18 January 2010

ROI is a Responsibility – Part 3

Jacob Varghese has 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)

There is, of course, legitimacy surrounding each of these classifications, but I want 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.

Transformational IT projects

Ross and Beath describe transformational IT projects as being "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)." Now, in for-profit organizations, my guess is that the real measure of "growth" is in two realms: revenues and profits. I doubt that there is a desire to grow the balance sheet just to call it "growth."

Another word for "barriers to long-term growth" would be a "constraint." So, "transformational" IT investments should be aimed at exploiting, elevating or breaking a constraint to long-term growth. And, while we are talking about it, let us set forth this axiom: It is not possible to exploit, elevate or break a constraint to long-term growth without the action also opening the door for short-term growth. So whatever investment your executive team makes in so-called "transformational" IT should still be able to be measured in the essential terms we used in earlier portions of this series: namely, increasing Throughput, reducing Inventories or demands for new Investment, and cutting or holding the line on Operating Expenses while supporting significant growth.

Let us look at each of these more closely in the context of "transformational" IT:

Increasing Throughput: Some business executives look at IT investments in, say, a new ERP system as though ROI for such investments were a given. There justification for yanking their present systems out and going through 18 months or more of upheaval in a traditional ERP – Everything Replacement Project is frequently little more than some general sense that "If we do it, things will get better." They hear that other companies have replaced or upgraded their ERP systems and report making more money, and they don't want to be left behind. But these same executives forget that other companies have also gone into Everything Replacement Projects only to be tapped for hundreds of thousands or even millions of dollars and not improved at all. In fact, some companies never recover from traditional ERP implementations and end up on the junk-heap of business history.

In the absence of the willingness or tools to create a valid estimate for their firm's "transformational" IT projects, some executives and IT managers seem to buy into the software vendors' and resellers' theory that somehow "new" or "improved" ERP systems are like oil to an engine – just pour it in and everything will run smoother, faster and with less friction.

Well, oil does that for an engine and we can accurately predict the effects of the lubrication on the engine because we have laws of physics and mechanics to guide us in calculating the predicted effect. Unfortunately, most business executives and IT managers today do not even have an accurate theoretical framework about what the constraint is – or constraints are – to their businesses' making more money tomorrow than they are making today. Instead, they accept the "mystical mojo" theory that "new" or "improved" technology will somehow make their enterprise also run smoother, faster and with less friction.

Would it not be more business-like for your executive management team to actually figure out how just how any investment in IT that is designed to "remove infrastructural barriers to long-term growth" will actually remove barriers to long-term growth? Would it not be more practical for the team to make some rational estimates of the measure of improvement that will result from the removal of these "barriers to long-term growth"? Does it not stand to reason that, if managers believe that implementing new technologies will, in fact, "remove… barriers to… growth" that they be asked also to define just how the technologies will elevate or break existing constraints to business growth?

That is what figuring out how much new technologies will contribute to increasing Throughput is all about. The executive management team should be able to say something along these lines before making a decision regarding any given IT project: We believe that investments in technology X will lead to increasing Throughput (for definitions see related posts) by Y dollars within N months. We base our estimates on the new technology's providing us with the ability to expand our reach into markets A, B and C accompanied by commitments from Sales and Marketing that targeted offers in Product Lines P, Q, R and T.

To do less than this is for your executive management team and IT staff to make a resolution to spend, perhaps, hundreds of thousands of dollars on new technologies based only on "hope" and we all know that "hope" is not a strategy, at all.

Reducing Inventories or other demands for new Investment: Much of what I just said about your executive team setting forth specifics in estimating changes in Throughput applies equally well in calculations regarding potential changes in Inventories or other Investment. If your IT staff or software vendor is encouraging you and your team to consider an investment of potentially hundreds of thousands of dollars, it seems that you would owe it to yourself and to your stakeholders to grapple with just how this investment may help the company with regard to liberating cash or reducing demands for new investments in other areas of the enterprise.

If investing in new supply chain technologies will help slash your $10 million average inventory by an estimated 22%, then that is $220,000 in cash that will be liberated in your operating cash flow. But your management team should figure out, in advance, just how the application of the technologies in your specific environment will lead to this 22% reduction in inventories. The 22% figure should not be grabbed out of the air; nor should it be taken for granted that because the technology vendor has reports from other clients that this number has been achieved that your organization can do the same.

However, on the positive side, if your proposed technology investment can cut your inventories by 22% while simultaneously support significant increases in Throughput, then you and your team are probably also looking at an apparent reduction in demand for new investment, as well. It means that your enterprise may be able to double or triple its Throughput without having to build a new warehouse or invest in the expansion of the existing one. This is all good news and should be calculated in the firm's ROI for the proposed investment in "transformational" IT.

Cutting or holding-the-line on Operating Expenses while supporting significant growth: Again, much of what I have said above regarding your executive team's willingness to "dig out the numbers" and figure out the "how" an investment in "transformational" IT will "remove barriers to… growth" applies to calculating changes in Operating Expenses (OE). Do not rely on rules-of-thumb and reports from technology vendors and resellers regarding the benefits other companies have achieved. If these are going to be real for your enterprise, then the how-to and resulting benefits should not be too difficult for your team to put down on paper.

Actually, in the example given above, we could already calculate at least one portion of the change in OE: If we know the firm's carrying costs for inventory, then the change in Operating Expenses from the reduction in inventory would simply be $220,000 times C%, where 'C' is carrying costs as a percent of inventory. If it costs your business 20.8% to carry inventory, then the change in Operating Expenses would be a decrease of $220,000 times 20.8% or $45,760 per annum.

The bottom line

The bottom line is "the bottom-line." Do not succumb to accepting ROI calculations from your technology vendor or base them on rules of thumb that may or may not be accurate for your enterprise. Besides, it is up to your management team to work out – in advance – precisely how they intend to leverage the proposed new technologies to achieve the ends of increasing Throughput, reducing Inventories or demands for new Investment, and cutting or holding the line on Operating Expenses when "transformational" IT projects claim to be "removing barriers to… growth."

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.

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