ROI

 
 
By eweek  |  Posted 2003-11-07 Print this article Print
 
 
 
 
 
 
 


for Allocating Decisions"> CIO Insight: What Im hearing is we need to take ROI value out of isolation for the rest of the business. We need to make this part of a process. We need to use that process to build trust. And that the real purpose of ROI is to make allocation decisions; that ultimately is really what its about. So, how do we transform our narrow, isolated approaches to ROI to something thats going to really get at the question of value, and is really going to help us make better decisions? Where do we start on that? Chris, can we learn something from Wall Street and how Wall Street looks at valuation of companies?
Gardner: Absolutely. My feeling is the top of the company is measured based on Wall Street style valuation models, and that should be reflected elsewhere in the company. Those [valuation models for IT] can be built, theyre complicated and theyre hard, but it can be done, and at least you have some assurance that your analysis ties back to something that is meaningful from a top executive standpoint.

CIO Insight: What would be the basic things needed to achieve that?
Gardner: Well, you need the free cash-flow approach that Denise was mentioning. Its ultimately about cash flow. Weve talked about ROI here, but my feeling is ROI is more of a general term that encompasses the concept of value for IT. The free cash-flow approach, theres strong evidence that shows it correlates with share price better than earnings per share and a bunch of other things. But this gets back to the inputs. If youve got a system that involves a lot of customer adoption, you need to understand the customers response to the design thats been proposed. Youve got to work out those costs in detail. You have to be complete about your costing. Youve got to make sure training is in there and change management, [and the] inefficiencies, the delays and that kind of thing. And some of these may not be known going into it, but you can see, well, what if were off here by 50 percent or 10 percent or 100 percent? Does it make any difference?
You can start to create something that you can use to manage the whole process of building a system. What were talking about isnt something you just use at the beginning of a project to decide whether to invest in it or not; its something of a tool that you use throughout the lifecycle of a project. So during the development you would know what are the get-rights. You know, if youve got a narrow market-opportunity window, schedules will be paramount. You can show that and model that. Then [theres] the operation of the system itself. This is really something that should be an operational tool and tie back to operational measures. Its hard, and theres a lot of uncertainty here. The key is to always ask questions and challenge it. Credibility is low right now, but a tool like this should start to predict that some projects are not worth doing and some projects are worth doing. IT should start to be able to show that the business might be recommending projects that dont make sense. This is a politically difficult kind of thing, but you should start to see some projects being turned down. A test is: What am I seeing coming out of this? Does it calibrate with reality? Am I getting some responses that look halfway credible? Can someone show me the evidence, make the case, you know, sometimes you have to put it on the line.

CIO Insight: Bobby, what do you think? Is looking at IT investments kind of the way investors look at portfolios a helpful way to look and think about ROI? Is that something we all need to be doing as part of changing and transforming ROI?
Cameron: Let me make a couple of comments before I answer that directly. One is that it really is about the process. No matter what you do, if the process doesnt involve everybody fully, meaning business and IT equally, and the justifications dont cover everything, nothing works. So just put that on the table and push it aside. The second overall statement is that weve focused on ROI as if it were the be all and end all, but not everything either merits [justification] or can be justified, and so we need to make sure that we put some clarity there. Most firms that identify minimum pain around prioritization isolate strategic mandatory and operational investments into those categories where strategic justification is different from mandatory, tax regulatory, biggest-customer-tells-me-I-got-to [justifications], and neither of those is justified based on ROI. ROI is really calculated for a portion of the investment stream that has to do with things that are justified based on changes to operations. In other words, I expect a business impact. And then there are firms who are committed to ROI who also justify projects based on softer metrics, EMC being one, for instance, where they use soft metrics for things that might improve customer satisfaction but would be very difficult to prove an ROI. So now thats sort of laid the ground for what Im about to say, which is that most firms want to invest, as someone said earlier, to drive competitive advantage and improve stakeholder value. Frequently firms do their darndest to understand what the strategies are, what the directions are that they need to accomplish these goals. The problem is [that] theres no linkage between that planning and thinking and investments usually in the prioritization process. What Ive seen emerging is, in fact, a portfolio mechanism, meaning we look at everything as a group of investments and we compare them to each other, and the process attempts to adjust the prioritization [of] strategic needs.

CIO Insight: So what are the first steps then that we need to do to change and improve the way we do ROI?
Cameron: Well, ROI is best used when its a relative comparison tool. It has no absolute characterization. What I mean by that is if I want to adjust the direction of my spend to parallel what Im trying to accomplish, I need to put [in] some funds behind [them]. The best firms start by committing capital-investment dollars in specific directions around customer value and customer impact, around creating value, which is manufacturing or back-office systems, or enabling [systems]. By picking three buckets, I then immediately isolate some of the worst arguments between the plant-committed guys and the customer-committed guys who start throwing ROI around. By breaking them into buckets, you start to clean up the conversation. For instance, if I have a $100 million to invest in capital projects, I say 60 percent is going to customers, 30 to value creation and 10 to enabling. Right there Ive gotten rid of a lot of most absurd argument. The second thing that then occurs is those buckets have specific business goals theyre trying to achieve-you know, improving employee productivity might be a good one in the value creation [bucket], improving customer satisfaction in the customer facing [bucket]. Then the third step is to prioritize projects based on their impact on those objectives, some of which are ROI and some of which are soft.

Kalafut: Can I just add to that a little bit? A value creation index which links measures like those you just mentioned back to things like market value, and getting estimates of how much a change of those will actually impact bottom-line performance, is another next step in the actual handling and treating those intangible drivers. Some of [those measures] are those that you mentioned, which are where we find three or four proxies to represent each of those drivers, and then link them back to market value so that they can be scored. [Theres] quite a difference [between] being able to actually put together several of those intangible drivers, particularly in this area of IT where so much of that is previously considered immeasurable.

CIO Insight: How do you generate trust that these drivers, these indicators actually work?
Kalafut: Well, this is a ten-year study of various organizations. We compiled various measures that tend to work in certain industries. We correlate them back to things like market value, [and] then watch them across time to see how those measures change. So its not a one point in time analysis that makes you decide that those measures are the correct ones, but actually watching them for several years. Once we were confident that those indicators were working and could be gathered for a variety of different industries and companies, we were able to go back and then start designing unique models, adding in additional characteristics for specific company types and build models around those, including various intangible drivers that might be measured in disparate parts of an organization but have never been pulled together into one model.

Next Page: ROI value as sharholder value.


 
 
 
 
 
 
 
 
 
 
 

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