Return on Investment Analysis for E-business Projects



Main Takeaways

• An Information Paradox existed during the 80s in which there was an apparent inconsistency of IT spending and productivity – proved to be false as the conclusion was based on aggregate data averages of the entire US economy.

• Review of Basic Finance

• Time Value of Money - $1 today is worth more than $1 in the future

• ROI includes Internal Rate of Return (IRR) which is compared to the Weighted Average Cost of Capital (WACC), Net Present Value (NPV), and Payback Period

• Also must consider the non-quantifiable benefits that may result such as the option value

• Uncertainty, Risk, and ROI – in analyzing ROI, a good assessment of the underlying assumptions and potential risks must be factored in. This includes sensitivity analysis of the major assumptions and consideration of non-quantifiable risks

• Before deciding on an IT investment, it is important to understand the strategic context of the firm within a given industry. The goal is to synchronize e-business and IT investments with the corporate strategy (value disciplines)

More In-depth Summary

• Some factors to consider when making an investment decision include:

• The assumptions underlying the costs of the project.

• The assumptions underlying the potential benefits.

• The ability to measure and quantify the costs and benefits

• The risk that the project will not be completed on time and on budget and will not deliver the expected benefits

• The strategic context of the firm; that is, does the project fit with the corporate strategy?

• The IT context of the project: that is, does the project align with the IT objectives of the firm, and how does it fit within the portfolio of all IT investments made by the firm?

• Productivity is defined similarly to ROI in the introduction – it is the amount of output produced per unit of input – and although easy to define, it can be very difficult to measure for a firm. The output of the firm should include not just the number of products produced, or the number of software modules completed, but also the value created to customers such as product quality, timeliness, customization, convenience, variety, and other intangibles.

• The productivity paradox was disproved as there was a consistent finding that IT has a positive and significant impact on a firm output but shows significant variation in the magnitude of this payoff. The variation is challenged by the fact that there is more to productivity than just investment in information technology. Other factors are just as important – the ability of the firm to exploit organizational change and how the IT investment fits in the context of the firm’s strategy in a given industry.

• IRR is compared to the company’s discount rate or WACC and if greater, then the project should be funded. A WACC of 15% or more is common in the technology industry. Also for e-business projects IRRs for time periods longer than 3 years are usually not considered, even though the project may have benefits in additional years. NPV is an alternative method of ROI and a positive NPV is when a project should be funded. One limitation of NPV is that it does not take into account management flexibility to defer decisions into the future. Payback period is the time it takes for the project to recoup the initial investment. It is unusual for an e-business project to have a payback period longer than 2 years. Projects that have good IRR and the shortest payback periods are most often selected.

• The first step to setting up any ROI analysis is to understand the base business case, which is called business discovery. Understanding the key business drivers, and which factors can improve business performance, is essential and can have important bottom-line implications.

• Benefits other than increased revenue or cut costs exist but may be hard to measure. For example, a new Web-portal may include benefits such as fewer errors in processing transactions, reduced time to process orders, improved information on customers, and improved customer satisfaction, because customers can place orders 24/7 and have access to up-to-date product data.

• Common risk factors for any technology project in order of importance:

1. Lack of top management commitment to the project

2. Failure to gain user commitment

3. Misunderstanding the requirements

4. Lack of adequate user involvement

5. Failure to manage user expectations

6. Changing scope/objectives

7. Lack of required knowledge/skills in the project personnel

8. Lack of frozen requirements

9. Introduction of new technology

10. Insufficient/ inappropriate staffing

11. Conflict between user departments

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