ROI (return on investment) is a widely used measure to compare the effectiveness of IT systems investments. It is commonly used to justify IT projects, but can measure project returns at any stage and be used to evaluate project team performance and other relevant factors.
Definition of ROI
The basic ROI calculation is to divide the net return from an investment by the cost of the investment, and to express this as a percentage. ROI, while a simple and extremely popular metric, may be easily modified for different situations. The ROI formula is:
ROI % = (Return – Investment Cost)/Investment Cost x 100
Using ROI within IT Projects
Comparing the ROI of different projects/proposals provides an indication as to which IT projects to undertake. ROI proves to corporate executives, shareholders, and other stakeholders that a particular project investment is beneficial for the business.
A project is more likely to proceed if its ROI is higher – the higher the better. For example, a 200% ROI over 4 years indicates a return of double the project investment over a 4 year period.
Financially, it makes sense to choose projects with the highest ROI first, then those with lower ROI’s. While there are exceptions, if a project has a negative ROI, it is questionable if it should be authorized to proceed.
ROI may not be useful in every IT project. Below is a list of examples where calculating the ROI may not be appropriate:
- Expenditure such as IT consumables, replacing broken PC’s
- Short duration maintenance projects that can be completed in less than 1 month.
- Projects that do not produce cost savings or revenue. For these ROI will be zero or negative.
- Projects that are mandated for regulatory and compliance.
- Projects that involve life or death. (e.g., Healthcare Solutions),
- Projects which only have intangible benefits and no measurable financial benefits
Issues with Basic ROI Calculations
ROI calculation may be erroneous and may appear to point to the wrong conclusions. Issues to be concerned about include:
- ROI calculations can be manipulated if you are not careful.
- Project savings, income and expenditures should be measurable and realistic. But sometimes these measures are not easily measurable and their realism is questionable.
- Project benefits may be attributable to more than one improvement – so care needs to be taken to avoid double counting.
- When forecasting costs and benefits, it is not always possible to obtain a high degree of certainty with respect to the accuracy of project costs and benefits.
ROI on IT system projects should be based on tangible (or hard) benefits. Generally, financial benefits can be placed into five categories:
Below are some examples of IT benefits, which should always be expressed in dollars.
- Providing a new service that results in increased sales to new and existing customers.
- Travel reduction (e.g., online meetings replacing face-to-face meetings, remote support replacing onsite support).
- Lower ongoing maintenance costs.
- Fewer days in receivables resulting in lower interest costs.
- Time saved (increased productivity and reduction in time to complete tasks).
- Time saved from reduced length and number of customer service calls.
- Time saved from reduced numbers of errors.
- Lower costs for servers and storage.
- Avoids planned purchase of new data center.
Non-financial benefits should not be included in ROI calculations. While they are often as important as tangible benefits, they are difficult to financially quantify. Non-financial benefits should be fully explained within the business case and, where possible, details provided of any quantification or measurement. Examples of intangible IT benefits include:
- Increased customer satisfaction.
- Ability to offer improved customer service and support.
- Increased usability leading to increased sales.
- Increased user satisfaction.
- Improved/automated business processes that the new system supports and enables faster and more accurate information.
- Improved analytical solutions.
- Better forecasting.
- Better controls to improve data input accuracy.
- Improved software vendor support and service, improved communications, better knowledge of software, system set-up, and the like.
Relevant factors to consider in ROI calculations include:
- Timeframe: The timeframe for calculating ROI for IT projects may vary. Three years is common for hardware projects, as technology is often obsolete after 3 years. However, 5 or more years is often used for new software systems. Changing the timeframe can make significant differences in ROI calculations. Try to be consistent from project to project.
- Consistency: ROI calculations should be consistently applied across all IT system projects. Consistency also applies to the assumptions behind the ROI calculations. For example treatment of inflation and taxation (corporate and VAT/sales taxes).
- Precision. Details shown to the last dollar or to cents lead users to believe in accuracy that does not exist. Using $000’s omitted would be more appropriate. Equally, every figure being rounded with two or more zeros may lead users to believe that calculations are fairly inaccurate. A balance has to be struck, combined with the need to be as certain and accurate as possible.
Other ROI calculations
Other calculations that are typically produced at the same time as calculating ROI are:
- NPV (net present value) i.e., the return a project will make at a specified discount rate. Ideally this should be a high/positive value.
- IRR (internal rate of return) i.e., the yearly return % of the investment – the higher, the better.
- Payback (also known as break even point). This is normally expressed as the number of years it takes to recover the investment. The shorter the payback, the better.