Calculating the Returns on IT, Increasing Added Value

Feature Article | May 4, 2005 by admin

Midmarket organizations are in a dilemma. If they want to be competitive internationally, they need modern and flexible software systems. Yet many companies in the past have delayed implementing essential modernization projects. Midmarket companies in particular often hammer their old systems for all they’ve got, as the META Group reveals in its study “IT für den Mittelstand” (IT for the midmarket). Yet the META Group’s conclusion is that sooner or later midmarket businesses will be unable to avoid modernizing their information technology.

Contradictory behavior

If you spend money on new IT solutions, you will want to define the added value it will generate for your company. To do so, companies need to conduct cost-benefit analyses that identify the concrete benefit of an IT investment. It is therefore hardly surprising that, as well as the topic of security, ROI and cost control are quickly becoming key factors for the midmarket in Europe, as a Hewlett-Packard (HP)-sponsored study by the consulting firm Benchmark Research recently discovered. According to the survey, 27 percent of those questioned focused on ROI and 22 percent on cost control.
However, business consultants Techconsult identified clearly contradictory behavior in terms of cost-benefit analyses at midmarket enterprises. 40.8 percent of those surveyed answered the question “How important is a cost-benefit analysis for IT projects in your company?” with “very important” and 44.5 percent with “important”. In contrast to the generally acknowledged high importance of cost-benefit analysis, 32 percent of those questioned conduct cost-benefit analyses only rarely, and 8.9 percent never do so. Techconsult identified several reasons for this, one of which being that the midmarket in particular shrink from the effort that is needed, and another that the available methods are not suitable for midmarket organizations.

Calculating the added value of IT

However, Bernhard Holtschke, MD of Accenture, can only partially understand these objections, as “a company ultimately needs to work out the cost benefit of any investment, regardless of whether the money is being spent on a new IT solution, an assembly line, or a printing press.” Holtschke also deflates the often-cited prejudice that IT swallows up too much money. He stresses that the actual costs of IT generally comprise no more than a single-figured percentage of a company’s total costs. However, IT has a strong impact on the total costs of a company, for the main objective of investments in IT is to improve the business processes within a company.
Cost-benefit analyses of information technology essentially consist of two analytical processes: the Return on Investment, an indicator that specifies the percentage proportion of the profit generated by an investment over a predefined period of time, and the Total Cost of Ownership, which refers to the procurement and operating costs of the information technologies used.

Focus on what is achievable

The ROI is thus an anticipated value that will or should be generated by an investment. Put simply, companies can use ROI analyses to identify the value that an investment will create. While this indicator is an important decision-making factor for investments in IT, it should not be the only one. For instance, the ROI does not really allow for predictions about the potential risks of the investment or the scale of the returns, particularly in view of the fact that various forms of ROI exist.
First there is the simple ROI. This is calculated based on the anticipated costs of a new investment within a particular period of time. These are then offset against the anticipated profits over that period. ROI variants include “Return on Invested Capital” (ROIC), “Return on Capital Employed” (ROCE), “Return on Total Assets” (ROTA), or “Return on Equity” (ROE). In some cases, ROI also refers to the cumulative cash flow (CFROI) over a period of time.

Additionally, models comparable to the ROI also exist. These include approaches such as Gartner’s Total Value of Opportunity (TVO) or Consensure’s Proof of Value concept. What these concepts have in common is that they go beyond a purely mathematical approach and take qualitative or “soft” factors into account (for instance better customer loyalty due to shorter response times; added value of employees etc.). SAP Value Assessment is a method from SAP that provides indicators for measuring the potential and value of planned IT projects in concrete terms and also identifies qualitative improvement potential, such as leaner production processes.
Faced with the calculation models presented here, midmarket companies are often unsure which particular method is right for them. If a company with relatively simple structures selects a complex method, this can quickly become unprofitable. Conversely, midmarket businesses with complex structures also require more complex calculation models. There is no standardized procedure for calculating the ROI. However, companies should focus on what is achievable. This means selecting a pragmatic approach and reducing the analyses to those costs that can actually be measured instead of evaluating all available information.

What IT really costs

Each ROI analysis includes a total cost calculation for IT. The model first presented by Gartner in 1987, termed Total Cost of Ownership (TCO), is intended to measure all IT costs, to put it in simple terms. Similar to printing presses, IT (both hardware and software) generates direct and indirect costs alongside the pure procurement costs, and these need to be included in a cost-benefit analysis. Direct costs include depreciation, hardware and software maintenance costs, system administration, support, network costs and software development costs. Indirect costs include technical downtime and user-based downtime (training).
Operating cost analyses have therefore become an important planning and decision-making aid for IT acquisitions, and they also help companies to identify “hidden” costs, or costs that are initially not so obvious, that may have been overlooked in initial budget plans. Tatjana Ullerich from the Business Solution Technology department at SAP Germany recently discussed this situation in an article on SAP INFO online, which is certainly worth reading. Ullerich describes this using the concrete example of an midmarket company which has prior experience of the SAP landscape and is implementing SAP Enterprise Portal (SAP EP). Ullerich’s advice is to take the specific criteria of the individual company into account in TCO calculations as this is the only way of generating a customized model.
With SupplyOn, a procurement marketplace for the automotive industry, a new marketplace infrastructure based on SAP XI and SAP Web AS resulted in considerable savings, according to a cost-benefit analysis of the project by Gartner Consulting in the summer of 2004. The investment of SupplyOn in an integrated platform solution based on SAP NetWeaver was seen to be beneficial with an ROI of 89 percent and an amortization period of around five years. The procurement marketplace itself calculates a permanent reduction of the Total Cost of Ownership of more than 20 percent over the next ten years. At ratiopharm, a manufacturer of OTC medicines, US business consultants Peppers and Rogers estimated that the deployment of mySAP CRM would generate an ROI of 63 percent within the first three years after implementation based on the internal rate of return.

Answering the sixty-four-thousand-dollar question

“The benefits of the IT must be reflected in considerably lower total costs,” is how Bernhard Holtschke summarizes the situation in a nutshell. In doing so, the question need to be asked as to how the IT can generate added value for the company’s own business activities, such as in the form of reduced material or warehousing costs or faster planning and production through improved processes. “For this reason, a cost-benefit analysis of IT should be compulsory for the management and translated into concrete business goals. A further important factor for Holtschke is that midmarket organizations consistently check their ongoing IT costs for improvement potential.
ROI/TCO models provide helpful and supporting approaches. There is no universal answer to this sixty-four-thousand-dollar question, but there is a way around it. Midmarket enterprises who invest in a mySAP All-in-One solution or SAP Business One, keep their IT costs transparent, improve processes, and increase added value.

For further information:

Studies: www.accenture.com, www.hewlett-packard.com, www.metagroup.com,
SAP: www.sap.com

Dr. Andreas Schaffry

Dr. Andreas Schaffry

Tags: , ,

Leave a Reply