For ROI on information technology, the basic principles remain the same but both the investment and the return grow more complicated. Bill Kirwin, vice-president and research director of the Connecticut-based IT research firm Gartner Inc., says companies should look not just at the immediate costs of hardware and software, but also at expenses such as training and the impact on the end user. One of the things left out of a traditional financial ROI is the risk of an investment, he adds.
"In the free-spending days of the late 1990s, a lot of these things were poorly thought out. Before, anything over $1 million was run through the higher financial [executives]. Now, if you want to get a pencil sharpener you have to justify it. One million dollars is a lot of money, and I think spending $50,000 to do the analysis on a million-dollar investment is very prudent. That should be built into the cost of doing business," Mr. Kirwin says. "You can even do the risk analysis on doing the financial analysis. If we make a bad decision, what are the risks? Are we going to lose customers? Are we making a million-dollar decision that will put us out of business in a year?"
In figuring out IT costs, the human factor looms large. A typical mid-sized company might spend $5 million on technology and barely $200,000 on implementation, according to Theresa Welbourne, CEO of Michigan-based eePulse. Ms. Welbourne, who is also a professor of entrepreneurship at the University of Michigan, says her company has developed software to measure the ROI of intangibles such as morale, productivity, and other employee-based factors.
On the return side of the equation, Mr. Kirwin says ROI should consider the full life cycle of an IT investment strategy. The CFO and technical staff must analyze how they will optimize business processes to take advantage of a piece of software, for example. Often, such projections are left out of the initial funding request. "It seems that the project sponsors keep going back to the well for more money that should have been thought through in the beginning," Mr. Kirwin explains. "Then it's called overspending, when it actually was underfunded in the beginning."
"I think that the real ROI comes from what's in the black box, and that's your employees," adds Ms. Welbourne. "If a company says, 'Implementing the technology resulted in laying off a lot of people and that's how I got my savings,' that's not how ROI works. The ROI is people transforming the technology and doing something with it. If you don't understand the black box, then you really don't understand ROI."
Although calculating ROI is a financial function, responsibility for it rests on all employees, including the CEO. Some chief executives love to see high-tech equipment in the office, regardless of the financial results. But such ego-pleasers aren't confined to IT. Mr. Orcí warns businesses against getting caught up in the flashy images of a marketing campaign. It's very unusual, he says, for a CEO to determine the return on investment of a million-dollar TV spot during the Super Bowl. "A rule of thumb is: What is the good business reason for doing this? It isn't because I did it last year," Mr. Orcí says. "There is no excuse for not knowing the bottom-line impact."
The Math Behind Roi
For the non-mathematical, figuring out Return on Investment can loom as a daunting task. Here are a few methods to help with the calculation.
As a Percentage. If your return is $1 million in 12 months on a total investment of $250,000 in the same time period, the ROI can be calculated as follows:
ROI = (Return – Investment)/(Investment) x 100, or
ROI = ($1 million – $250,000)/($250,000) x 100 = 300%
As a Ratio. Divide the return by the investment:
ROI = $1 million /$250,000 = 4:1
Break-Even Time. If you are trying to determine the break-even ROI, you want to find how long it takes to make back your initial investment. You can calculate it in days, weeks, or months. For break-even ROI, follow this formula:
ROI = (Investment)/(Return) x (Time Period), or
ROI = ($250,000)/($1 million) x 12 months = (0.25) x 12 = 3 months
More complicated versions of ROI usually involve adding elements to the "return." For example, when figuring ROI on a marketing campaign, a company might value new customers more than old ones, on the assumption that new customers will buy again in the future. Therefore, the new-customer purchases may be multiplied by a certain factor to reflect future returns on the investment.