Risky business: Beyond TCO and ROI
Financial managers have long scorned the idea of judging an IT project solely on the basis of product prices. Beyond software licensing fees and any hardware infrastructure upgrades, there are many costs associated with implementing e-business projects, such as consulting, training, data preparation, software integration, documentation, change management, and project management. Collectively, these costs usually outstrip licensing costs several times over. TCO strives to provide a more complete assessment of costs by tallying all necessary e-business project expenses, not just the initial technology acquisition costs.
Although TCO certainly provides a more complete picture of costs, it can't answer the question "if we pay for all this, what do we get for our money?" ROI analysis evaluates anticipated costs in light of expected benefits but, like TCO, it doesn't really provide a complete business case evaluation. (For a more in-depth look at the inadequacies of ROI analysis, see my column "Why ROI can sometimes lie.") TCO and ROI are useless when it comes to evaluating risk, flexibility, and intangible benefits-factors that have a critical impact on business and should be factored into spending decisions.
Assessing risks
Risks are everywhere in business but you won't find them in most spreadsheets, partly because risks don't lend themselves to precise quantification. But that doesn't mean you should ignore them. You can create a general framework for risk that provides a more realistic sense of the possible outcomes of a business decision, its cost variability, and potential payoffs.
You don't need to understand specifics of each occurrence of each risk to model their potential effect on costs and benefits, according to Chip Gliedman, a Giga Information Group vice president. "Imagine you were going to do this project 50 times. One time everything will go right. Another time everything will go wrong. Most of the time some things will go right and others will go wrong. Ask yourself what it will cost in each of those situations." From this, he says, you'll get a distribution curve for the possible outcomes.
Here are a number of common risk factors to consider when modeling the potential outcomes and costs of e-business projects:
Project size. The bigger the e-business project the more susceptible it is to risk. Bigger projects are more difficult to scope. Small projects are more tangible, and it's easier to predict how long they'll take to complete.
Technology. Every time you put a new technology in place you run the risk that it won't work as planned--will that new CRM package really do everything you expected? This also happens when modifying an enterprise's legacy technology. Software integration projects are a notorious example of this.
Vendors. Vendors regularly modify the services they offer, by either shifting strategy or through acquisitions, mergers, or simply going out of business. All of these can have serious effects on availability and support for enterprises.
Resources. Necessary resources aren't always available throughout a project's lifecycle, which can result in expensive delays. This is particularly true of staffing resources.
Management. Enterprise leadership isn't static and this can have a dramatic effect on costs. Management can change business direction or there can be changes in management itself. For example, the new VP of sales throws out the old sales force automation system to appease the sales staff that hates it.
Market conditions. Changing market conditions are probably the most infamous risk. For example, since the events of last fall the travel industry has plummeted while demand for security products and services has grown dramatically. In the face of such changes, IT projects are forced to dramatically scale up or down. Also, some markets are particularly influenced by changes in government regulations--new ones are introduced, or existing regulations are modified. The effects of these changes need to be considered.
Culture. When new technology is introduced it can meet a chilly reception if the users don't want to change the way they are used to working. More than one e-business project has gone nowhere because of resistance to change. Even if enterprise users are receptive to change, there's always a risk that a new technology will be ignored or used improperly or incompletely. You should not only factor in the training costs but consider the risk that some staff won't effectively grasp the training they receive.Once you've assessed a project's risks you can take measures to mitigate that risk by building in options. Enterprises often make the mistake of discounting options because they inflate TCO, and reduce overall ROI--but options provide needed flexibility to manage the inevitability of change and the risks that go along with it. For example, you might pay a little more for a supplier that offers extra capacity in case your project is wildly successful, requiring your enterprise to scale the project dramatically. It can also be a wise move to maintain relationships with multiple vendors if you suspect them to be volatile or subject to change.
Research and development is an excellent example of a cost that provides an enterprise with needed options. Yet R&D is immune to the logic of TCO and ROI, says Giga's Gliedman, because it drives costs up and offers no direct return. Of course, companies that reduce R&D spending run the risk of losing competitive advantage when they fail to innovate.
Pilot projects can also be an excellent source of options. Pilot projects prepare a company to respond quickly in the face of new opportunities. Should business conditions change, having the right pilot on the back burner means an enterprise has enough basic experience with a technology that it can turn that project on much more quickly in the face of changing requirements.
Using pilot projects to reduce the risk of lost opportunities is fairly common approach--companies often buy IT to hedge their bets in case a new technology turns out to be a winner. For example, if a newly-implemented CRM system turns out to provide a strategic advantage, companies need to be poised to take advantage by gaining experience with it and seeing how it works within other contexts of their business. But like R&D pilot projects evade TCO or ROI analysis, because they aren't directly related to the company's immediate business requirements. You can't always tell what technology options will produce an advantage, but if you don't experiment with them you don't provide yourself with options and can lose out on opportunities as a result.
Evaluating which options to pursue is an undeniably difficult task. Every enterprise will have an individual approach to options depending on its particular circumstances. Generally speaking, the more volatile or uncertain the situation, the more valuable the options become. According to both AMR's Parker and Giga's Gliebman, some companies are beginning to apply Black-Scholes analysis, a method of evaluating options in financial markets to help quantify the potential value of IT projects and other business options.
Quantifying risks and evaluating options are really just extensions to the business discipline that motivates enterprises to analyze e-business and other IT projects on the basis of ROI and TCO. Although risks and options can't be evaluated with the seeming certainty of ROI and TCO projections, they are nonetheless real. In some sense, they represent a more realistic approach; estimating costs and benefits while ignoring the potential intrusion of the unknown is the rightful province of dreamers.
Do you think it's important to calculate the risks and options of e-business projects? E-mail Adrian or Talk Back below.