Roi for It Projects
Return on Investment Analysis for E-business Projects
Mark Jeffery, Northwestern University Introduction The Information Paradox Review of Basic Finance The Time Value of Money ROI, Internal Rate of Return (IRR), and Payback Period Calculating ROI for an E-business Project Base Case Incorporating the E-business Project Incremental Cash Flows and IRR Uncertainty, Risk, and ROI Uncertainty Sensitivity Analysis 1 2 4 4 6 6 7 8 10 11 11 11 Project and Technology Risks Monte Carlo Analysis Applied to ROI Executive Insights The Important Questions to Ask When Reviewing an ROI Analysis A Framework for Synchronizing e-Business Investments With Corporate Strategy Beyond ROI: Trends for the Future Acknowledgments Glossary Cross References References 12 13 14 14 14 16 17 17 17 17
INTRODUCTION
As the late 1990s came to a close, many companies had invested heavily in Internet, e-business, and information technology. As the technology bubble burst in 2000 many executives were asking “Where is the return on investment?” When capital to invest is scarce new e-business and information technology (IT) projects must show a good return on investment (ROI) in order to be funded. This chapter will give the reader the key concepts necessary to understand and calculate ROI for e-business and IT projects. In addition, the limitations of calculating ROI, best practices for incorporating uncertainty and risk into ROI analysis, and the role ROI plays in synchronizing IT investments with corporate strategy will be discussed. What is ROI? One conceptual definition is that ROI is a project’s net output (cost savings and/or new revenue that results from a project less the total project costs), divided by the project’s total inputs (total costs), and expressed as a percentage. The inputs are all of the project costs such as hardware, software, programmers’ time, external consultants, and training. Therefore if a project has an ROI of 100%, from this definition the cash benefits out of the
Mark Jeffery, Northwestern University Introduction The Information Paradox Review of Basic Finance The Time Value of Money ROI, Internal Rate of Return (IRR), and Payback Period Calculating ROI for an E-business Project Base Case Incorporating the E-business Project Incremental Cash Flows and IRR Uncertainty, Risk, and ROI Uncertainty Sensitivity Analysis 1 2 4 4 6 6 7 8 10 11 11 11 Project and Technology Risks Monte Carlo Analysis Applied to ROI Executive Insights The Important Questions to Ask When Reviewing an ROI Analysis A Framework for Synchronizing e-Business Investments With Corporate Strategy Beyond ROI: Trends for the Future Acknowledgments Glossary Cross References References 12 13 14 14 14 16 17 17 17 17
INTRODUCTION
As the late 1990s came to a close, many companies had invested heavily in Internet, e-business, and information technology. As the technology bubble burst in 2000 many executives were asking “Where is the return on investment?” When capital to invest is scarce new e-business and information technology (IT) projects must show a good return on investment (ROI) in order to be funded. This chapter will give the reader the key concepts necessary to understand and calculate ROI for e-business and IT projects. In addition, the limitations of calculating ROI, best practices for incorporating uncertainty and risk into ROI analysis, and the role ROI plays in synchronizing IT investments with corporate strategy will be discussed. What is ROI? One conceptual definition is that ROI is a project’s net output (cost savings and/or new revenue that results from a project less the total project costs), divided by the project’s total inputs (total costs), and expressed as a percentage. The inputs are all of the project costs such as hardware, software, programmers’ time, external consultants, and training. Therefore if a project has an ROI of 100%, from this definition the cash benefits out of the
References: The question of how investment in information technology impacts corporate productivity has been debated for almost a decade (for reviews see Brynjolfsson & Hitt, 1998; Dehning & Richardson, 2002; Strassmann, 1990).