Most organizations have extensive technology wish lists, but a limited amount of resources to deliver on the wish list. Around every corner lies a new opportunity to rebuild, re-platform, or reinvent the tech stack that’s gotten you this far. But with so many opportunities, it’s often challenging to assess and prioritize which projects to tackle first, particularly since each has a unique risk profile and investment requirement. This post, which includes our free ROI calculator for IT projects, will help you swiftly and effectively evaluate the return on investment (ROI) of each opportunity.
Evaluating opportunities to decide which ones to pursue is an important task. While there is not a one-size-fits-all approach to making this decision, a consistent approach can be very helpful. Developing a business case to understand both quantitative benefits like the financial return on investment (ROI) and qualitative benefits such as employee satisfaction is ideal.
Measuring the ROI of projects is inherently tricky. On one hand, there are simple ways to compare some key performance indicators – errors and speed, for example. However, other metrics – such as employee engagement or customer satisfaction – are often more difficult to quantify. Not surprisingly, your methods for measuring ROI will greatly depend on your particular use cases, so it is critical to begin with your original goals for each project. In short, it’s a straightforward task to measure investment; however, measuring benefits can be more complex. Let’s look at each.
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Investment Inputs for our ROI Calculator for IT Projects
Investment expenses are typically categorized as being either ongoing or variable (one-time). Ongoing expenses refer to both software licenses and maintenance. As platform license costs vary according to usage, understanding the number of licenses required is essential.
One-time expenses refer to single purchases that are not necessarily repeated every year. These could refer to hardware expenses, set-up costs, or even contracted labor. Some one-time expenses are financed through capital budgets rather than operating expenses, as there are different tax implications for each.
Benefit Inputs for our ROI Calculator for IT Projects
Benefits refer to the expected quantitative and qualitative outcomes of a given initiative. As these projects explicitly lead to new results, such benefits can be tricky to measure, but not impossible. Here are some ways to approach measuring benefits.
- Reduced overhead. Today, many IT projects aim to reduce manual workload which in turn will reduce company expenses. But how much and from which departments matter if you’re seeking to justify the project expense, so considering the likely results of such initiatives in advance is critical.
- Reduced errors. Process-heavy organizations generally understand the cost of human errors. In some scenarios, these are negligible. But even simple ecommerce errors add up when coupled with restocking and shipping costs. In compliance-heavy organizations, however, fines often number in the thousands of dollars. In short, the amount your organization stands to save in reduced errors is highly specific to your use case. Error reduction might mean saving a little money every day or it might mean protecting the organization from fewer more significant losses. Your risk reduction tolerance is key when evaluating this component of ROI.
- Increased revenue/profits. The above two inputs have theoretical ceilings; you can’t save any more money than you are already spending. Conversely, increased revenues and profits represent the additional business opportunities that result from successful IT projects. If throughput is increased through innovation, capture the anticipated amount of increased revenue or profits. This could be from increasing sales of existing products, developing new products, or increasing customer retention and earning more per customer.
- Qualitative benefits. While your CFO will be thrilled that you’ve approached this project from such a quantitative perspective, the truth is most technology projects go beyond the numbers. In some cases, new technology projects create new opportunities. In other cases, older platforms may no longer be supported, requiring projects to be completed. In short, it’s critical to document benefits that don’t fit as neatly into a calculator.
Next: Consider Time
Few projects provide an immediate, positive ROI. Each company will select its own horizon, based on experience, risk tolerance, etc. Shorter time frames require better execution to generate returns more quickly. Meanwhile, longer-term projections rely on your ability to predict further into the future, a difficult task for anyone.
For our ROI calculator for IT projects, we’ve assumed a five-year payback period. Your mileage may vary!
It’s All About the Hurdle
Assuming you’ve filled out the inputs and time horizon in our calculator, you now have a predicted ROI. Still, it is only a number until you consider the “hurdle rate.” In investing, the hurdle rate refers to your company’s established barometer that determines the initiatives worthy of investment.
You’ll want to know this number for your use case, as it can vary. Some companies aggressively pursue market share. (Think GE when Jack Welch took over.) Others are content with slow and steady growth. (Think GE for the sixty years before Jack took over.) Venture capital (VC) funded companies have higher hurdles because they chase higher returns and have higher risk tolerances. In truth, there is no “right” philosophy: there is simply the right one for you. It is likely that your finance team will have an idea of what sort of hurdle to apply to investment decisions.
Putting it All Together & Then Keeping it Going
With all of your inputs calculated, you’re ready to juxtapose your expected ROI against your organization’s hurdle rate. If your predicted ROI is greater than the hurdle rate, the project is deemed worthy of investment. Conversely, if it underperforms, it doesn’t make the cut.
If you Find the Math is Not in your Favor, Consider the Following:
Your project costs are too high. If your projected ROI is too low, first consider your assumptions for project costs. Have multiple solutions or vendors been considered? Can project timelines be shortened? Are you building features that do not increase benefits?
Did you capture all the benefits? Perhaps you did not canvass widely enough to understand all the parties that will benefit from your improvement. Did you estimate benefits too conservatively? Can you be more aggressive without being reckless?
Start with the projects with the biggest bang for the buck. In agile, the term Weighted Shortest Job First is used to prioritize what delivers the greatest ROI in the least amount of time. Plus, shorter timelines equate to inherently less risk, so you’ll be more confident in your expected ROI.
If necessary, extend the timeline – but be careful. Just as a six-year car loan has smaller payments than a five-year loan, a six-year event horizon will spread your capital expenses over a longer period. That said, be sure to consider how vibrant your industry vertical may be. If the projects you’ve earmarked for replatforming have been in place for a decade or more, you might be safe extending the payback period. But if you’re in an industry that frequently changes, six years can feel like an eternity!
Now you’re ready to start building the business case for your next IT Project. Download the free ROI calculator for IT projects to get started.