Examine the many ways that the perennial business term is misunderstood.
In several of our columns, we have discussed ROI and its use as a measure to show the contribution of a particular project or program. Unfortunately, the term ROI is subject to much abuse and certainly a lot of misunderstanding. In this column we will capture some of the key culprits.
How's Your ROI?
Unfortunately, many people refer to ROI as a concept of benefit. Some who ask, "What's the ROI on that project?" are not necessarily asking about financial returns but merely the benefit. When someone claims a huge ROI or suggests that you can achieve a very high ROI with a project, they're not necessarily thinking about the financial return on investment. This line of thinking can pose a problem, because the ROI concept comes from the finance and accounting professions, to which ROI means financial ROI. Using the term improperly could undermine a relationship with that key person in the organization, the chief financial officer.
The CFO Is Your Friend
The concept of ROI is now used to measure the impact of a variety of projects and programs, having moved beyond the traditional use for return on investments in capital projects. When ROI is pursued in the traditional way, the CFO will be interested. However, we're using a term and a concept that the finance and accounting communities have used for more three hundred years and are applying to non-capital expenditures. This means we must explain our use of ROI to the finance/accounting person, or in some cases the CFO -- explaining what it is and what it is intended to do. We need to describe our methodology, including the standards and all the steps taken to make it conservative and credible. The ROI Methodology that we propose is very CFO-friendly. When the CFO or finance and accounting team takes time to understand how it works, they appreciate it. That is very important to the success of our projects.
It Is Only One Measure
A huge misunderstanding is that ROI is everything for a program or project. In reality, it is only one measure. The original developers of ROI to measure the payoff of capital expenditures (professors and economists) stated that ROI was an imprecise measure, suggesting it be used in conjunction with other measures (never alone) to make decisions about the investment. Within the ROI Methodology, ROI is only one of six measures. We measure reaction to the project, learning that is necessary to make the project work, application of what is involved in the project, the impact of the project on one or more business measures, and the actual financial return on investment of that impact. The sixth type of measure is the intangibles, those measures we cannot credibly convert to money with minimum resources.
"I Don't Believe It"
Many executives find that very high ROI values are unbelievable. Their reference point is the typical capital investment, where the hurdle rate in North America is typically in the 15 to 20 percent range. When a project delivers 200 to 300 percent or more, the common reaction is disbelief. But high values can and do happen. When people are involved, and they are in most every project, they can reap significant successes. This is particularly the case in programs that involve the entire work team.
An ROI might be a seemingly unbelievable high value, and that's when we point out that the methodology's Twelve Guiding Principles are built on a very conservative philosophy. This conservatism helps us when we try to convince key decision makers that, "Yes, it is a large value, and it is probably even higher than reflected here. Because of our conservative approach, we have understated the value. Incidentally, we also have intangibles, which are not in the ROI calculation but represent more value."
Okay, Whom Are We Going To Shoot?
At the opposite end of the spectrum -- when the ROI is negative -- executives often want to find out who is responsible, prevent the disaster from occurring again, and punish those who caused it. Unfortunately, this is not the right approach. The ROI Methodology is a process improvement tool. If the ROI is negative, we have a tremendous amount of data that tells us what we can do to make it positive. The complete data set uncovers the problems, identifies the barriers, and pinpoints the enablers to success. Thus, we have a clear understanding of what we must do to make it better. The headline on our study is not, "Who's the culprit for this terrible ROI?" Instead, we say, "Now we know this project is not delivering the value we thought it was, but we know what to do to make it work."
It Is All About Process Improvement
One of the greatest impediments to the use of ROI is this concept of process improvement. There is considerable fear about the consequences of an ROI evaluation. A negative ROI might mean a lack of funding, a lack of support, or a reduction of influence. In extreme cases, people fear the loss of their jobs. This is not (and should not) be the case. The use of ROI in a non-traditional setting must be pursued only from the perspective that it is evaluation of data. It is collected to improve projects, not necessarily prove their success.
For more information on the ROI Methodology, please contact the ROI Institute by visiting www.roiinstitute.net. And do not forget, ROI is much easier when it is automated, and some of the best automation for ROI comes from iDNA. For more information about them, visit www.idnausa.com.