It's an age-old struggle: How do businesses justify IT expenses? Despite all the advances in technology, the importance of IT in the organization, and the innumerable ways in which it can further strategic business goals, the cold fact is that company executives still have to estimate the value of their IT investments. It's not the IT department that needs to demonstrate the value of IT investments to the business, but the business that needs to understand the value of the IT investments it's making in relation to other investment opportunities it may be considering.

While that's a simple exercise in ROI for some projects, it's often difficult to come up with hard numbers to validate IT proposals aimed at delivering mostly soft benefits, such as enhanced customer service, competitive advantage, and a long-term shift in the business model. What's needed is a way to link project costs to the resulting business benefits in a clear line of sight with corporate goals and strategies.

With this in mind, we at CSC have developed a systematic and repeatable way of analyzing technology investments in business terms. One $2 billion instrument manufacturer applied our methodology to estimate a 40% improvement in operating profit from implementing systems that standardize global operations. In another case, a $5 billion industrial-products company used our technique to show a 46% ROI from consolidating multiple divisional applications into a single global instance.




Step by step
So how does our approach work? Basically, it involves four steps.

1. Map business goals to IT capabilities. Clearly, IT investments must support overall business goals. But the connection between the two is indirect. That nexus unfolds in a series of steps that build on one another and must be separately understood (see diagram, below).

At the top of the pyramid is the corporate vision, which will vary from company to company. For example, one organization may aspire to be the foremost manufacturer of aircraft instrumentation in North America, while another may want to become a leading global drug distributor.

The corporate vision must be backed up by a set of specific, quantitative business objectives. In the case of the drug distributor above, the objectives will need to indicate, for example, what the company means by "leading." Such a term could be expressed in terms of revenue ($10 billion in sales by 2010), profitability (10% return on sales by 2010), or innovation (40% of sales from new products by 2010). "Leading" could even mean a combination of objectives. In any event, the important thing is to set a target and a time frame.

To achieve its objectives, an organization must undertake specific strategic initiatives. For example, increasing revenue may require providing additional training to the sales force or negotiating exclusive rights with manufacturers. Improving profitability may require reducing overhead costs and streamlining the supply chain.

The means needed to carry out the strategic initiatives are known as business capabilities. For example, training a global sales force may require knowledge of sales reps' individualized needs, as well as an understanding of the business environment in which the sales take place.

At the base of the pyramid are IT capabilities—features, functions, and services provided by IT applications, infrastructure, and staff—that enable the business capabilities. In the case of global sales-force training, such capabilities may include remote access by geographically scattered employees, together with a database of individual training histories and typical training requirements by role.

2. Categorize IT capabilities. IT capabilities fall into four general categories: information, automation, coordination, and connectivity.

Information is the most obvious category. It includes data on customers, products, and finance. Information serves to reduce uncertainty.

Automation reduces time and effort. Examples of IT automation include systems that help balance workloads across factories, order supplies, and process payments. While reducing human effort minimizes errors, it doesn't eliminate human involvement—indeed, a person may still be required to approve a payment. But hopefully, that individual won't have to write out a check and put it in the mail.

IT systems in the coordination category serve to reduce conflicts. For instance, scheduling systems ensure that parts arrive when they're needed, while group-calendaring systems verify the availability of participants for a meeting.

Last but not least are the connectivity-related IT functions. These are provided most notably by E-mail systems, chat services, and file-transfer facilities that offer nearly instant transfer of data, messages, music, photos, and videos.

The taxonomy I've outlined is important in two respects. First, it groups IT capabilities under headings that are meaningful to the business—for instance, the benefits of a "financial-reporting system" are less obvious than those of "producing financial reports in half the time" (through automation). Second, the taxonomy simplifies discussions between IT executives and their business counterparts so the parties don't lose the forest for the trees.

3. Estimate the economic benefits. Business benefits manifest themselves in innumerable ways, including increased inventory turns, enhanced customer satisfaction, increased market share, and improved staff morale. But despite their diversity, such benefits have one thing in common: They all eventually lead to higher revenue or reduced costs. That's why you can always express them in economic terms. Until you've quantified the benefits to be gained from a proposed IT enhancement, you can't really compare it with alternative solutions.

There are only six ways to achieve economic benefits—a fact that greatly simplifies any benefit analysis. For example, revenue improvements can be achieved only through increases (obtaining more), preservation (keeping what you have), or acceleration (obtaining revenue sooner). Correspondingly, cost reductions can be achieved only through decreases (lowering the amount), avoidance (not incurring costs), or delay (incurring costs later).

Admittedly, the connection between some business improvements and their economic benefits isn't entirely direct; customer satisfaction and staff morale are two examples. That's no reason to ignore them, however. Many executives intuitively sense a connection between such improvements and increased revenue or reduced costs. Fortunately, you can make that connection explicit—by asking yourself a series of questions designed to quantify a given IT capability's anticipated business benefits. This technique, which we've applied in our work with dozens of major corporations over the years, is based on N. Dean Meyer and Mary E. Boone's pioneering book, The Information Edge (Irwin Professional Publishing, 1989).

For starters, ask yourself what changes you'd readily see if you implemented the proposed IT project. Results might include reports showing profitability by customer, the ability to produce financials a week sooner, or an ability to know which warehouse has the part you need. These needn't be mutually exclusive.

Next, take each change separately and drill down to determine why it's beneficial. For example, why is it good to know customer profitability? Because it lets the company concentrate sales efforts on its most profitable customers. Why is that concentration good? Because the same sales force could expand the more profitable accounts and shrink the less profitable ones. Why is that good? Because a sale to a good customer brings $10,000 more to the company's bottom line.

Now you can begin to quantify the anticipated benefits based on probabilities. For example, if the company concentrates its sales force, what are its chances of making at least one more such highly profitable sale per month—or, for that matter, 10 more or even 100 more? This is all the information you need to estimate the number of sales that will each contribute $10,000 to the bottom line—and, in turn, the total bottom-line contribution you can expect from implementing the proposed IT system. Rather than arrive at a single number, you'll want to come up with a probability distribution that automatically builds in the appropriate risk adjustments.

This isn't an exercise in accounting, but in credibility. The reliability of any budget projection, or of any forecast of future business performance, depends on the track record of the person doing the projecting. Therefore, the right executive must be involved in the discussion. For instance, only those responsible for sales can legitimately project sales improvements. Similarly, only those responsible for the factory can claim improvements in assembly-line productivity. Involving the right executive results not only in a credible risk-adjusted estimate of potential benefits, but in an implicit commitment to achieve them if the company puts the enabling capabilities in place.

4. Weigh the costs against the benefits. Since well-known techniques for estimating costs and calculating ROI already exist, there's no need to invent new ones. But companies should estimate costs comprehensively and conservatively. Cost estimates should encompass initial and ongoing costs within all affected areas, including both capital and expense items. In addition, they should factor in the project risks.

When assessing alternative investment opportunities, compare costs and benefits in the manner your organization customarily employs—whether it be economic value added (EVA), internal rate of return (IRR), net present value (NPV), or ROI. It doesn't really matter which financial metric you use, as long as it's consistent with established corporate practice.




Bottom-line impact
In summary, our four-step approach lets executives do three things: