As consultants, we’re constantly being asked by customers—both internal and external—to justify those big-budget IT expenditures with more than fuzzy platitudes about increased productivity and enhanced communications.
How do IT consultants help their clients calculate the worth of the IT initiatives they implement? Variables related to the success of our solutions—such as the client’s readiness for change and willingness to act on our recommendations—make committing to a quantifiable financial benefit risky. Yet, in this new environment of conservatism in IT expenditure, our ability and eagerness to apply measurable financial yardsticks to our work can mean the difference between selling that project and not. This column provides reasons why it’s crucial to prove IT value, some models and examples for measuring “net value,” and my own cost/benefit analysis worksheet that I use for client engagements.
Earlier incarnations of IT spending were easier to justify, but now there’s a whole industry dedicated to the substantiation of such expenditures. Douglas Hubbard, a principal at Hubbard Ross—a firm that specializes in applying financial metrics to IT projects—recently told CIO Magazine, "When you had a new mainframe program that replaced 30 workers, the benefit was obvious. But with e-business, groupware, and expert systems, you're not doing a head-count reduction—you’re communicating better."
Hubbard Ross, with its Applied Information Economics methodology, is just one of a host of firms offering IT justification services. The Balanced Scorecard Collaborative is another firm that works with CIOs and other IT pros to develop cost/benefit analyses of IT programs. David Norton, one of the two original developers of the Balanced Scorecard and president of the collaborative, said: "There isn't a first-order relationship between IT investment and financial outcome. Investment in IT typically has a third-order financial effect."
While increases in customer satisfaction and loyalty can obviously have a positive effect on business, directly measuring that effect is challenging at best. Other firms, such as Cutter Information Corp. and QSM Associates, have developed their own proprietary models of IT value measurement. Even Microsoft has weighed in, with its Rapid Economic Justification (REJ) model, which is used to illustrate the benefits of implementing Microsoft products in the enterprise.
Download Freedman’s cost/benefit analysis
A supplementary worksheet illustrates the ideas Rick discusses in this column. He has incorporated the most obvious costs and benefits that he describes here, and he has set up the sheet to present the “net value” of an IT investment. He’s also included an example of one of his own recent projects, wherein he helped a telecommunications provider implement billing software that captured additional revenue and helped the client to gain efficiencies and enhance productivity. The new software was much easier to use and manage, thus ending an employee retention problem. All of these benefits were quantified, with the client’s assistance, and are illustrated in the example worksheet. Download it now.
IT expenditures must align with business goals
A focus on the alignment of IT spending with corporate strategy is the first key element to justifying costs. As Microsoft states in its REJ white paper, “The goal is to ensure that any IT investment decision can be shown to be consistent with the organization’s business objectives.”
Directing justification efforts towards the organization’s critical success factors and strategies makes obvious sense, especially in an environment where IT investment has been accused of being “technology for technology’s sake.”
Measuring costs and benefits is especially tricky. IT managers and consultants are usually skilled at estimating costs, based on experience in budgeting for projects and for ongoing operations. Many cost models, such as Gartner’s Total Cost of Ownership (TCO) model, are well known and in widespread use for cost estimation. This model calculates project costs, such as capital outlays like hardware and software costs; labor costs for IT staff, consultants, and developers; training and support costs; hardware and software maintenance fees; and vendor fees such as data communications. There are some preexisting estimates that planners can use to plug in some of these numbers rather than trying to figure them out from scratch. For example, Gartner estimates that, for each user on an enterprise local area network (LAN), costs in 2001 will range from $7,091 to $13,485, including all labor and capital-related costs. Using this as a baseline cost number can be a start toward developing a value measurement for your IT project. (TechRepublic is an independent subsidiary of Gartner.)
The benefit side of the ledger is much more difficult. Once you get past the reductions in labor costs that some systems can provide, the financial benefits are much more slippery. Some possible IT system benefits include the following:
- Increased revenue
- Increases in productivity
- Enhanced speed of processing
- Enhanced customer satisfaction and loyalty
- Reduction in support costs
- Increased flexibility
- Increased employee retention
Show them the money
Turning these ambiguous value statements into measurable dollar figures is the challenge. Let’s take, for instance, a scenario where an organization is considering the migration to a new help-desk automation package, which promises to cut the time to process a customer support call in half. If that firm has 10 customer service reps, each earning $30,000 a year, cutting call time in half equals the addition of 10 new reps, with a total value of $300,000. Of course, until the software is implemented, we can’t guarantee that the benefits will be as advertised, but a calculation like this at least gives us a rough starting point for our benefits calculations.
One thing the Internet bubble has taught us is that projections of revenue on the Web were all wet. Many companies made large investments in e-commerce systems in the Internet frenzy, and for some, such as Dell Computer, the payoff in increased revenue was real and substantial. For many others, the benefits were more ambiguous. We need to apply some cold reason to this area and make sure that our clients are being realistic about the revenue possibilities of Internet investments.
It’s key in this benefit calculation scenario to encourage participation by the client. As an advisor, it’s your responsibility to collaborate with the client and develop some similar financial metrics that apply to the project at hand. The clients understand the business requirements and are the appropriate source for ideas and metrics around their own key performance indicators. While we, as the consultants, should offer the framework for calculating IT value, there’s no substitute for the client’s participation in developing the figures for the hard-dollar estimates of value. Only the clients know what that extra communication or employee retention is worth in their environment.
Rick Freedman is the founder of Consulting Strategies Inc., a training firm that advises and mentors IT professional services firms in fundamental IT project management and consulting skills. He is author of The IT Consultant: A Commonsense Framework for Managing the Client Relationship and two upcoming works: The e-Consultant and Building the IT Consulting Practice, both scheduled for publication later this year.
Rick Freedman is the author of three books on IT consulting, including "The IT Consultant." Rick is an independent consultant and trainer, working, through his company Consulting Strategies Inc., to help agile teams and organizations understand agile practices and migrate successfully.