Developing Your ROI

There are three common ways to analyze ROI:

• Net present value: Derived by subtracting the total of the costs (converted to present values using the discount rate) from the total present value of the benefits.

• Pay-back period: The period required for the total costs (development and support) to be met or paid back by the accumulated benefits.

• Internal rate of return: Derived using an exponential equation that calculates the interest rate required to make the total future value of the benefits equal to the total future value of the costs (Microsoft Excel can calculate this as a function).

Cost-Effectiveness

As we covered in Chapter 9, if your project is simply upgrading equipment such as computers and there is functional replacement only, it is acceptable to ignore benefits and use cost-effectiveness as an alternative to ROI. This technique assumes that the new technology has the same implicit benefits as the technology that is being replaced .

The P Files Episode 13: The Return of the Consultants from Hell

We were consulting at an executive level to a major government organization. We had worked with the team during project initiation and feasibility to work up figures for the ROI calculation. We left to work with another client and the organization hired some experts on cost “benefit from another well-known consulting organization. The sponsor of the project sent us by e-mail the ROI undertaken by the consultants prior to it being sent to the premier of the state (a governor in U.S. terms). It took us no more than 10 minutes to realize that the ROI had been based on the best case estimates for both costs and benefits. Our team had also developed worst case scenarios for costs and benefits (which were right under the best case scenarios in the document given to consultants). On the best case scenario, the project returned 100%. On the worst case scenario, the project returned “50%. It was a high-risk project. It was canned before it started.

The P Files Team Comment

It is really too easy to knock consulting companies. We'll leave that to Lewis Pinault (2000), a former Boston Consulting and Cap Gemini consultant, whose book Consulting Demons: Inside The Unscrupulous World of Global Corporate Consulting does a complete expos of the tricks of these companies. However, this deliberate fiddling with the project financials to get a project approved is still far too common.

Case Study ”Develop ROI

Benefits Summary

Working with Edwina you analyze the expected volumes , fees, and charges. These figures are based on Big Bucks clients only.

• Expected number of Premium clients (per year):

  200 (best case), 120 (likely case), 100 (worst case)

  Additional fee per premium client: $1,000

• Number of revisits caused by poor client preference information (per year):

  20 (best case), 18 (likely case), 12 (worst case)

  Cost per revisit (to Smuthe): $200

• Number of Big Bucks clients who seek other services:

  30 (best case), 15 (likely case), 10 (worst case)

  Fee normal client: $1,000

• Estimated retention:

  25 (best case), 10 (likely case), 5 (worst case)

Remember that the outputs all lead to the same outcome so as long as we calculate the outcome benefits stream, we can add the output benefits as a bonus.

Objective	Output	Outcome
To capture extended client personal details	More information about the client's family, life-style, and accommodation preference for Smuthe consultants	More appropriate placement for clients
	Improve service (to Smuthe clients and Smuthe consultants)	Increased revenue (increase in fees for premium service)
	Avoid costs (less research required for consultants, fewer accommodation showings)	Best case $100,000 p.a. Likely case $60,000 p.a.
	Best case $4,000 p.a. Likely case $4,000 p.a. Worst case $4,000 p.a.	Worst case $50,000 p.a. Notional avoided cost (reduced level of potential clients loss) Best case $25,000 p.a. Likely case $10,000 p.a. Worst case $5,000 p.a.

Edwina is "on a winner" here.

Costs Summary

Based on the likely case estimates of 234 hours (which include Joan Jette's effort), plus 10% for project management and 10% for internal quality assurance (don't forget the $1,600 for external quality assurance), you derive a cost estimate of 300 hours (rounded) at $100 per hour .

• Basic Costs

  Development: $30,000

  Support (for 3 years ): $30,000

ROI Analysis

You calculate the ROI using just the likely case costs (you are pretty confident) and over three years. Just for illustration, we'll use the likely case benefits estimates. Of course, you'd derive a complete set of ROI calculations based on best case benefits, best case costs, best case benefits, likely costs, and so on.

The discount rate you agree on with Edwina is 8% and you assume no yearly increase in clients' usage.

	Year 0	Year 1	Year 2	Year 3
Returns (F.V.)		$74,000	$74,000	$74,000
Returns (P.V.)		$68,517	$63,440	$58,741
Costs (F.V.)	$30,000	$10,000	$10,000	$10,000
Costs (P.V.)	$30,000	$9,259	$8,573	$7,938
FV = future value; PV = present value.

This gives you the following ROI

• Net present value

  $190,698 “$55,770 = $134,928

• Payback period

  0.8 years

Clearly, this is a viable project for Edwina (remembering that it scored high on the added value drivers as well). In addition, there is the expected growth into Watchout Insurance at a later stage.