There was a sidebar in the May 15 issue of CIO magazine on ROI vs. TCO.
It said ROI (Return on Investment) quantifies both cost and benefit of projects and TCO (Total Cost of Ownership) includes only costs. In their survey (of 225 technology managers), about 60% said ROI influenced project justification and 40% said TCO helped justify the decision.
I don’t think it’s one or the other: it’s both. The total cost of ownership needs to be included in the cost side of the ROI equation. ROI is “simply” the difference between how much something costs and how much cash it brings in the door (adjusted over time). I say “simply” because the devil is in the details of cost and cash in.
Here are some of the “total” cost ingredients to consider when developing your ROI:
- the cost to build or acquire the system (hardware, software, network costs)
- don’t forget the ancillary costs to the above (for example a system may require an add-on license for an RDBMs or middleware)
- the cost to operate, maintain, and upgrade
- the training costs (administrators & users)
- the cost to install and implement
- the cost to upgrade or troubleshoot and fix any impact the system will have on other existing systems
- the potential consulting cost to re-engineer processes that are being automated
- the cost to temporarily back-fill any headcount that has been ‘seconded’ for this initiative
- the labor components of all of the above (procurement staff, IT staff, new-hire administrators, trainers, consultants, and so on).
And here are some of the cash-in-the-door ingredients to consider:
- how many net new customers will we acquire by having the new or updated system that we wouldn’t otherwise have, and what’s the average lifetime revenue per customer?
- How many more products or services can we sell?
- Will the system let me improve my prices or price/volume mix?
- Will the system make my margin improve…measurably?
- Will the system increase the velocity of cash flow?
- Can I improve cross-sell & up-sell opportunities
And in a subtle twist: look at less cash-out-the-door:
- Will the system make me more efficient and produce more with fewer resources (measurable productivity)?
- Is there a direct headcount reduction associated with this initiative?
- Can I reduce inventory costs? Raw material costs? Transportation and storage costs?
- Will it reduce my selling, general, and administrative expenses?
- Can it reduce debt and/or improve our cost of capital?
One approach to reduce the reliance on nebulous ROI is to create several layers of IT investments each requiring a different approach to justification. For example:
1. Infrastructure and “Lights On” operations – this is the fixed cost that it takes to run the business effectively and efficiently. It includes the network infrastructure, servers and desktops, office productivity and messaging software and the staff to administer them. This is the first part of the annual I.T. budget. ROI may be a known quantity or even a non-issue.
2. Tactical business systems – these are your G/L, ERP, time & expense, supply-chain systems that generate, track, and reconcile day-to-day business transactions. This is the second part of the annual I.T. budget, with some allowance for unexpected capex. ROI is case-by-case.
3. Strategic systems – these are the systems that you may or may not have on your roadmap, but get introduced or accelerated due to competitive pressures. You are convinced that this system (or upgrade) will give you a measurable advantage in the market and will help you out-perform your competitors. The ROI will not be quantifiable sometimes.
ROI has always been a nebulous tool for justifying I.T. investments. While an ROI case should be included in making a decision (around upgrading, new systems, training decisions, etc.) it may not be the primary consideration.
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