Standard Financial Metrics: There Is No Substitute

In its in-depth analyses of more than 100 technology deployments in the past year, Nucleus found that most companies' IT strategies lack a key ingredient required for success: a set of standard financial metrics for measuring technology value across the enterprise. Nearly 60 percent of the companies Nucleus surveyed admitted that they weren't consistently measuring the value of the technology deployments that had claimed their IT dollars.

The enterprise deployments Nucleus studied covered customer relationship management (CRM), business intelligence (BI), supply chain management (SCM), enterprise resource planning (ERP), product lifecycle management (PLM), and supplier relationship management (SRM) solutions, to mention just a few categories. The deployment scope varied from multimillion-dollar initiatives to leaner pilots involving a handful of super users, and the industry verticals represented in the surveys were equally diverse.

Subjective Investment Criteria

More often than not, Nucleus found companies basing their technology decisions on some combination of educated guesses, opinion-based research, end-user preference, industry hearsay, executive mandates, and, worst of all, ROI estimations provided by vendors. Although factors like user feedback and qualitative research do merit a place in the evaluation process, such considerations should be supplementing the quantitative evaluation of costs and benefits, not replacing it.

Existing Methodologies: Far from Perfect

Companies that claimed a standard metric, methodology, template, or protocol for quantitatively evaluating and tracking IT projects didn't hit the bull's eye either. For example, many companies' interest in looking at ROI diminished with the size of the investment in question, with decision makers only scrutinizing the ROI from projects exceeding a certain size - a strategy that is self-defeating if one considers the cumulative impact of bad investment decisions on the bottom line. Ill-conceived deployments are leading to stricter evaluation processes and the adoption of metrics such as ROI and TCO, although not as fast as they should be.

Many companies undermined their predeployment efforts to evaluate ROI and TCO by completely neglecting to track IT value and costs on an ongoing basis. Time and again, Nucleus found project evangelists that had zealously developed business cases for a deployment only to abandon any benefit-tracking or cost-tracking efforts. This approach is shortsighted and will ultimately work to the IT buyer's disadvantage. Without monitoring project performance, companies can't test initial assumptions against the real-world impact of the solution or decide whether the project should be retired, continued, expanded, or downsized.

Common Mistakes and Malpractices

Even those companies attempting to quantify ROI often made mistakes that prevented them from accurately measuring IT value, such as the following:

  • Buying or believing vendors' "average ROI," cumulative ROI, or "black box" ROI estimates. Average ROI - often touted by vendors as an indicator of potential benefits - is of little value to IT buyers because it indicates only the changes experienced by others without predicting what will happen in a new environment.
  • Restricting ROI calculations to investments exceeding a certain dollar limit. A series of unevaluated, albeit smaller, investments will not only hamper the ROI from the corporation's IT portfolio but could also progressively take away from the bottom line.
  • Considering a payback period over five years. Companies that wait more than half a decade to recoup their investments are exposing their projects to the risks of competition and obsolescence. Ideally, companies should undertake projects with a 3-year or shorter payback period so that they can follow a "deploy-and-replace" strategy, retiring solutions as better technologies emerge.
  • Using internal rate of return (IRR). IRR calculates the effective interest rate of a project but has a serious flaw: It assumes a reinvestment rate equal to the IRR. In most cases, the calculation is misleading, and it should never be used for evaluating technology.
  • Excluding indirect benefits such as productivity. Companies overlooking productivity gains because they don't directly show on financial statements are cheating themselves out of solutions that could eliminate the future need to hire additional employees and improve worker performance and caliber.

Recommendations

As companies run out of excuses for not evaluating technology quantitatively, decision makers can start following these steps to apply time-tested and reliable financial methodologies for assessing IT investments:

  • Assess the direct and indirect costs and expected benefits from the solution. This doesn't have to be hard if companies follow some simple and consistent methodologies.
  • Assess payback time and the risk factors associated with the project.
  • Use an independent ROI calculation as a road map for pre- and postdeployment project evaluation, treating metrics such as TCO and NPV as supplementary guidelines rather than key indicators of value.
  • Disregard vendors' ROI calculations. ROI is not about a quick calculator generated by a black box, but about accurately and honestly measuring the real costs and benefits of a solution over time.

Conclusion

Despite the growing concern over ROI and the quantitative scrutiny of technology initiatives, most companies don't get a passing grade when it comes to practicing the consistent measurement of IT value. Nearly 60 percent of companies studied by Nucleus in the past year have yet to instate a standard financial methodology for evaluating technology acquisitions. Of the corporations leveraging financial metrics, few are using the appropriate combination of metrics or applying these metrics consistently to every software deployment across the enterprise. To maximize the returns from their overall portfolio, companies should use ROI with supporting metrics to approve and plan each deployment and continuously track benefits and costs over the life cycle of every solution.

Copyright © 2003 IDG Communications, Inc.

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