Few organizations realize that ROI is not just about technology. Whatever the underlying technology for which ROI is being calculated, such as Web services, there is always a set of business and personnel factors that have a great impact. I cannot stress enough that technology alone will not produce the quantifiable results and benefits projected in any ROI matrix or calculation. Several business factors, such as the speed of rollout and systems adoption rate, play a critical role in determining the final numbers.
Let’s look at the formula for calculating your Web services ROI and the fundamental methodologies that companies can use to analyze ROI.
Learn more about Web services ROI
The article “Road map to higher ROI for Web services” provides the initial steps to follow to calculate ROI for your project. Another article, “Factors for calculating the ROI of Web services,” explains the factors you must consider to accurately calculate your ROI.
What is ROI for Web services?
ROI for Web services is a key financial metric of the value of business investments and expenditures. It is a ratio of the net benefits of using Web services over costs, expressed as a percentage, and it takes into account the quantifiable risk factors. This formula can be expressed as ROI = [(monetary benefits of using Web services (tangible and intangible) – cost of using Web services technology) / (cost of using Web services technology + quantifiable risk factors)] x 100.
An example of ROI calculation
Consider a scenario where the IT group within Company A determines that there is a 10 percent increase in the automation of software development following the implementation of services-based Web services for an organization’s IT project. Other data from Company A’s IT group reveals that each 1 percent increase in the automation of software development is equal to increased annual revenue of $25,000. Further, the IT group knows that the Web services implementation will cost $75,000. Lastly, the group determines that the quantifiable risk—such as security, exploration of new technology, immaturity of Web services standards—that Company A will have to bear for using Web services as the implementation technology is $20,000.
For this example, the ROI for using Web services within Company A is calculated as:
[($250,000 – $75,000) / (75,000 + 20,000)] x 100 = 184%
This means that for every dollar invested in the Web services implementation, the organization realized a net benefit of $1.84 in the form of increased revenue from the automation of software development.
There are two fundamental ways or methodologies through which companies can conduct ROI analysis for Web services: discounted cash flow analysis and payback period analysis. Let’s look at these methods and some fundamental concepts behind them.
Direct and indirect measures
When calculating ROI, you should consider both the direct cash-flow-generating contributions of a new technology or project and the indirect measures valued by management.
Discount rate or weighted average cost of capital (WACC)
The discount rate, also known as the weighted average cost of capital (WACC), is the opportunity cost of capital, which is the expected rate of return that could be obtained from other projects of similar risk.
Net present value (NPV)
NPV is the difference between the cost of an investment and the return on an investment measured in today’s dollars. In other words, NPV calculations account for money’s time value by discounting the future cash flow of the investment at some discount rate that varies with the risk of the investment.
Internal rate of return (IRR)
If there is an investment that requires and produces a number of cash flows over time, the IRR is defined to be the discount rate that makes the net present value of those cash flows equal to zero. In other words, the discount rate that makes the project have a zero NPV is the IRR.
ROI is just a percentage, so include the payback time to make it persuasive. Costs divided by monthly benefits yield the number of months to pay back.
Discounted cash flow analysis
In the discounted cash flow ROI analysis methodology, the expected cash flows relating to investments for a Web services project spanning across multiple years are discounted using an appropriate discount rate to determine an NPV and/or IRR. If the NPV is positive, the project’s present value exceeds its required cash outlay, and the project should be undertaken. When a project has a positive NPV, the NPV decreases as the discount rate increases. Similarly, if the IRR is greater than the cost of capital for the company, the project should be undertaken.
Payback period analysis
In the payback period ROI analysis methodology, consider the period of time it takes for a Web services project to yield enough returns to pay for the initial investment or to break even.
Stick to the basics
In tough economic times, when it’s hard to find funding for any new project or technology within companies of all sizes and sectors, it is paramount for senior IT executives and development managers to stick to the basics and see whether it really makes a business case to introduce Web services.
Answer the following questions before jumping into a conclusion based solely on the results of using the ROI formula presented in the above sections:
- Do I really understand this technology? (If not, get an understanding through reading and attending conferences.)
- Does this technology fit within my organization?
- What will be the ROI for its usage?
- Is my organization prepared for it?
- How can our business-to-business (B2B) relationships evolve in the future, and how can our trading partners utilize Web services to expose their external systems and business data?
- Does the enterprise application integration (EAI) and business-to-business integration (B2Bi) infrastructure built on Web services provide secure, location-independent access points to applications? (This is a necessity for today’s mobile workforce and extended corporation.)
- Will the usage of Web services within your company provide a holistic approach to e-business networking that provides an infrastructure for an entire e-business enterprise, including internal operations, business partners, and customers?
- Are the packed applications, such as customer relationship management (CRM), supply chain management (SCM), and enterprise resource planning (ERP), used within your company providing support for Web services? If so, at what level?
- Are the integration brokers and application servers used within your company providing support for Web services? If so, at what level?