What is an ROI and what’s the big deal?

Believe it or not, your company’s CEO and CFO have tough jobs with difficult decisions to make. It’s not a matter of sitting in the nicest offices and beaming over your company’s successes. There are hurdles around every corner and overcoming challenge is the name of the game for any top executive.

You’ve heard me say before that the CEO has limited resources just as you do in your IT management or CIO role. You will probably never have an organization where you have all the resources you need to do the things you would like to do, , , or even need to do. If you do, you are either not wanting to do enough or you probably have more resources than you should have.

One of the things CEO’s have to balance is where to put the cash in funding new projects. Every department manager needs funds to do the things that will make a tangible difference for his/her department. For example:

  • The HR Director needs a new HR system to streamline his operation and to avoid hiring four more people.
  • An operations unit needs more office space due to growth. A move to a new office is anticipated.
  • Your internal Billing and Receivables department wants scanning & imaging capability to eliminate tons of paper.
  • A new company acquisition is being eyed to expand the company’s market share.

And then there are the IT initiative needs.

Get the picture?

First of all, the company can’t do everything at once. Even if it had all the available cash to do so, the company’s staff resources may not be able to absorb this amount of change simultaneously.

This means that the CEO has to balance approving new capital intensive initiatives and handing out the funds. In order to make knowledgeable decisions as to which project makes sense, has more benefit, etc. the CEO and CFO need something that can sort of “normalize” all the project initiatives so they can compare them side by side.

One of the tools they use is a Return on Investment (ROI) calculation.

A new initiative proposal that includes an ROI calculation tells senior executives several things:

  1. Cost of the project
  2. Timing of expenditures
  3. Benefits of the project and how the investment will be recouped
  4. Timing of when the benefits will occur to pay for the investment

Just because a project has a huge payoff does not necessarily mean it gets priority over projects with less return. For example, if a project costs the company $1,000,000 and has a $2,000,000 expected return over three to five years, it’s probably a worthwhile project to do. However, a $100,000 project that has a 9 month payback might get preference for several reasons:

  • The cost is lower and more affordable at the time.
  • The payback is much quicker and the company needs to show faster results for any number of reasons.
  • There may be issues such as compliance or other types of risk that push the smaller project to the front of the line.

Three things have major influence with your CEO and CFO in getting your projects funded:

  1. Your track record of success
  2. The company’s need for what you are proposing
  3. A good feeling that the return is real and of reasonable time for the cost

This third item is where having an ROI component in your IT initiatives recommendation will make the difference. It also makes a difference in that you are presenting a business solution with elements that speak the same language as your CEO and CFO, something that helps them a great deal.

So, how do you go about calculating an ROI?

First, understand how companies will look at the financial part of a proposed initiative. Some companies take a very deep, analytical look at it including time value of money etc. However, most company execs will look at the issue at a higher level. What most want to know is how much does it cost, how long to recoup the cost, and how are you going to recoup the cost.

I will typically map out by month the expenses we expect to incur in the project and actually break it down by type of expense (labor, supplies, travel, outside contractor, etc.). This is simply part of building a high level budget for the project as you normally expect to do.

Then, I extend the time to show when and how much savings we start to see beginning at the appropriate time until the project is paid for. The total number of months it takes to complete the project and receive the benefits that pay for the project is the ROI, , , or “X” months to pay us back for our investment.

Let’s take a very simple and hypothetical example to show you what I mean.

Assume we have a project to cut our $80,000 per month postage cost in half. The project takes three months and costs the company $240,000 to complete. Let’s also assume that once the project is completed, we start saving the company half of our average monthly postage cost, or $40,000 per month.

One quick calculation of dividing the cost ($240,000) by the monthly savings ($40,000) tells you the payback is 6 months upon completing the project. Every CEO will jump at such an opportunity, especially since the $40,000 monthly savings will be an ongoing benefit to the company.

In my proposal, I will show the project time line, estimated cost, and a forecasted Return on Investment of 6 months after the project is completed. I will also explain how the savings are going to occur and other benefits that may result by doing the project.

Behind the scenes, I will develop more detail to help me arrive at the numbers I need to present to the executive committee. This detail will include a high level summary of the project’s budget and detail showing how much we will save, when savings are being achieved and where they occur.

A sample of the  proposal to the executive committee will include something like the following:

In this example, the project has a 9 month Return On Investment (ROI). It takes nine months from beginning the project to completely recoup the costs of the project.

Most CEO’s and CFO’s relate to the entire time frame it takes to implement the project and to recover the project cost. As long as you can give them a reasonable assurance it can be done in the amount of time you forecast, you have a good chance in getting the project approved assuming it falls within their “reasonable payback criteria”.

CEO’s differ in how long a reasonable payback is. Some will jump at almost anything that has an 18 month payback or less while others are more selective. It helps to understand your executive team’s personality and how they look at funding new initiatives.

Even at this level, it’s still a summary. You should estimate the labor costs based on the types of resources needed even though you may not have picked out the staff to do the project yet. Other costs will be estimated and you should gain a pretty good idea for the equipment and software costs as they are more significant and a major part of the actual solution.

Bottom line is that you will have exact numbers for some cost items and will estimate conservatively for other cost items to insure you can meet or exceed the cost expectations you are setting with your proposal.

The good thing about having the project summarized like the example above is that it is very easy for your executive team to follow and understand.

What do you do if there are no clear financial savings to be gained?

Good question and one that often occurs. In such a case, you need to translate tangible benefits into dollar equivalents, if possible. For example, if a proposed initiative reduces systems downtime, take the expected time of additional uptime and multiply by an hourly dollar factor of the total number of users that are affected by such downtime, , , to get an estimated “cost of downtime” hit in productivity. Learn more about this in my Calculating Cost of Downtime article.

In some cases, arriving at a dollar value may be virtually impossible. In those cases, you still need tangible benefit such as meeting a compliance issue, maintaining business continuity, supporting company growth, etc. If you can’t quantify cost savings or identify tangible benefits, your proposal has a difficult chance in getting approved.

Remember, a project doesn’t have to have financial savings to have a return on investment. Addressing a compliance issue and reducing the risk of business interruption is like buying insurance. You don’t plan to use homeowner’s insurance but it comes in handy if you have a catastrophic event.

Make it a habit to include a Return on Investment section in all of your technology initiative proposals and start tracking the actual results to determine if the ROI objectives are actually being met.  This type of action exhibits business maturity similar to that of a business owner, a sure winner in the eyes of CEO and CFO’s.

Need help in calculating an ROI? CLICK HERE to learn more and download my free ROI Tool.

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