Magazine Article | June 1, 2003

ROI: Proof, Not Promises

Source: Innovative Retail Technologies

Return on investment, or ROI, has become the latest buzzword to dominate the IT industry and strike fear in the hearts of CTOs across the nation.

Integrated Solutions For Retailers, June 2003

An economic downturn and profit-minded business imperatives have reversed the kind of features-and-functions-based IT decisions seen years ago. Today, purchases require cost justification and accurate ROI calculations prior to investing.

CTOs now have to think like CFOs to get the technology they need, and everything has to benefit the bottom line. A recent Gartner Inc. survey illustrates the point. According to the report, IT projects are 60% more likely to be approved with a cost justification and business case.

One example is the retail industry. Whether the largest chain wants to outfit 5,000 stores with new POS systems, or the smallest independent wants to upgrade its scanners, the technology must demonstrate business value and show financial impact. But how can companies accurately calculate ROI? The key is an effective ROI analysis tool.

ROI Tool Or ROI Fool?
An ROI tool can range from an Excel spreadsheet to elaborate analytical software that factors a number of parameters and assumptions. Many companies sell or use generic ROI tools that cover a broad range of industries, but the most effective analyzers are specific to each industry and provide the parameters and assumptions that fit a company's particular business model.

An effective analyzer also provides comprehensive ROI statements that answer three important questions: How much ROI? How soon? And how certain? For example, an ideal report would read, "We are 95% confident that we will be able to achieve a net present value of $3.5 million with a payback period of nine months."

Characteristics Of Effective ROI Tools
There are 10 major characteristics of effective ROI tools. Look for these when considering the right analyzer:

Provide industry-specific modeling. An effective ROI tool should not only model benefits related to general technology investments, but also should be specific to the company's industry. Benefits derived from efficiency gains, productivity improvements, risk reduction, cost/loss reduction, and revenue generation need to be considered.

Account for all investment costs. The analyzer must account for all initial and ongoing investment costs. This includes capital licenses, resources, procurement, training, installation, and maintenance.

Be easy to understand and communicate. People other than the CFO will need to read and understand the ROI statement. Large, complicated spreadsheets are poor vehicles to communicate complex ROI models. A simple, straightforward report is best.

Be flexible and easily modified. The ROI tool should allow quick, smooth, and interactive modification of the base model and parameters, allowing easy what-if analysis and addition of new, unforeseen benefits.

Provide key project viability measures. The analyzer should provide key project viability measures necessary for management to make their decisions. Those measures include net present value (NPV), internal rate of return (IRR), payback period, and ROI.

Model hard and soft benefits. The tool should distinguish between benefits that remove exiting costs, avoid future costs, and improve performance. This will enable decision-makers to only include benefits they feel comfortable counting.

Allow for risk adjustments and real-world parameter modeling. Decision-makers need to assess the realistic versus potential ROI outcome of any purchase. An effective analyzer should produce both a best-case ROI statement and a more achievable and risk-adjusted statement. Producing a credible ROI statement requires effective modeling of reality. In the real world, certain parameters are either not known with exactness or are better modeled as uncertain to reflect risk. In addition, some parameters vary over the lifetime of the investment, while others remain constant. These features differentiate a world-class analyzer from the ordinary analyzer.

Perform sensitivity analysis. ROI analyzers may use hundreds of parameters and assumptions to gain an accurate result. Sensitivity analysis determines the most important parameters so management can use appropriate time and resources to accurately determine those values.

Audit all changes. An effective ROI tool should audit and log all parameter changes and supply decision-makers with a record on the evolution of the ROI statement. This allows decisionmakers to compare the current results to an earlier data set.

Provide for target versus actual ROI comparison. After making a purchase, decision-makers need to validate their decisions by conducting post-implementation audits. A good ROI analyzer should give actual versus target ROI comparisons for the investment.