The ROI Series, Part 3: Predicting ROI

June 2, 2011Homefield IT

The ROI Series: Calculating the ROI of a Technology Investment—Part 3. Cost savings are usually important to small businesses even in the best of times. New technology solutions may be necessary for survival and growth, however—and they may not be as expensive as you think when you consider their return on investment (ROI). In this four-part series, we’ll explain what ROI is, help you understand indirect ROI, and provide guidelines for predicting and measuring the ROI of a technology investment.

Part 3: Predicting ROI

As we explained in part 2 of this series, you can’t measure ROI simply by asking what a technology implementation will do for your bottom line. However, if the new technology leads different parts of your company to collaborate, which in turn produces better goods and services that lead to top-line growth, then your ROI is likely strong. Getting at those indirect ROI numbers, however, may be the greatest challenge of ROI analysis. Few models exist to guide you, and with good reason: determining ROI involves looking at many components, then applying those components to your particular situation. But there are things you must take into account, from both a cost and a benefit perspective, when considering the ROI of a technology investment.

• Your existing technology infrastructure. There are few companies without existing technologies in place, and any new solution will need to work with these systems to be effective. There will likely be costs associated with the new technology’s impact on existing systems—but there will also be benefits. For example, a new technology might automate the tracking of hourly employees’ work hours. Or, it might offer more efficient collaboration.

• Your business processes. A new technology can clearly improve your business processes by reducing downtime, improving productivity, and lowering costs. But implementing the new technology will likely involve training staff in using the technology—and that can have associated costs.

• Your external relationships. Finally, no business is an island. Your systems may link to customer and vendor systems. As a result, any new technology may impose constraints on or require changes of external organizations or individuals—in the way information is delivered or received, for example.

To solve this puzzle, it can be helpful to ask three different but related questions about the technology solution’s direct and indirect costs as well as its efficiency.

• Direct costs: Can you afford the technology—and will it pay for itself? To answer these questions, you’ll need to know the cost of the solution itself and the monetary value of the resources used to implement it, measured in standard financial terms. You’ll then compare the dollar cost of all expenditures to the expected return in terms of the projected savings and revenue increases. You may need to project the cost and return over a multi-month or multi-year time span in order to show a payback period.

• Indirect costs: How much bang for your buck will you realize? Now the analysis becomes more complex. Analyzing the effectiveness of a technology solution requires you to look at its costs in relation to how effective it is at producing the desired results—in essence, to expand your measurement of ROI beyond cost savings and revenue increases to include performance relative to your company’s goals.

• Efficiency: Is this the most you can get for this much investment? Finally, you’ll want to ask whether the technology will produce the greatest possible value relative to its direct and indirect costs. That can present difficulties, as it will require you to conduct a similar analysis on many alternatives, perhaps simulating the performance of the alternatives in some way.

These three types of measurements differ in several ways. While the first is based simply on financial metrics, the second includes the quality of goods or services, customer satisfaction, employee morale, or in the case of some companies (such as manufacturers of “green” products or non-profits), social or political benefits. All of these measurements, however, will help you answer the same basic question: Which technology investments will pay off in the long term?

In the next part of this series, we offer specific tips for measuring ROI.