ROI IT Project Viability & Ranking

Posted by Kevin Brady on Fri 15th August 2008 at 11:55 PM, Filed in Programme Management,  Project Management

This week I went to see a client about how to put in place a simple process for identifying those projects that are financially viable propositions and then ranking them in order of importance ?

At the outset it was clear that there was no easy answer to this common problem because most mechanistic approaches to ranking fail to take into account intangible benefits. Taking this into account we decided that the correct approach would be the use of a suitable project feasibility assessment framework combined with portfolio /programme governance to prioritise further those projects with difficult to measure intangible benefits.

The agreed framework we chose to use in order to identify viable projects and rank them was the tried and tested Rate of Return on Investment (ROI) method.

This method delivers one percentage figure for each project which is simple to understand and quickly decides viability and subsequent ranking of any portfolio of IT Projects. It is a method which has received serious industry interest in recent years with high levels of adoption among many companies:-

• 79 percent of companies now require ROI analysis to be performed on IT investments (Ernst & Young, 2002)
• 60 percent of all technology spending is controlled by business or functional managers and 40 percent by IT organisations (Gartner, 2002)

I can hear some readers saying “That’s all well and good but what’s in it for me?”
Well the more specific advantages of ROI run as follows:-

• It’s a great selling technique for senior executives. ROI is something they understand and moves away from discussions of intangible benefits and often spurious discussions about the benefits of new technology.
• It allows you to set investment screening thresholds (e.g, considering only projects that deliver ROI of at least 180 percent). A kind of gateway GO/NO go project filtering mechanism only offering up projects for sign-off to programme /portfolio governance boards which deliver acceptable returns on investment.
• It enforces an understanding of the top /bottom-line business impact of the investment, since it is impossible to complete an ROI analysis without understanding the potential impact on cost and revenue generation.
• It facilitates investment prioritization by making a project-to-project comparison between investment options, letting stakeholders focus on intangible benefits separately.
• It brings discipline on the part of vendors and decision makers to support business impact claims by taking a more quantifiable approach to business justification
• Lastly, it enforces accountability on the part of the project executive for the success or failure of the project. Achievement of ROI as agreed at initiation is a key measurable and achievable project objective.

Starting to get the big picture why this is so important  

However, the real head scratcher came when I was given the task of documenting the ROI analysis process and carrying out an ROI analysis on two projects in my client’s portfolio. The first problem was that after a short chat with the clients finance director (important sponsor necessary to make such changes stick) and a look on Google, it became clear that organisations had more different ways of measuring of ROI than I have fingers. However, in its simplest form for the purposes of this post ROI is the ratio of present value of expected benefits over the present value of expected costs:-
ROI = (PV of Expected Benefits /PV of Expected Cost) * 100
The problem with making this formula work in real life depended on three things:-

• Common understanding of how to calculate present value.
• How to quantify expected benefits and factor them into the ROI analysis
• How to factor in the minimum pay back periods expected by my clients finance director

At first sight this all seemed quite easy but problems soon came up when asking project managers for data and actually running the data through a set of formulas to deliver the required percentages. It was clear that the clients project managers only new the expected costs for their projects and it took sometime for the finance director to agree a cut off ROI (150% with maximum payback period of 5 years).

The next battle was to try and quantify expected benefits. You may say, “Hold on a moment. Some IT investments are nearly impossible to quantify.” I agree, but there’s always a way and it often involves the use of what is called proxie measures. For example the measurement of the intangible benefit of better call centre software usability and its effect on staff moral is something difficult to measure directly, but could be proxie measured by looking at staff turnover rates. Even the most difficult to quantify benefits can be quantified with some creativity. For me it took sometime to train the clients project managers to quantify all their projects benefits and get these agreed by their respective project executives.

The next challenge was to calculate Present Value for the benefits and the costs for each project I was asked to look at. The definition of PV is the amount in today’s dollars (present value) of all the income derived from the projects benefits and all the investment spent on costs.
PV for Expected Benefits:-

EB = Income /savings Expected from Benefits
i =Interest or discount rate taking into account risk factor /money market deposit rates and inflation.
t = years in the future. This example 5 years
Example:-

XYZ Project

EB = £1.5 million
i = 8% taking into account inflation and risk
t = 5 years

PV of expected benefits after 5 years = £1.02 million
PV for Expected Costs:-

EC = Cost /Investment
i =Interest or discount rate taking into account risk factor /money market deposit rates and inflation.
t = years in the future. This example 5 years
Example:-

XYZ Project

c = £500,000
i = 7% cost of capital invested (2% over expected base rate for the period)
t = 5 years
PV of expected costs after 5 years= £ 356,493
ROI = £1.02 million /£0.356 million * 100 = 287%
This example would achieved my clients ROI project viability target of 150% over 5 years. The XYZ project would have been entered into the final stage of the project approval process.

The next thing to do was to make sure the ROI analysis process was as automated as possible. This required the design and build of an excel based IT ROI analysis spreadsheet (available in my next post). This little widget makes the whole process really quick and easy as long as the users understand the theory detailed above. This was important should project managers get challenged in financial audits or at programme or portfolio boards.

The final stage was to train the Project Managers and Project /Programme Executives and Responsible Owners at programme and project level as to why ROI is important, what is in it for them and how to use the analysis to assess project viability and to rank those projects which in this case had ROI’s in access of 150% over a maximum pay back period of 5 years.

During training we emphasised that when making decisions to change a projects resources / activities and products designated for delivery, one must always carry out an impact on ROI analysis in terms of cost benefit. For example during the build phases of a project there is unlikely to be any measurable benefits. However, if a project goes live early, it stands to reason that project costs are reduced and revenue is increased over the designated investment period and increasing ROI. Despite this obvious way of “bumping up” ROI it was pointed out conversely that simply “nose diving” or reducing the build phase of a project by adding more resources (i.e more developers) will not bring about a better ROI, because more resources will add to the investment cost. We ran ROI optimisation workshop to teach project managers the different ways in which ROI can be maintaining or increased during the lifecycle of a project.

In make sure this new process was embedded I was lucky to have the support of the finance director as my project sponsor. A key aspect of this embedding was the joint effort in writing the ROI process Manuel and making sure the process was audited by the finance department. These audits help stop much of the circumventing by project and business managers wanting to get projects fast tracked and “slipped in under the radar” for departmental rather than corporate interests.

At its highest level the key ROI process steps detailed the manual for the approval and ranking of new projects were:-

• Step 1 – Determine the full scope of the project and baseline it
• Step 2 – Estimate the resource costs to be used on the project
• Step 3 – Use the ROI template. Get reviewed by accountant from finance
• Step 4 – Submit to the project review board.
• Step 5 – Once initiated agree ROI review point milestones to be submitted to the project or programme executive board in order to make sure the project still makes financial success. The 80/20 rule often comes to play at some point during this ROI review process.

If anyone wants to try this for themselves and has any queries just use the comments section below and I will endeavour to answer you questions.

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