As budget debates rage on for 2004 planning, most CIOs do not expect to see big increases over last year's funding. The growing project backlog dictates that money earmarked for the next year is already accounted for holdover initiatives. The struggles over which projects are approved and which will fall by the wayside are just beginning.
Strong ROI analysis is one way to ease the turmoil of project decision-making and approvals. The process rationalizes decisions among the stakeholders, helping avoid backstabbing, political infighting and rogue IT investing when business units and users do not get a 'green-light' for desired projects. Without reliable financial analysis that quantifies the impact on corporate financials, a technology investment isn't likely to make it through the approval process.
This situation sets up a Catch-22 for CIOs when evaluating new IT investments: Quantifying the ROI of proposed projects is necessary, yet day-to-day management and operations barely leave time to institute new analysis methodologies to make sure IT gets its fair share. At the same time, many IT professionals struggle to tie financial benefits to technology gains. Meanwhile, CFOs are holding budgets tight, in part, because past projects may have fallen short of expectations.
As a result of this circular problem, more than 80 percent of IT buyers now rely on vendors to help them quantify the value proposition of solutions. In fact, many CIOs now elevate the ability of a vendor to proactively justify their solutions to one of the top five most important selection criteria.
This does not mean that CIOs are giving the keys of the henhouse to the fox. Some, like Garrett Grainger from Dixon Ticonderoga, turn to several vendors at once, asking each to generate a business case. He then uses the best of these ROI analyses to build his own justification business case. Other CIOs indicate that they utilize the vendor ROI analysis as a starting point. If the analysis passes muster, they take ownership of the analysis themselves for fine-tuning and presentation.
Yet CIOs remain skeptical of vendor-created ROI analysis -- based on years of business cases promising magical 1000 percent-plus returns, immediate payback periods, drastic overestimation of benefits and underestimation of real costs to implement and own the solution. As a result, fewer than five percent of buyers say vendors succeed at quantifying their value propositions, and fewer still find vendors' analysis credible.
So how can vendors step up and meet CIOs' requirements for credible ROI?
- Set the stage
First, strive to minimize up-front analysis time with a quick, yet thorough, business case to help the team pinpoint and communicate the value of proceeding. The vendor needs to communicate to the CIO which key metrics and methodology will be used, what costs and benefits to consider, any requisite data needed to assess results, and how much time the CIO must invest. The more credible this preliminary analysis, the more likely the CIO will want to move forward with further business case analysis.
- Get things started with good research
To save time, start the analysis with industry research scaled to match the company's size, location, industry, management practices and other key metrics. Use third-party information to establish customized industry-standard costs and ensure that the team's initial analysis is both credible and accurate.
- Justify and document the cost and benefit assumptions
Thoroughly document standard industry costs, often known as 'defaults.' Then estimate the organization's "as-is" costs -- those prior to project implementation -- to include how those defaults are customized and what research forms the basis any modifications. Next, document all benefits to include new features, key performance indicators and the source of savings or business benefit assumptions. An extra benefit: case studies of savings achieved by similar vertical companies can help improve the credibility in your savings assumptions.
- Allow no stone to be unturned
Document and simplify key calculations so all stakeholders can easily understand projected results. Equally important, the CIO must be able to modify defaults to further customize the business case, and adjust anticipated savings and costs. Fine-tune the analysis with "what-if" scenarios so that the business case is both conservative and realistic.
- Include strategic benefits
Projects may be implemented for specific financial benefit. Other projects are strategic -- undertaken to improve future performance. Many C-level executives rank strategic or intangible benefits as equal to or even more important than projects that focus primarily on hard-dollar cost-savings. Many view tangible benefits as a necessary hurdle, and grant project approval if the project bolsters the company's competitive and strategic advantage.
- Scale the analysis for estimated benefits and project risks
Business cases often underestimate costs and overestimate benefits. One cure is to scale the business case results with an eye towards project risk, or use advanced modeling to calculate the range of possible outcomes, scaled by risk probabilities and impacts. Another solution is to discount the anticipated bottom-line contribution of soft, or indirect, benefits. These are often second- and third-order effects of the solution and include benefits tied to areas such as customer satisfaction and availability improvements. One common gauge is to discount these benefits 10-to-40 percent of their original value.
- Pass the "sniff test"
Step back: If the business case is unrealistic, it will not pass a board of directors' review and may damage the entire team's credibility. Document how promised results are already risk-adjusted and that benefits are well within reach.
- Commit to the partnership with an ROI SLA
CIOs know that vendors who commit to minimizing their risks and maximizing their reward are vital for success. One of the best ways to be sure the ROI is realistic and that results can be achieved is to get the vendor to commit an ROI service level agreement, establishes target ROI and key performance indicators, against which the team tracks progress. A portion of a vendor's compensation can be based on meeting key performance metrics. This reduces the customer's risk, and underscores the vendor's commitment to success.
For the vendor, the advantages are clear: A cost-justification report and business case increases the likelihood of a project's approval by 60 percent and reduces the sales cycle by 30-40 percent, according to IDC, the research firm.
Strategically, providing this detailed ROI analysis gives CIOs the analysis they need -- along with a vendor who is also a partner, committed to the realization of promised value -- which means reducing risks, increasing rewards and improving the bottom-line.
This was first published in November 2003