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What is an ROI and what's the big deal ?
Believe it or not, your company's CEO and CFO have tough jobs with difficult decisions to make. It's not a matter of sitting in the nicest offices and beaming over your company's successes. There are hurdles around every corner and overcoming challenge is the name of the game for any top executive.
You've heard me say before that the CEO has limited resources just as you do in your IT management or CIO role. You will probably never have an organization where you have all the resources you need to do the things you would like to do. If you do, you are either not wanting to do enough or you probably have more resources than you should have.
One of the things CEO's have to balance is where to put the cash in funding new projects. Every department manager needs funds to do the things that will make a tangible difference for his/her department. For example:
- The HR Director needs a new HR system to streamline his operation and to avoid hiring four more people.
- The West Coast operation needs more office space due to growth. A move to a new office is anticipated.
- Your internal Billing and Receivables department wants scanning & imaging capability to eliminate tons of paper.
- A new company acquisition is being eyed to expand the company's market share in the southeast.
And then there is the IT initiative needs.
Get the picture?
First of all, the company can't do everything at once. Even if it had all the available cash to do so, the company's staff resources may not be able to absorb this amount of change simultaneously.
This means that the CEO has to balance approving new capital intensive initiatives and handing out the funds. In order to make knowledgeable decisions as to which project makes sense, has more benefit, etc. the CEO and CFO need something that can sort of "normalize" all the project initiatives so they can compare them side by side.
One of the tools they use is a Return on Investment (ROI) calculation.
A new initiative proposal that includes an ROI calculation tells senior executives several things:
1. Cost of the project
2. Timing of expenditures
3. Benefits of the project and how the investment will be recouped
4. Timing of when the benefits will occur to pay for the investment
Just because a project has a huge payoff does not necessarily mean it gets priority over projects with less return. For example, if a project costs the company $1,000,000 and has a $2,000,000 expected return over three to five years, it's probably a worthwhile project to do. However, a $100,000 project that has a 9 month payback might get preference for several reasons:
1. The cost is lower and more affordable at the time.
2. The payback is much quicker and the company needs to show faster results for any number of reasons.
3. There may be issues such as compliance or other types of risk that push the smaller project to the front of the line.
Three things are big influencers with your CEO and CFO in getting your projects funded:
1. Your track record of success
2. The company's need for what you are proposing
3. A good feeling that the return is real and of reasonable time for the cost
This third item is where having an ROI component in your IT initiatives recommendation will make the difference. It also makes a difference in that you are presenting a business solution with elements that speak the same language as your CEO and CFO, something that helps them a great deal.
So, how do you go about calculating an ROI?
First, understand how companies will look at the financial part of a proposed initiative. Some companies take a very deep, analytical look at it including time value of money etc.. However, most company execs will look at the issue at a higher level. What most want to know is how much, how long to recoup the cost, and how are you going to recoup the cost.
I will typically map out by month the expenses I expect to have in the project, and I'll actually break it down by type of expense (labor, supplies, travel, outside contractor, etc.). This is simply part of building a budget for the project as you normally expect to do. Then, I extend the time to show when and how much savings we start to see beginning at the appropriate time until the project is paid for. The total number of months it takes to complete the project and receive the benefits that pay for the project is the ROI.
Let's take a very simple and hypothetical example to show you what I mean.
Assume we have a project to cut our $80,000 per month postage cost in half. The project takes three months and costs the company $240,000 to complete. Let's also assume that once the project is completed, we start saving the company half of the monthly cost, or $40,000 per month.
One quick calculation of dividing the cost ($240,000) by the monthly savings ($40,000) tells you the payback is 6 months upon completing the project. Every CEO will jump at such an opportunity, especially since the $40,000 monthly savings will be an ongoing benefit to the company.
In my proposal, I will just show the project, estimated cost, and a forecasted Return on Investment of 6 months after the project is completed. I will also explain how the savings are to occur and other benefits that may result by doing the project.
Behind the scenes, I will develop more detail to help me arrive at the numbers I need to present to the executive committee. This detail will include a high level summary of the project's budget and detail showing how much and when savings are being achieved and where they occur. A sample of what I need to arrive at the information proposed to the executive committee will include something like the following:
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