Lies, Damn Lies and Average ROI

Everyone’s talking about ROI these days and vendors often tout the “average ROI” their users are getting. Others promote cumulative ROI (cROI) as the truest measure of value. Although both are great for marketing, both are laughable for the folks in finance. If you’re spending real money, you should be using real metrics and that means if it’s not in your CFO’s old finance textbook, you shouldn’t rely on it to evaluate technology investments.

Average ROI can’t predict the future

“Average ROI” represents the average gains that a group of companies reported after deploying a given technology. As such, it provides some indication of the level of satisfaction among the current customer base; if average ROI is high, then most of the surveyed users are happy, presumably. But those users could have been really bad off before. Average ROI only measures the change a set number of companies experienced it doesn’t predict what you will get.

Cumulative ROI lies about the past

Cumulative ROI pretends to represent the sum of the gains made by a specific company over a certain length of time. The number adds the benefits from all years under consideration, then divides by the initial cost.

Cumulative ROI is deeply flawed for a number of reasons. First, it can be used to refer to any length of time – even to the entire “life cycle” of the product measured – which means it yields a number that is several times greater than the real return on investment. For example, if a vendor’s promise of a 200 percent cROI depends on a 5-year span, they’re really offering 40 percent ROI per year, and even less once the time value of money is taken into account.

Because it aggregates returns unreasonably, cROI gives an exaggerated portrayal of returns, and gives no sense of what will happen to the bottom line when the company closes its books at the end of each year.

Because returns from a technology deployment tend to grow over time, cROI also gives a very misleading picture of what will happen in the crucial first year, and of the likely payback period. This metric is far more likely to deceive than clarify when a company needs to make a purchase decision or to predict actual returns on an investment.

Annual ROI and payback measure best

Annual ROI measures returns per year, relative to an initial investment, for a specific company; often, an average of annual ROI taken over a three-to-five year period is used to provide the fairest picture of results. Payback period indicates the length of time that will pass before a company recoups its original investment. Together, these two metrics make the best basis for making purchase decisions and the best tool for predicting returns.

Unlike an average ROI drawn from a survey of other companies, annual ROI can serve as a trustworthy prediction of the effect that deployment will have on a specific company’s bottom line. To calculate or estimate annual ROI, prospective technology buyers can take into account costs and benefits and timelines that reflect their company’s real environment, not a hypothetical or “average” one. Although this requires a structured look at current assets and resources to support a project, and evaluation of the real benefits users will receive (not just the advertised ones), it’s the only way to clearly measure the impact technology will have on the corporate bottom line.

Annual ROI and payback period together correct the faults of cumulative ROI. While annual ROI provides a number that hasn’t been puffed up for show, payback period provides a reliable indication of what will happen in the first year or two following deployment.

Average ROI may satisfy the lazy, and cumulative ROI may impress the foolish; but only a well-grounded analysis based on annual ROI and payback period will suffice when real money is on the line.