Posted by: Randy Kerns
when relevant content is
added and updated.
While working on a project for the IT organization of a large company recently, I began questioning the information it included in its Return On Investment (ROI) calculations. The organization used ROI as a measurement to buy storage as part of a storage efficiency project, but I found problems with the measurement based on what was included in the calculations.
Before explaining the difficulties I had with the information they used, let’s first look at what is typically included in ROI calculations. The definition I give for ROI is: the assessment of return on investment money for savings or gains from project implementation. For a storage project, the ROI calculations include:
ROI is usually expressed as a percentage of gain with a payback over a given period of time. I can still hear a salesman saying, “It pays for itself in just 11 months.” That’s the way ROI is used as an economic metric for decision making.
But, there are two types of gains usually included in ROI calculations. They are called hard benefits and soft benefits. The hard and soft benefits are usually defined like this:
Hard benefits include capital savings or deferred capital investments, operational savings, and productivity improvements.
Soft benefits consists of opportunity costs such as maximizing revenue potential by making enterprise information and applications more available, and cost avoidance through minimizing down time.
It is easy to add items — taking credit for potential economic benefits — or make your numbers overly optimistic in soft benefits. I’ve seen this become a game of liar’s poker in a competitive situation. Because of that, I recommend not including soft benefits while making a decision. Many times the soft benefits are being listed by a party with a lot to gain. It is best to leave those soft benefits as potential opportunities – preferably just listed but not quantified.
Soft gains can still be used to help validate the accuracy of the project planning and for future corrective action. That’s why as part of the closed-loop process we cover in our Evaluator Group classes, we recommend including soft gains in the actual returns at the completion of the ROI time period.
The important thing to take from this is that using ROI for economic decision-making needs to have a more discerning review of the inputs, and the review process must include a validation of the underlying assumptions.
(Randy Kerns is Senior Strategist at Evaluator Group, an IT analyst firm).