The term ROI is probably used more in business these days than ever before, particularly in areas where it has not been discussed previously.
Originally, the concept of return on investment was used in the context of showing value from investing in capital expenditures, such as buildings, equipment, and companies. In the past two decades, it has been used in the context of showing return on investing in a variety of non-capital expenditures like human resources, technology, quality, and marketing. But the term ROI is entered into the business lexicon on a routine basis. What's the ROI on that? is a common question. Can you show me the ROI? Can you show me the money? are often requests from executives. This will deliver a very high ROI or You can expect a very high ROI with our particular product or service are commonly heard from sales professionals. Most of these requests are brought into play without understanding the true meaning of ROI.
In reality, the return on investment is a financial term. It shows, in a single metric, the ultimate contribution of different projects, services, programs, and events. Since those of us concerned with the contribution of non-capital expenditures borrowed this formula from the financial and accounting community, we should use it appropriately. In doing so, however, a variety of myths and misunderstanding have surfaced, causing vast amounts of confusion. Here are 10 important misunderstandings about ROI as it is used to evaluate non-capital investments.
Myth #1: Why should my project come down to one financial number?
Reality: It should not come down to one number. The original developers of the concept of return on investment for capital expenditures argued that it is an imprecise measure and should never be used in isolation of other performance measures. The financial community considers a vast array of measures in making major funding decisions. We should follow their cue. The ROI Methodology advocated in these columns generates six types of data about a project:
- Reaction to the project
- Learning to make the project successful
- Application and implementation of the project
- The business impact connected to the project
- The financial return on investment
- Intangible measures
A balanced profile of performance results is needed and is always developed when ROI Methodology is used properly.
Myth # 2: ROI is too complex for us to use.
Reality: Not necessarily. The ROI Methodology is broken down in a simple step-by-step process for collecting, analyzing, and reporting data. It applies a discipline approach to show the value of the project as it collects the six types of data described above. It also includes a step to isolate the effects of the project, making results more credible. The key is planning carefully, sharing the responsibilities, and building capabilities so that it can be done quickly. Using technology is also important to reduce the complexity and time involved.
Myth # 3: ROI costs too much.
Reality: Not necessarily. The key is building internal capability to show the value of projects, not always depending on a consultant to do it for you. ROI studies on projects can be conducted internally for as little as $1,000-$2,000. As a percentage of the project itself, the cost of the ROI study, if done internally, is often 1%-2% of the total project. Expensive projects may require greater investment, sometimes 5%-10% of project costs. A variety of cost-saving tips can be utilized to make it an affordable, usable process.
Myth #4: I don't have a finance, accounting, statistics or mathematics background; therefore, this tool is not for me.
Reality: Mastery of finance, accounting, statistics, and mathematics is not necessary to make ROI work. It is void of complicated statistical processes, although it is based on very sound practices. The only finance and accounting needed is an understanding of cost, profits, and the actual ROI calculation.
Myth #5: ROI is too subjective, involving only estimates.
Reality: Not true. Estimates are used only in small segments or parts of the process. When used, they are collected from the most credible source and adjusted for error to ensure the most conservative estimate is reported. The philosophy is simple; estimates are never preferred but only used when other methods for obtaining the data or converting the data to money are not feasible. Even then, we make the process as credible as possible in order to defend them. In short, we do not prefer them, but we are prepared to defend them.
Myth 6: My top executives aren't asking for ROI; therefore, I shouldn't be interested in this process.
Reality: Unfortunately, this is a serious misunderstanding. Waiting for a top executive to ask for ROI puts us in a very vulnerable position. To build capability and expertise with ROI and change the practices that are necessary to make our projects even more successful takes time, often much more time than an executive is willing to tolerate. Essentially, if executives request it, we are on their timeline and their agenda. If we take a proactive stance, we manage the agenda and the time. Unfortunately, we have seen disastrous results when evaluators wait for the ROI request because they struggle to do it, cannot do it credibly, and often suffer the consequences.
Myth #7: I don't have time for this.
Reality: Unfortunately, the use of ROI does take additional time, but the time could be managed if the process is planned from the outset of project implementation. Also, by building data collection into the project and sharing responsibilities with others, additional time can be saved. The use of ROI may ultimately save time as certain projects are radically altered and changed when they are not adding value. Some projects are prevented in the beginning due to their lack of potential, freeing up time to spend on more productive, value-adding projects. Imagine if you implemented or managed 10 new projects or programs per year. How much would you benefit from knowing which of the 10 were the most valuable and which were of less value, thereby giving you the information you need to make necessary choices? The ROI methodology can show you. The additional time could be used to work on the more effective ones. There is an old saying that fits this situation squarely: "We take time for things that are very important." If it is important to know the contribution of your projects and programs; how to use data in ways to improve those projects; build support for those projects, and maintain your budget, then time must be allocated to make it work.
Myth #8: ROI is not appropriate for my type of projects.
Reality: ROI is being used with all types of projects and programs in areas where it was unthinkable a few years ago. ROI is being calculated for internal communications projects, public relations initiatives, conferences, diversity, sponsorships, and even language training. The reality is, when the expenditures are significant and there are limited funds available, someone, the ultimate client, is concerned about the ROI of the project. This person or group of people wants to know if the project is a good investment of funds. This information helps them make decisions as to where they should place the funds in the future.
Mythi#9: ROI examines what has already happened and does not look forward.
Reality: Not true. The ROI methodology can be used to measure the success of a project before it is implemented, even in the conceptual stage. A follow-up evaluation can show if it is actually successful. Use of forecasting and follow-up ROI is recommended.
Myth #10: It's hard to find ROI resources that can fit my situation.
Reality: Not anymore. Through the ROI Institute and the ROI Resource Center, all types of tools, templates, and documents are available. Books ranging from simple introductions to extensive How-to Manuals are available. Case studies and software guides are all available, all aimed at making it easier to understand and easier to use. Contact us at the ROI Institute (www.roiinstitute.net) for more details.
We hope this column has been helpful to you over the past months. While this is our last contribution, we hope to continue hearing from you as you pursue the use of ROI in your organization.