“Return on Investment (ROI)” based business cases are used by CIOs, IT directors and financial executives for planned IT actions and acquisitions.

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1IT Business Case PAGEREF _Toc88460450 2<br />1.1Need for Business Case PAGEREF _Toc88460451 2<br />1.2Essentials for building a Business Case PAGEREF _Toc88460452 2<br />1.3Cost Benefit Analysis – In a Nut Shell PAGEREF _Toc88460453 3<br />1.4Cost and Benefit Allocation PAGEREF _Toc88460454 3<br />1.5Use of Incremental or Total Value Approach PAGEREF _Toc88460455 4<br />2Arriving at an ROI – Step by Step Approach PAGEREF _Toc88460456 4<br />2.1Establish the Purpose PAGEREF _Toc88460457 4<br />2.2Establish a Team PAGEREF _Toc88460458 4<br />2.3Arrive at an Appropriate Cost/Benefit Model PAGEREF _Toc88460459 4<br />2.3.1Costs PAGEREF _Toc88460460 4<br />2.3.2Benefits PAGEREF _Toc88460461 4<br />2.4Collect data based on the Cost model PAGEREF _Toc88460462 4<br />Generic IT Cost / Benefit Model PAGEREF _Toc88460463 4<br />IT Business Case<br />ROI and Business Case<br />Business cases are built for various scenarios:<br />Getting budget approval for specific IT projects<br />To get management “buy-in” for strategic decisions<br />To justify the IT investments being made in the past few years (some kind of interim business case that can aim at the future of the project)<br />“Return on Investment (ROI)” based business cases are used by CIOs, IT directors and financial executives for planned IT actions and acquisitions.<br />Return On Investment (ROI) is the most common method to quantify the costs and benefits of new IT initiatives. A study published by InformationWeek found that 82% of organizations require some form of Return on Investment (ROI) analysis prior to approving any significant new IT purchase.<br />There are – and have been – proven techniques and tools for building ROI based business cases. But the credibility and accuracy of the IT business case is often questionable and the personnel end up frustrated as they are unable to sell the business case to whoever that matters.<br />Why has effective ROI measurement for IT been so difficult to establish? Respondents to the Information Week study suggested the following: <br />77.9% said it is simply too difficult to measure the benefits of IT <br />53.8% have no comprehensive or reliable metrics available <br />35.6% can't provide a complete accounting of IT investments <br />This article aims at providing a methodology and a “step-by-step” approach on how to proceed with arriving at IT ROI figures.<br />Essentials for building a Business Case<br />Building a good IT business case requires the following:<br />Track down the costs, benefits and potential impacts. The more thoroughly this is done, the more accurate the business case is. Of course, the availability of time and expected usage of this business case will ultimately decide the approach adopted. It is always recommended that the exclusions are still documented.<br />Clearly and logically articulate the cause and effect chain that leads to each of the cost or benefit impact (note that all are not direct effects). IT resource requirements, available capacity, service levels, user needs, mandatory requirements are all interlinked.<br />Be objective and unbiased (trying to justify an investment may lead to a biased data collection which focuses more on benefits than costs or risks). Try to include all the relevant inputs – whether good or bad.<br />Use good models (as it would help to take care some of the issues of identifying the cost/benefit heads and essential features of financial aspects)<br />Use systematic rules for finding and summarizing data<br />Usage of appropriate methodology and exploiting proven techniques would help in making this process more objective and hence reliable.<br />Cost Benefit Analysis – In a Nut Shell<br />Net ResultBusiness ImpactCategoryNet CostIncrease in CostDirect Cost Impacts (based on ASIS and TOBE states)Neutral ImpactContinuing CostNet BenefitDecrease in Cost Avoided CostCash InflowAdditional Benefits expected due to the initiativeTangible but non financial benefitContribution to strategic business objective<br />Arriving at a cost model is identifying items that produce any of these “business impact”. And a business case (and a ROI) is arrived at by assigning financial value to each of these items, to see the “net effect” of the IT Initiative.<br />Cost and Benefit Allocation<br />IT changes are typically evolutionary in nature where the upgrades are made to the existing infrastructure. While some of the existing resources (e.g., operation personnel) is shared, new technologies are added. What fraction of the existing resources costs should be allocated to the new initiative? – is a major question.<br />Consider a scenario where a COTS product is going to replace an existing application and will use the existing infrastructure (with some upgrade, if necessary). How to account for the cost factors for arriving at a business case for this situation? There are multiple ways of handling this:<br />Using techniques such as activity based costing, capacity planning etc., objectively assign the cost based on the expected usage of the new system. (But it doesn’t give a correct picture for decision making if the available unused resource can be used at apparently no addl. Cost).<br />If ROI is to be arrived at based on total investment cost estimate, the shared resources costs can be assigned at some proportion (based on judgement) to the new system<br />Two cost / benefit scenarios – one for current situation and one with the proposed system be arrived at. The difference between these two gives the net effect of the proposal. Though this is not strictly “ROI” (based on total costs and benefits), this approach can be used for decision-making purposes.<br />Use of Incremental or Total Value Approach<br />Under the total value approach, cost/benefit items are given the total value in each of the scenarios. The decision making is typically based by comparing the cost/benefit data at “Current scenario” with the “proposed scenario”. Similarly this approach can be used to evaluate multiple options.<br />In case of incremental approach, the current situation is treated as the baseline and only the incremental changes are assigned as values of line items. The net effect of this will show whether the proposal means better or worse situation compared to current setup.<br />The total value approach is preferred when:<br />Case is meant for budgeting purposes – where the total cost detail is required<br />No viable “current scenario” to be used as the baseline<br />The cost part of the analysis is expected to be used as input for “TCO” analysis<br />The incremental value approach is suitable when:<br />the investment decision is to be taken based on expected effect of the action, independent of other financial factors<br />The incremental costs and returns are small compared to total costs and benefits<br />Both these approaches can be effectively used for decision making. But the problem is when mixed approach is used – where for some line items the value assigned is total and for other incremental. <br />Arriving at an ROI – Step by Step Approach<br />Establish the Purpose<br />When you are asked to do an IT business case analysis – Cost/benefit, TCO, financial justification etc – clearly establish the purpose of the exercise. As discussed earlier, the purpose (for e.g., budget planning or decision making) would clearly influence the cost model you will adapt. <br />Similarly try to establish some guidelines on cost data collection, rationale of assigning values to benefits, analysis period over which you will consider the cost and benefit, any constraint in terms of breaking even etc.<br />Establish a Team<br />Though it could be tempting to go ahead, collect all cost and benefit details and then present the results, it is risky to proceed in that fashion. Similarly, getting data from one source should be strictly avoided.<br />A team approach is preferred due to following reasons:<br />Cost and benefit data collection involves various arena and hence requires involvement from personnel with different experience and perspective:<br />Operational impact of IT areas needs to be obtained from managers of each impacted area (e.g., customer service, marketing, procurement etc.)<br />Financial perspective is required to take into account the long term business plans<br />HR perspective to account for personnel costs (recruitments, retraining, job satisfaction impact etc.)<br />Senior Management perspective to be able to prioritize and assign meaningful values of IT impact (directly connected to organization’s strategic objectives)<br />The nature of information technology is such that it impacts almost every functional aspect of an organization. IT impact analysis in a corporate environment can be complex and to some extent relies on assumptions, judgments. Hence it is not impossible for two people to evaluate a same proposal and come up with two different results. Involvement of a team would help in mitigating this risk to a certain extent.<br />If you are a consultant doing this work, make sure that the appropriate personnel from the clients’ enterprise would provide you the data and clarification as required. Also make sure that periodical review is planned for – to avoid last minute surprises.<br />Arrive at an Appropriate Cost/Benefit Model<br />Establishing a cost model early on is recommended (as compared to building the model as and when the data is made available which obviously has the flaw that some critical but not so obvious factors are easily missed out). <br />A cost model is nothing but a list of all possible cost and benefits (expected over a period of time). <br />The cost model should have the following:<br />Identify the factors that have cost impact (include decisions on which data to omit)<br />Ensure that double counting is avoided<br />Establish the reasoning behind why a factor is included (or excluded)<br />Establish link between the common causes or effects (so that change impact can be easily handled)<br />Take into account the additional financial factors like Interest rates, Net Present Value, depreciation, tax rate, cost of capital etc.<br />This would provide the template based on which the data collection process can be carried out. The cost model – which is going to be the base – has to be reviewed and agreed upon. This would avoid missing of a major component or factor in the analysis. <br />Costs<br />The major cost heads are:<br />Infrastructure Related<br />Hardware (e.g., Server, Storage and other peripheral HW)<br />Software (e.g., software license, software development costs)<br />Network and Communications <br />Other Infrastructure costs (e.g., floor space, site planning etc.)<br />Personnel Related<br />IT Personnel costs (e.g., System setup cost, external consultant cost etc.)<br />User Personnel costs (e.g., user training)<br />Other costs<br />Marketing costs (e.g., brochures to be sent to customers about the new products)<br />Travel costs (e.g., promotional activities)<br />The common pitfalls when arriving at the costs are:<br />Focus more on Hardware and Software costs (whereas the people costs may form the majority)<br />Focus on the initial acquisition costs (or one time costs only – whereas the recurring operational costs alone are considered)<br />Focus on the cost without considering the growth factor.<br />Cost gathering can be done as follows:<br />Everything that is directly and exclusively associated with the project/initiative should be included at 100%<br />Purchases that are partially driven by the specific project/initiative should be included as percentage representing the extent to which the project drives the expenditure<br />General infrastructure costs not associated with the project/initiative should not be included<br />Benefits<br />The benefits expected from an IT initiative can be broadly classified into two categories:<br />Cost Savings and Avoided costs – e.g., reduction in license fees, reduction in communication charges, paper usage reduction, reduced number of employees etc.<br />Benefits besides these savings – e.g., increased productivity<br />The cost savings are easier to arrive at as it basically depends on the costs from the ASIS scenario and the post IT Initiative scenario (and in most cases directly related to usage of IT resources).<br />In case of major IT initiatives, the real (or significant) benefits are the ones besides savings – Cash inflows, Tangible but non financial benefits, Contributions to strategic business objectives, avoided risks etc.<br />Accounting for these benefits is tricky for the following reasons:<br />Some are “Soft benefits” whose impact is not certain and may not translate to real money (e.g., improved professionalism of staff, quicker customer service)<br />Benefits are difficult to quantify<br />Benefits that results from other actions besides IT (e.g., introduction of a new product)<br />It is essential that the benefits to be excluded (or included) and reasoning behind the same is made with the agreement of the clients’ management.<br />Also the reasoning behind building the business case would influence the factors that are to be included. For e.g., if the exercise is aimed at arriving at the financial budget for IT, non-financial impacts such as “improved staff morale” need not be included. But if it is a question of making a decision on whether to go or no-go, then all considering all benefits is appropriate.<br />Collect data based on the Cost model<br />Start collecting the data to fill in your cost model. In the process, get information on the assumptions, risks and inter-linkages between these cost items. <br />An IT investment can provide benefits such as improved customer satisfaction, more professional work environment, better brand image etc. But unless these benefits are quantified, these will get “zero” value in financial summary (based on which the decision may be taken) and undermines these crucial benefits which are aligned with the organizational strategic business objectives.<br />For example, improved customer satisfaction could be the organizational objectives, towards which the IT initiative alone may not be able to guarantee results (additionally orienting the staff on customer service and other non-IT related costs may have to be incurred). But the Thumb-rule is, if the IT action is necessary and clearly a contributing factor to achieve this business goal, then the credit of it should be considered.<br />Alternate approaches of quantifying these business benefits are:<br />Quantify the value of the effect of the benefit - “More Professional work environment” – benefit can be in terms of improved employee turn-over – quantifiable in terms of reduced recruiting, training costs and increased productivity.<br />Consider the cost of an alternate solution – for e.g., “availability of customer data” to field-officers, the benefit of IT can be measured as equivalent to the cost of the alternate approach by which the same can be achieved (e.g., phone calls to dedicated employees who will provide the information)<br />Consider the cost of not having the benefit (e.g., System availability benefit can be measured in terms of “downtime costs”)<br />Analyze data and Present Findings<br />By following all the above steps, you have now arrived at the requisites to calculate ROI. ROI is typically calculated as a Ratio or Percentage – based on the Costs and the Benefits. Using Net Present value, taking into account the interest rate for the capital, is recommended. <br />Simple ROI can be calculated as “(Benefits – Costs)/Costs” as a percentage. While this can be useful in giving a opinion on whether the project is worthwhile, it is better to breakdown the costs and benefits expected on a yearly basis. This will give the decision maker insight on the pay-back period.<br />Based on these, the trend of the costs (onetime as well as the recurring costs), benefits can be useful in making informed decision. In addition to this, depending on the granularity of cost and benefits used for analysis, What-if analysis can also be carried out.<br />Generic IT Cost / Benefit Model<br />CostsImplementation costsOperational CostsGrowth CostsHardware CostsServer purchase / UpgradeClient system purchaseStorage purchase / upgradePrintersScannersOther peripheral H/WH/W maintenanceH/W lease Additional Server costsAdditional client costsServer CPU UpgradesStorage space expansionOther peripheral h/w acquisitionSoftware CostsSystem software purchase / licenseApplication software purchase/licenseS/W Development costsS/W migration costsPeriodic S/W license changesS/w maintenance chargesSystem software upgradeAddl. s/w licensesNetwork & CommunicationsNetwork / Commn. Hardware purchaseNetwork / Commn. Software purchaseLine acquisitionInstallation of commn wiring, cables etc.Line usage chargesWireless chargesOutside Internet service provider chargesSatellite or other WAN chargesN/W Change planning costsAdditional network H/w or S/wAdditional cabling / preparation chargesOther InfrastructureFloor space (acquisition/construction)Initial site planningElectricity costsSecurity costsSite expansion / renovation / consolidationPersonnel Costs: ITPlanning costsH/W installation effortS/w installation effortNetwork setup effortApplication s/w setup effortS/w Migration effortInitial training costsHiring costsAdministration effort (OS, Network, etc.)Trouble shooting effortContinued trainingH/W reconfiguring, setupOS Upgrade effortNW changesCapacity planning effortPersonnel Costs: UserInitial user training costsUser trouble shootingUser help Continuing user trainingAdditional user trainingMiscellaneousDowntime costs due to upgrade<br />BenefitsCategoryItemsDirect SavingsDecrease in cost / Avoided costReduced printing and postageReduced returns handling costsCash InflowIncrease Revenue / ProfitsIncreased profit from distributorsIncreased cross-selling revenuesIncreased up-selling profitsIncreased profit from sales efficiencyOther BenefitsImproved Technology MgmtReduced development costsReduced integration timeReduced Integration testing costsReduced System Maintenance costsReduced IT employee trainingReduced Infrastructure costsReduced network costsReduced project planning costsOther BenefitsImproved Process MgmtReduced administrative overheadIncreased worker productivityReduced cost of errors and omissionReduced communication costsReduced cost of salesReduced Employee training, hiringImproved working capitalReduced cost of regulatory filing and approvalOther BenefitsImproved Customer and Partner communicationImproved inventory managementReduced or managed time to marketReduced logistics costsReduced product reworkProfit on increased revenueReduced customer care costsIncreased customer retentionImproved working capitalOther BenefitsImproved information organization and accessReduced marketing costsReduced product reworkReduced communication costsReduced/managed time to marketIncreased worker productivityLower employee turnoverReduced employee training costs<br />