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IT’s Payback Time – Calculating the ROI on IT Innovation – Part 1

To justify investment in new IT projects, we need to show that it pays off – here’s how to do that.

Les Viszlaiby Les Viszlai

ROI Calculation“Innovation in IT pays for itself.”  That’s something pretty much everyone in IT believes. But it’s also something that a surprising number of companies I visit aren’t in a position to prove.  Why? Because most companies don’t actually know what it costs to provide their IT services and can’t quite put a figure on the benefits IT innovation projects can bring.  Missing these key data points can make it very difficult to quantify the Return on Investment (ROI) or payback on any IT project, making it harder for IT to compete internally with other departments for scarce business funding.  Many times, approved IT budgets get frozen or delayed because the business does not understand the value of the projects in question and opportunities are missed or delayed.

In Part 1 of this blog series, let’s begin at a basic level in order to get you familiar with the topic of calculating ROI.  We’ll dig in to what you can do to calculate whether an IT project will be self-funding.

Calculating Basic ROI

ROI Increased Revenue Cost ReductionEconomists have used many formal models to calculate ROI (Return on Investment), TCO (Total Cost of Ownership), as well as methods for determining IT Business Value and payback periods.  For this conversation, let’s focus on basic ROI, and ask the question: if we spend X dollars on a new IT project or service in order to get a new or existing capability, will we spend less money than we are paying now for the equivalent capability or service that we will replace?   If an initiative does this, then we can easily make the case for moving forward with that innovation program.

To figure this out, we’ll look at these two areas:

  • Reduced or avoided capital and/or operational costs
  • Increased/Enhanced Revenue

Hard Costs and Soft Costs

Hard cost is money we have to pay. Most hard cost savings or cost avoidance opportunities are fairly easy to quantify. These savings will include the cost of hardware and software you no longer need to pay for and savings from staff reductions and licenses you will no longer need.   However, don’t forget to factor the added cost of the new hardware and software you are installing, any one time professional services fees you will need in order to deploy everything in place and any new staffing needs.  But this should all be relatively easy to quantify from a hard cost standpoint.

Soft cost savings or cost avoidance is more complex, because the benefits accrued are harder to put actual numbers on and its harder to get internal agreement on how its determined. In addition, most companies capture this information over a 3 to 5-year period, which may compete with short-term goals.

If you are already measuring soft costs today, then you’re ahead of the game.  However, you might be surprised by how often I see organizations failing to quantify them. The main reason, typically, is that nobody wants to do the work or no one understands the benefit. Quite often, I see companies look at an IT project purely from a hard cost savings perspective and say, “We can’t figure out how much time this will save, or how much happier this will make the client, so we’re not going to use these additional metrics as a measurement for this project.”

For those of you that want to start looking at this, I suggest reviewing the benefits below to see if they are addressed in the proposed project.  These project benefits are easier to quantify and can easily add up to substantial savings over time.  To calculate the savings for projects designed to improve existing capabilities, look at the current delivery time and associated costs and then subtract those numbers from the new projected delivery time and costs.

Will this IT project:

  • Provide faster delivery times?
    With simplified work flows and more repeatable processes being done more often by a machine automation, we can look forward to faster delivery times.  In order to calculate this, we multiply the current hourly FTE costs by the average delivery duration, by the number of requests on a yearly basis and compare that to the new times and costs.
  • Reduce the cost of training?
    With a simplified system, can we reduce training times for people new to the company, and likely employ more junior staff and divert more senior staff to innovation activities.   These savings can be quite high in organizations that have seasonal hiring needs and organizations that have a high staff turnover.
  • Lower regulatory and compliance costs?
    Automation and simplification activities can have a significant impact on reducing the cost of compliance, especially in regulation-intensive sectors like healthcare or finance.  These savings can be calculated by tracking the current FTE time used to manually record and document audit related activities and compare that to the improvements driven by the project.
  • Reduce human and machine errors?
    With simpler, more repeatable processes being done more often by a machine, we can look forward to less failures.  In order to calculate this, we multiply the current hourly loss, by the average downtime duration, by the number of times this happens on a yearly basis.
  • Drive faster resolution times?
    Using MTTR (how long it takes, on average, to restore a system) we multiply the number of incidents, by the time it takes to resolve, by the cost of personal on a yearly basis.

The above is the short list of soft cost savings you can use as a starting point.  They are easier to quantify and get agreement on, and collectively they can seriously add up.

Projecting Increases in Revenue

It should also be entirely possible to figure what the IT project change will do for your revenues.  Just to be clear: we’re not talking about the results of funding an entirely new product. We’re talking about the revenue enhancements that come with the cost avoidance/reductions and efficiencies tied to existing product/service lines.

Let’s take this scenario for quantifying IT Project payback: A business owner is running a web store where it takes a customer 3 minutes to buy something, but 90% of customers abandon the sale after 38 seconds. Along comes the innovative IT team, offering a project that reduces the average time-to-purchase down to 30 seconds. It’s entirely feasible, then, to figure the increased revenues that ought to accrue, all other things being equal, from the technology change and the faster buy time.

Again, the biggest thing that I see getting in the way of these kinds of calculations is that businesses first have to commit to doing them. I don’t think it really matters which method we use (ROI, EVA, TCO, they’re all fine). We just have to get agreement to pick one.

By doing the work upfront and having those numbers available for review, you put senior leadership in a better position to approve the IT project proposal.  It also leaves very little room for debate on the savings value of the project since we have established agreement within the organization on how the ROI is determined.

Key Take-Aways

  • Don’t forget to establish how you will calculate the expected ROI as you set an innovation strategy.
  • Don’t be hesitant to dive in.  Just pick an accounting method, get agreement on it within your organization, and then start doing the math.
  • This pays off!  In all likelihood it will help you prove that IT innovation does indeed pay for itself.
  • When IT innovation can pay for itself, this leads to more innovation, and that leads to increased customer satisfaction or added brand value, which of course will have a positive direct impact on your business.

Stay tuned.  In my next blog we will dig into the obstacles to watch out for that impact our ability achieve the projected savings.


Les Viszlai is a principal strategist with VMware Advisory Services based in Atlanta, GA.

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