EXECUTIVE
SUMMARY | The difficulty of
calculating the return on an IT
investment often has weakened the case for
funding such initiatives.
Financial managers
and other decision makers
expect requests for IT funding to be
framed in an ROI or shareholder value
format so they can compare them with
other investment options.
The successful
measurement of IT projects
involves evaluating critical resources
and processes that produce desirable
results and lead to overall
organizational success.
It’s essential to
assign monetary values to
nonfinancial IT results. Although some
benefits of IT initiatives do not always
produce short-term profits, they should
reduce costs or increase revenue.
To calculate the
return on an IT investment,
measure its total costs, including those
related to disruptions and risks, as
well as its total benefits.
Marc J. Epstein
is Distinguished Research Professor
of Management at Jones Graduate School
of Management at Rice University in
Houston. His e-mail address is
epstein@rice.edu
.
Adriana Rejc Buhovac
is assistant professor on the
Faculty of Economics at the University
of Ljubljana, Slovenia. Her e-mail
address is
adriana.rejcbuhovac@ef.uni-lj.si
.
|
n too many
organizations, decision makers overlook economic
rationality in justifying information technology
(IT) spending. Instead they acquire the best and
most recent technologies to outpace other
companies. The pressure to remain competitive is
forcing many organizations to consider a more
results-based approach, where the central question
is: Will we see a return on investment (ROI)?
Large IT, e-commerce and enterprise resource
planning (ERP) system investments all face the
same challenge: demonstrating their value in light
of the historical difficulty of estimating the
revenues they generate and their total costs.
Note: This article is
related to one the authors wrote for the
February 2005 issue of CMA Management
magazine and is based on
Evaluating Performance in
Information Technology, one of a
series of Management Accounting Guidelines
published by the AICPA and the Society of
Management Accountants of Canada
(CMA-Canada).
| It typically
falls on senior corporate and financial managers
to evaluate the payoffs and recommend resource
allocations, and CPAs who know how to accurately
calculate the return on technology investments can
guide them through this process.
Talk Is Cheap— But
Can
Be Costly
Nine of 10 executives agreed
that information technology
could create significant competitive
advantages, but only 6 of 10 agreed
that their organization’s IT spending
was completely aligned with its
business strategy.
Source: Management Tools and Trends
survey, Bain & Company,
www.bain.com , 2005.
| With CEOs
and CFOs demanding accountability for the
tremendous investment in IT, managers are required
to calculate the ROI and make a bottom-line
contribution. Few things are more convincing to
top executives than measurable results. IT
executives must find ways to measure and
communicate the contribution of IT so that
existing initiatives are managed appropriately,
new projects are approved only when there is
satisfactory return and marginal or ineffective
projects are revised or eliminated. They need
comprehensive systems to evaluate the impact of IT
initiatives on financial performance.
Typically, the payoffs of IT are not measured,
ROI is not calculated and IT investments are not
evaluated with the same rigor as other corporate
investments. While senior IT managers are
convinced they do create value and their
initiatives would be significant profit centers if
measured properly, they have difficulty proving
it. Because CEOs and CFOs lack the information
necessary to make well-informed decisions on the
payoffs of these investments, most companies seem
to focus on reducing the cost of IT rather than
maximizing its potential to create value.
This article describes a model that CPAs can
use to evaluate IT performance and calculate the
payoff. Accountants can use it to help CIOs
evaluate and justify their initiatives and to
assist CEOs and CFOs in making better
resource-allocation decisions.
THE STARTING POINT
Exhibit 1
describes the inputs, processes, outputs and
outcomes of IT initiatives. An organization’s IT
success is dependent on inputs . These
include the existing corporate strategy, structure
and systems. Along with available resources and
the external environment, these are critical
inputs that affect IT strategies. Other factors,
such as leadership, IT structure and systems or
processes , also significantly affect
the performance and success of IT initiatives. The
inputs and processes have an impact on IT
outputs , which can be classified as
either internal outputs —such as
improvement in productivity, time savings, quality
or overall cost reduction—or external outputs,
such as customer acquisition, satisfaction
and loyalty. If the IT strategy and implementation
are successful, these outputs should result in
improved overall corporate profitability—the
outcome . Every IT project or
initiative must be measured and evaluated along
the four dimensions of the IT Contribution Model.
It is important to understand the relationships
leading from the inputs to the processes and then
flowing to the desired outputs and outcomes. For
example, if an organization inputs more resources
to consolidate and standardize its IT
infrastructure, its improved IT processes will
lead to time savings, which in turn will increase
customer satisfaction and loyalty, sales and
revenues.
USE THE RIGHT YARDSTICK
Companies must develop appropriate metrics
to closely monitor cause-and-effect relationships.
Because some elements, such as leadership, are
more difficult to measure, the temptation is to
avoid measuring them at all. However, if they are
considered crucial in demonstrating how IT can
improve business success, they must be
incorporated in the performance measurement
system. It may be that nonfinancial performance
measurement is more appropriate in such cases, but
CPAs should try to use monetary values as often as
possible when measuring drivers as well as
outputs. For example, improvements in quality may
be measured by the percentage of high-quality
products, but it is more important to measure the
dollars saved on reduced rework. Similarly,
increased employee productivity can be measured by
the percentage increase in production output per
employee, but it’s better to measure the
additional sales that result.
Exhibit 2
lists a selection of measurement criteria. A
more complete list of performance measures can be
found in the Management Accounting Guideline,
Evaluating Performance in Information
Technology, published by the Society of
Management Accountants of Canada (CMA-Canada) and
the AICPA (see “ AICPA Resources
”). There is no rule for the right number of
metrics to include in measurement systems, but
using too many tends to distract managers from
pursuing focused IT initiatives. It is important
to focus on the key indicators. Generally, a
complete IT performance measurement system should
include no more than 20 measures.
CALCULATING THE RETURN
The metrics for IT inputs, processes and
outputs provide the tools IT managers and
financial managers need to calculate the ROI. For
the calculation to be complete, IT benefits and IT
costs must be carefully identified and addressed.
The IT Contribution Model plays a vital role by
articulating the drivers of IT ROI, the
relationships among them and all potential
benefits. One study (“What CEOs Really Think about
IT” by Erik Monnoyer in The McKinsey
Quarterly, No. 3, 2004) reported that only
half of companies actually monitored expected
benefits. The challenge of calculating the ROI of
IT lies primarily in determining the benefits of
IT projects and transforming them into monetary
values. Because many IT projects overrun
their cost projections, it’s important to be
careful when estimating costs. Base estimates on
the total lifetime costs of the project, including
planning, forecasting potential risks, development
and implementation, as well as maintenance and
upgrades and disruption costs, both human and
organizational. In general, the ROI
calculation should be performed on a marginal
basis, including only additional costs incurred by
the new system. Likewise only new or additional
benefits should be compared with the costs.
A PRACTICAL EXAMPLE
Company ABC decided to standardize and
consolidate its computer software and hardware,
including new notebook computers. It began a pilot
study of 100 employees to estimate how much the
notebooks would improve productivity and financial
results. On the cost side, ABC considered
the front-end direct costs, the operating costs,
the disruption costs related to human factors
(hours lost due to IT training), the disruption
costs related to organizational factors (lost
orders and lower customer satisfaction) and the
costs of risk mitigation (the development and
implementation of an IT performance framework).
When it came to benefits, the employees in
the pilot study reported average weekly time
savings of two hours using the new notebook
computers. Their productivity improved because
they were likely to use their laptops more
frequently and in more locations. As a
consequence, ABC began offering more services,
which in turn led to an increase in the number of
new customers acquired. The notebooks also enabled
faster and on-time placement of orders, which
improved the manufacturing capacity utilization
(saving an estimated $50,000 in operating costs)
and shortened delivery times. The overall quality
of business processes improved, reducing grievance
costs by $10,000. Customer loyalty also improved,
leading to an increase in the profitability of the
average existing customer. Finally, the study
reported savings in direct IT costs based on the
increase in information systems security, which
reduced system downtime by 10 hours. (More details
are provided in exhibit 3
.) The ROI should be calculated before
beginning an IT project to estimate its potential
cost effectiveness and after the project to
measure the results. Because the benefits of an IT
investment increase over time, ROI should be
calculated yearly throughout the life of the
project. This facilitates budgeting, planning and
resource allocation, and fits into a broad
performance evaluation and reward system.
APPLES TO APPLES
In the early days of computing, investments
were made almost exclusively on the basis of
direct financial benefits that generally related
to direct cost savings. But the opportunities for
such direct savings have been reduced greatly.
Despite the difficulty involved, using
nonfinancial measures of performance—such as
improved organizational agility and
communications, enhanced employee performance,
more flexible working conditions, safer
environments and higher job satisfaction—to
quantify the longer-term or indirect benefits has
become increasingly significant. These longer-term
benefits may stem from enhanced management
performance through better and timelier
information, an improved decision support
capability or a reduction in the number of
meetings because of better communication.
Integration of IT systems, enhanced security and
improved relationships with suppliers also are
drivers of more indirect, longer-term benefits.
These benefits will not always clearly
translate into short-term profits, but they should
ultimately lead to either cost savings or
increased revenues. The transformation of these
internal outputs to monetary terms is illustrated
in exhibit
4 . Generally, cost savings from IT,
which traditionally applied primarily to staff
displacement, now can be traced to reduced
employee overtime, less need for specialized and
more expensive staff, and reduced travel costs.
All sources of time savings—such as less searching
for information, fewer phone calls and queries and
reduced order processing time—lead to cost savings
and potentially to increased sales. Improved
quality control saves cost by reducing rework,
rejections at final inspection, mistakes in
invoicing and delivery, customer returns and
help-desk requirements. These improvements
originate from reduced capital and maintenance
costs for new equipment and enhanced
inventory-control systems that lead to savings on
cash flow and reduced inventory, floor space and
employee time. With respect to additional
revenues, some systems make it possible to
introduce new products, to develop products faster
and in a more focused manner or to provide
economic justification for previously unacceptable
products. Improved asset utilization also can lead
to potential increases in production and
consequently in revenues. But external outputs,
such as channel optimization, customer
acquisition, customer loyalty and adding value,
are more directly related to creating business
value. Thus, translating these benefits into
monetary value shouldn’t be a difficult task.
But metrics for customer satisfaction,
acquisition and loyalty must be chosen carefully.
Customer approval ratings that are based on
satisfaction surveys, for example, are more of a
leading indicator of customer satisfaction and
represent a customer wish list more than they do
real requirements. Also, while the customer
acquisition rate can be an important indicator,
the best signs of customer satisfaction may be the
customer retention ratio, the ratio of serious
customer complaints to quantity of services and
products provided, and the level of increased
spending per retained customer. |
Understand
relationships between inputs,
such as corporate strategy and
systems, and outputs, such as
time savings and customer
satisfaction.
Because the
benefits of IT investments
increase over time, calculate
ROI yearly throughout the life
of the project.
Choose customer
satisfaction, acquisition and
loyalty metrics carefully.
Customer approval ratings
based on satisfaction surveys,
for example, are more of a
customer wish list than real
requirements.
Before
implementing the IT
Contribution Model, establish
baseline indicators for the
specified performance measures
so you can draw conclusions
about the actual benefits of
IT initiatives.
To maintain your
IT budget’s return on
investment, pay ongoing
attention to asset tracking,
usage data, total cost of
ownership and IT performance
measurements.
| |
KNOW WHERE YOU BEGAN
Before implementing the model, establish
baseline indicators for each performance measure
you intend to track. This will enable you to draw
conclusions about the actual benefits of your IT
initiatives. With more historical data from within
your organization and from other organizations,
you can establish benchmarks and use them to
objectively evaluate the results your IT projects
achieve. It’s essential that you identify
and measure the present and future marginal costs
and benefits of IT initiatives in order to have a
comprehensive and objective calculation of the ROI
of your IT initiative. In particular, disruption
costs that are associated with the adoption of IT
initiatives typically are significant and require
a thorough evaluation. Getting real business
value from an IT initiative begins with a
structured and careful examination of costs,
benefits and risks from the initial feasibility
through postimplementation. Companies need to pay
continuous attention to asset tracking, usage
data, total cost of ownership and IT performance
measurement. By using some forethought and
a structured approach, CPAs can convert diverse
and often imprecise data into coherent and
measurable management strategies. That, in turn,
can help management choose the IT investments that
will boost profitability and—almost as
important—pay for themselves.
|
AICPA
RESOURCES
Special interest group
The AICPA Information
Technology (IT) Membership
Section is an AICPA voluntary
membership section for CPAs
who want to maximize their IT
skills in order to increase
efficiency and boost profits (
http://infotech.aicpa.org/Memberships/Information+
Technology+Membership+Section+Overview.htm
).
Credential
Certified Information
Technology Professional (CITP)
designation. A CITP is a CPA
credentialed as a technology
professional and recognized
for his or her unique ability
to bridge the gaps between
business and technology.
Information about the program
and applying for it is
available at
http://infotech.aicpa.org/Memberships/The+Certified+Information+
Technology+Professional+Credential.htm
.
Conference
Tech 2006: The AICPA
Information Technology
Conference Hilton Austin
Austin, Texas June
12–14, 2006
Publication
Management Accounting
Guideline, Evaluating
Performance in Information
Technology (paperback,
# 030000JA; download, #
030000PDFJA). For more
information or to order, go to
www.cpa2biz.com or call
the Institute at 888-777-7077. | | |