Can a switch to Windows Vista really create $316 in labor savings per user? That's what one Microsoft partner claims -- although not all small businesses Vista customers would agree.

That kind of claim is hardly unusual. Any business owner or IT exec who's shopped for software in the last few years has encountered similar vendor statements about the ROI to be had by installing the latest version of some new operating system or application. Some claim their apps "pay for themselves" in a year, or even a few months. But the details on exactly how this repayment happens rarely stand up to much scrutiny.

"When you see a software vendor provide an ROI claim, just ignore it," advises Victor Cheng, president of Bookmercial Productions which produces books as marketing tools for client companies. In a previous job at a software company, Cheng used to create those claims himself. "It's not that they're deliberately misleading," he explains. "The problem is these claims are theoretical, and not specific to your situation. The only way to determine the ROI for your company (not some mythical typical company) is to look at what would happen if you used the software you're considering."

According to Forrester Vice President Ray Wang, who specializes in software ROI, a new investment in software makes sense if it does one of the following:

  1. Provides efficiency gains that reduce overhead or allow you to do more without adding resources;
  2. Puts you in compliance with legal or contractual requirements, decreases security risk or makes your technology compatible with that of your clients or customers;
  3. Supports a new strategic initiative (such as a customer loyalty program);
  4. Provides increased capacity or functionality to allow your business to grow.

Unless the new software helps at least one of these objectives, Wang notes, it's probably not worth it. "Technology should be an enabler," he says.

Avoiding small business errors

But even when new software would bring solid business benefits, it's easy for small companies to make common mistakes when deciding whether or not to make a purchase. To avoid these errors, make sure to ask:

  • What is the software's full cost? As Wang points out the initial purchase price may be only the beginning of your software investment. "We look at costs for licensing fees, maintenance, implementation, staffing and training," he says. For instance, software maintenance and support contracts may cost as much as 20 percent of the initial license. "In five years, you'll have paid for the software all over again," he notes. "In ten years, you'll have paid for it twice." Advocates of Web-hosted software, or software-as-a-service (SaaS), praise this option for its low upfront costs. Over the long term, however, hosted software can cost more than licensed software purchased and installed on site, so you should consider other business factors (for instance, how well the software fits your specific business needs) when choosing between licensed and hosted software.
  • Who will manage the software? "Small businesses don't have an army of IT people to support a product," Wang notes. "So you want software that is easy to adjust, where users themselves can make changes."
  • What features will we actually use? Too many small businesses start by letting a vendor tell them what they need, or sell them on the benefits of new features, rather than first considering their business needs and then asking how software will fill those, Wang says. "In the best case scenario, most businesses use only 10 percent of the features in Microsoft Word, for instance," says Ilya Bogorad, principal of Bizvortex Consulting Group, Inc., a technology consulting firm. "So it's important not to get carried away by wonderful features."
  • Are we confusing capacity with savings? "In one business case I reviewed recently, the company said: 'The person doing this work makes $20 an hour. This software will free two hours of his time every day, for a savings of $40 a day or more than $800 a month." The problem, he says, is that freeing someone's time does not necessarily translate directly into economic benefit. A lot depends on what new tasks will replace the old ones. If the newly freed employee spends that extra time making sales pitches for the company's product, it may well gain more than $800 a month in benefit. If he spends it performing make-work that doesn't affect the bottom line, it will gain much less.

At the same time, Bogorad notes, it's important to consider opportunity costs that may come with using new software. "If I pay an accountant $1,200 a year to do our taxes, and then I buy a $200 piece of software so that I can do them myself, the jury is out as to whether that's really the best use of my time and money. You have to take those things into account."

Ultimately, the best way to judge whether your company would benefit economically from a new piece of software is to ask others who've used it. "You can do that by talking to colleagues in trade associations for instance," Wang says. As well as finding out about the software, make sure to ask if the vendor was easy to work with, and what is required to maintain the software over time, he advises. "Most companies are open about sharing that kind of information."