Is ROI King In Evaluating IT Investments? Part 2. Measuring the Impact of IT Investments

  • Written By: William Friend
  • Published On: July 24 2002



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Measuring the Impact of IT Investments

Ray Tucker, CFO of the $1.3 B adhesives manufacture H.B. Fuller, finds, " We can't really understand all of the benefits that will come from electronically enabling our business. We know that as we standardize on technologies we will grow our business. The benefits will probably come from places we don't expect to see them". Tucker states that the problem with financial analysis of technology investment is, "Technology investments can impact organizations in many ways. When we can associate operational metrics with technology investments we have another tool to measure if we are getting positive results."

Here is a hypothetical example of how operational metrics or Key Performance Indicators (KPIs) might be associated with the cash flow projections for an IT project.

A company plans to install Radio Frequency/Bar Coding in its main warehouse. The project's cash flow projection is based on 1) enabling the company to carry lower inventory, thus reducing working capital and 2) reducing the staff required during peak shipping hours. For the IRR calculation the value of the lower working capital and the lower staff salaries are put in monetary terms. In other words, the projected dollar savings will be estimated and used to justify the project. Let's assume that the payback period for the investment is projected to be 3 years. If all the conditions that are in place today remain static for 3 years, the company will be able to measure if the project met the cash flow/financial projections. But if the number of SKU's shipped from the warehouse change or shipping volume goes up or down the cash flow impact will be skewed. The company could develop KPI's that are associated with but not the same as the cash flow/financial measures. Here are some options:

  • Units shipped per man hour

  • Orders shipped accurately

  • Warehouse inventory turns

  • Orders shipped on time

  • Time it takes to ship standard orders

  • Average days of inventory on hand

None of the KPI's we've developed can be easily turned into monetary terms. But the KPI's we've suggested are indicators of more effective use of working capital or better utilization of labor. No KPI will be perfect nor will KPIs be immune from the impact of changing business conditions. However, if the underlying business assumptions change, the cash flow projections may be critically flawed but the KPI's can still be relatively reliable indicators of the impact of an IT project.

This is Part Two of a two-part tutorial. Part One discussed the difficulty using ROI to evaluate an IT Investment.

The Supply Chain Investment Problem

Another emerging problem with traditional financial analysis and IT investments involves the expanding scope of IT projects. Today, companies are increasingly making IT investments that impact the cash flows of themselves, their suppliers, and customers.

The financial analyses justification for an IT project traditionally has been confined to the improvements in cash flow that accrue to the company that is doing the project as it is extremely hard to put into monetary terms the long term benefits that accrue from supply chain improvements. This is another opportunity to use KPI's to measure the impact of an IT project. It is relatively easy to develop KPI's that measure supply chain metrics like lead time requirements, supplier responsiveness to change orders, or the reliability of customer service information.

As software technology improves, the benefits to a single company in a supply chain will be even more difficult to measure in financial terms. Companies will need to increasingly rely on KPIs that are associated with the financial projections they used to justify IT investment.

Conclusions

Certainly the free spending era of IT is over. Unfortunately, the traditional financial measures that companies use to make investment decisions are only partly applicable to IT investment. Companies that have a strategic imperative to gain competitive advantage through investment in IT infrastructure should look to develop KPI measures that can be indicators of the financial performance of their IT investments. In the long run, IT project KPIs may be the best indicators for IT managers to use in evaluating the results of their IT investments.

About the Authors

William "Bill" Friend and Olin Thompson are consultants who specialize in the application of IT to business problems in the process industries. Bill is a principal of WR Friend & Associates (www.wrfriend.com) and has over 25 years executive experience in food and chemical manufacturing and can be reached at bill@wrfriend.com.

Olin has over 25 years experience in the software industry and is the founder of Process ERP Partners (www.processerp.com). He can be reached at olin@processerp.com They co-write a monthly column for Food Engineering (www.foodengineeringmag.com) and are the co-founders of the Food, Chemical and Life Science CIO Forums which are found at www.foodcioforum.com, www.chemcioforum.com, and www.lifesciencecioforum.com.

 
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