Nothing puts a dampener on IT investment more than an inability to measure benefits and keep control of costs.
IT managers everywhere are nervously fingering their collars and clearing their throats in the face of steely-eyed finance men, casting their unsympathetic gaze over sizeable technology investments that do not demonstrate a tangible return or where costs have often overrun.
Consultants Butler Group confirm what we all know that measuring benefits is the key to restoring faith in IT and are helpful in identifying the three main contributions that IT makes to an organisation:
1) Cost reduction - typically through labour displacement. This is the traditional use of IT where benefits are relatively easy to demonstrate simply though the loss of headcount.
2) Value creation - enabling new processes, entry to new markets, new channels to existing markets, and other activities that add value. Butler point out that the benefits from projects that "create value" are notoriously difficult to measure, but ultimately must be reflected in transactional activity.
3) Knowledge capital - this is closely correlated with the way an organisation uses knowledge and information and is traditionally seen as the difference between the market value of an organisation and the value of its hard assets.
Traditional ROI
Nowadays, with diminishing returns coming from point 1: cost reduction, points 2 and 3 from the above list hold greater importance and are driving new metrics that are not confined to the traditional ROI (Return On Investment) model.
Traditional IT ROI calculations ask a company to consider four things. Firstly, how much do their current IT systems cost to run their business on say a monthly basis. Secondly, how much will the new technology cost to buy. Thirdly, how much will the new system cost to run their business on a monthly basis and finally, crucially, how soon in the future will the savings on running costs cover the original outlay on the technology and then move way beyond.
But measures such as this that fail to account for intangibles can be misleading. For example, easing time-consuming business processes free staff for other more productive activities and opportunities but an "opportunity cost per hour" is not generally a fixed amount.
Jay Cross, CEO of Internet Time Group who help organisations improve the performance of their people through e-learning initiatives, is no stranger to justifying the IT dollar. He favours metrics: "Metrics are broader than ROI and are the measurements that matter most. Decision-makers use metrics to:
- choose the best course of action
- supplement gut feel with a framework of logic
- assess project failure or success
- monitor progress
- uncover ways to make improvements
- divine ways to do better next time
- focus attention on profitable activities."
Choosing metrics
Cross also points out that often, metrics are in the eye of the beholder. They aren't simply the application of a rote formula or accounting rule, instead they're subject to interpretation. This is what makes metrics worthy of discussion. Additionally, the sponsor of an IT project has the strongest influence over decisions on how to spend money, so the sponsor decides what markers constitute proof of its worth."
His advice is this: "The best proof describes quantitatively the link between your IT initiative and business results, using assumptions your sponsor will buy into and explicitly stating the what-ifs and maybes. Do this in writing, in a performance agreement that:
- provides a shared understanding of the problem to be solved
- describes what you intend to provide in its solution
- estimates the expected increase in profit and the step to get there
- sets out a way to assess whether the goal was accomplished or not
- lays the foundation for solving the next problem."
ERP Vendors Forum
In the UK, the ERP Vendors Forum has this to say about applying ROI in the manufacturing application marketplace.
"Most manufacturing organisations are well versed in the process of developing an investment model for acquisition of capital equipment. Often, they have established a minimum Return on investment (ROI) by which the expenditure is judged. Sometimes referred to as the Internal Rate of Return (IRR). Equal or exceed the IRR and the expenditure is considered justifiable.
Unfortunately, the same rigour is not always applied to the acquisition and implementation of Management Information Systems.
Start by asking yourself why you are buying an ERP system. Specifically, you are buying an ERP system to overcome a limitation. The limitation ERP helps to overcome is the lack of information needed to make management decisions. ERP Systems don't take control of your shop floor - they help you take control. ERP Systems don't take control of your material planning - they help you take control.
Better material planning information so that you can buy additional material to exploit low prices when necessary. Better information means you can also choose not to buy even if the price is low because you know there is no demand to use the product and buying surplus quantities will tie up money without saving anything.
Once you have identified the limitations you are trying to overcome, calculate the benefits you might achieve. For example, % reduction in WIP from better planning x Cost of Carrying = saving."
Continued . . .
