17 Feb 2012

How should you evaluate ROI for IT projects?

Return on investment, or ROI, is one of the most important considerations to make when tackling any new technology project.

What exactly do we mean by ROI?

Unfortunately, there’s no exact definition. What’s generally meant however is this – what return am I going to see on this investment, and how long will it be before the benefits outweigh the costs?

It can be a complex question, but it’s one that’s important to ask. Without a thorough assessment, you can’t be confident that a product or project is right for your business.

Assessing ROI

Any assessment of ROI must evaluate benefits and costs. The biggest mistake in most ROI assessments is the latter: businesses often underestimate project costs.

That’s because they fail to take into account what is known in IT as total cost of ownership (TCO). TCO includes not only the direct and immediate cost of a new IT system, but also what expenses it will incur in the long run.

Make sure that your assessment includes labour and maintenance costs, the costs of any associated management or service contracts, as well as usage costs.

Often overlooked is what I call “adhoc discretionary spending” – the expense of the additional projects that often accompany a large IT investment, such as adding new features or deeper integration six months or a year from now.

Remember to assess both tangible and intangible costs and benefits. Tangible items (such as a direct saving when a new system costs, say, $5,000 a month to run instead of $8,000) should always figure more heavily in your evaluation than intangible benefits which you can’t price.

What’s acceptable?

Of course, it all depends on what you’re looking for, but for most IT projects an ROI of between 12 and 18 months is considered a fair payback.

On bigger projects, such as infrastructure deals, a reasonable ROI can stretch out to two years.

The closer the project gets to its point of positive return, the faster it should usually be delivering its returns.

Improving the equation

The ROI equation is affected not only by the technology you’re introducing but also the current state of your business.

The best time to achieve good ROI is usually at the end of a refresh cycle when your current equipment can be depreciated.

Moving offices or establishing a new location also tends to tip the ROI equation in your favour.

Interrogate what your vendor tells you

Because there’s no standardised way of calculating ROI, it’s important to carefully interrogate any ROI assessments that potential IT providers offer you.

Examine carefully which costs they’re including in their equations and whether the benefits they’re suggesting you’ll achieve are reasonable. They’re not out to dupe you (many will in fact deliberately present a conservative case) but they don’t know your business as well as you do, specifically the precise productivity, efficiency or other dividends you’re likely to gain.

The best isn’t always best

Finally, keep in mind that the solution that promises the best ROI won’t always be best.

There will always be providers out there who are willing to do things very cheaply, and their ROI equations will hide the fact that their solutions are inferior.

Be sure that in addition to presenting a positive ROI case, your IT vendor is also one who you’re confident will deliver. IT projects always work best where there’s a long-term relationship in which both parties have “skin the game”.

Dave Stevens is MD, Brennan IT

(This blog post was first published on the SmartCompany website on February 16 2012).