment) might not be a good way to make  determinations regarding IT investments. In doing so, he references work  by Ross and Beath:

 

"In  'New Approaches to IT Investment,' Jeanne W. Ross and Cynthia M. Beath  break all IT investments along two dimensions: (1) strategic objectives  (short-term profitability vs. long-term growth) and (2) technological  scope (shared infrastructure vs. business solutions)…. Based on those  two dimensions, all IT investments can be broken into one of the  following four categories:

 

"Transformational:  IT investments that aim to remove the infrastructural barriers to  long-term growth across the organization (for example, integrated CRM,  enterprise information portals, or end-to-end processing). Given the  organization-wide impact and the imperative that such investments must  be in line with organizational strategy, the CEO must own these  investment decisions. The success of these projects should be his  responsibility.

 

"Renewal:  The aim of renewal IT investments (such as legacy modernization and  platform conversion) is to improve the service levels of the existing  shared infrastructure or reduce the cost of support and maintenance. The  ownership of such projects should lie with the CIO, since the  boundaries of these projects are well defined and benefits accrued can  be quantified up front. Moreover, it is the CIO's responsibility to  ensure the service levels from the shared IT infrastructure are  constantly improved.

 

"Process Improvements:  The end objective of IT investments that focus on short-term  profitability or incremental process improvements might be to speed time  to market, lower the cost of operations, or to differentiate  services/product offerings. The ownership of such investments should lie  with the business unit head, functional head, or the process owner,  depending on how the organization is structured.

 

"Experiments:  New technological trends that present significant opportunities for  long-term growth should be the focus of IT experiments that use pilot  programs to validate the technology's promise and impact. There is no  fixed home for these projects. In one the industry, they might reside  within the R&D organizations, in another, the enterprise  architecture teams of MIS departments might take responsibility."  (Varghese 2003)

 

I have concurred that there is,  of course, legitimacy surrounding each of these classifications, but I  wanted to take a closer look at each since it is my firm belief that  business organizations really should be seeking ongoing  improvement and, for for-profit organizations, real improvement should  lead to making more money. In Part 3 we discussed "Transformational" IT  projects. In this portion, we will try to cover, in a more brief way,  the other three Ross and Beath categories for IT projects.

 

Renewal IT projects

Ross and Beath describe "renewal" IT projects as "investments  (such as legacy modernization and platform conversion) is to improve the  service levels of the existing shared infrastructure or reduce the cost  of support and maintenance."

 

It seems clear from this description that most "renewal" projects will not contribute in any significant way to an increase in Throughput (T). However, it is likely that such projects will lead to reducing Operating Expenses (OE), and, in some cases, it may be possible that a "renewal" project could reduce the demand for (other) Investments  (I). If this is true, then is it too much to ask for the IT department  or the executive team to actually sit down and put some rational numbers  (i.e., estimates) to the potential savings from investments in proposed IT "renewal" projects?

 

For  example, if investment in SAN or virtualization technologies will  contribute to savings in support or drive down the need for investments  in new servers or other types of data storage in the future, then let  the IT department bring forth such estimates and present them for  consideration by the executive management team. There is a place for  such projects, and the more the firm emphasizes and prioritizes around  IT projects that increase Throughput (based on calculated ROI for  projects competing for the investment dollars), the more cash flow will  increase and the less difficulty the enterprise will have in coming up  with the funds when ROI calculations show that a "renewal" project makes  a lot of sense.

 

However, I would like to suggest  another approach. One of the former managers for the New York Yankees  used to have a strict policy: "Put a rookie in the lineup every year."  This makes sense because then your team never gets "old" all at once.  This approach makes sense, too, in the IT infrastructure world.  Organizations should build into their regular annual budgets an  Operating Expense amount allocated to "renewal" of their IT  infrastructure. Some years the full renewal budget will be spent. Other  times the renewal budget will not be spent in full. In that case, any  budget balance should roll-over into the next year when a larger renewal  project may be required.

 

If this approach is used,  then "renewal" projects in IT become a part of operating expenses  necessary to maintain the enterprise's health. In this case, a "renewal"  project's ROI is still calculated in the same way using the same  formula. The calculations would run along these lines:

 

ROI = (delta-T – delta-OE) / delta-I

where T = Throughput (Revenue less Truly Variable Costs),

OE = Operating Expenses, and I = Investment

 

Since,  for IT "renewal" projects there is not likely to be rationale for  concluding that the project will contribute to increasing Throughput,  then that leaves only reductions in Operating Expenses and Investment as  factors.  If a "renewal" project requiring an investment of $25,000  will reduce annual maintenance and support costs by $6,000, but will  also reduce a potential additional investment in year 2 by $18,000, then  one can calculate as follows:

 

ROI (Year 1) = ($0 – (-$6,000))/$25,000 = 24%

 

ROI (Year 2) ($0 – (-$6,000))/($25,000 - $18,000) = $6,000/$7,000 = 85.7%

 

Note:  When comparing multiple projects that produce multi-year variable  cash-flows it may make sense to compare projects based on NPV (net  present value) or, potentially, FMRR (financial management rate of  return).

 

The bottom line

To reiterate: the bottom line is "the bottom-line." Do  not succumb to accepting the concept that it is not possible to  calculate ROI for an IT project destined for "renewal." We have just  proven that, if your executive management and IT staff will commit to  thinking through estimates and causes for changes in T, OE and I, then  it is possible to rationally calculate the benefits to proposed IT  projects – "renewal" or otherwise.

 

We will continue with the other kinds of IT investment from Ross and Beath in future posts.

 

[To be continued]

 

©2010 Richard D. Cushing

Works Cited

Varghese, Jacob. "ROI Is Not a Formula, It is a Responsibility." Journal of Business Strategy, May/June 2003: 21-23.