Tag Archives: ram sundaram

Should You Quantify IT’s ROI? (Part 2)

In Part I, I laid out the shortcomings of using a quantitative business case to decide whether to proceed with big insurance modernization projects. Recently, I’ve been fortunate to partner with several clients who’ve taken a different approach to funding initiatives and measuring value on a continuing basis, and I’ll describe those approaches here. 

Deciding whether to fund an initiative

Example one: One alternative approach when deciding whether to fund an initiative is the “critical thinking” model. Leadership groups may, rather than insist on the quantitative business case, instead request “arguments” and answers to questions. Why? Why not? What are the risks? What is the order of magnitude of investments — instead of precise estimates? What will happen if the initiative is not undertaken? Is it a “table stakes” initiative that everyone in the industry must undertake, or might there be competitive advantage?

Armed with honest answers to these questions and order-of-magnitude estimates, leaders then discuss, debate and engage in critical thinking to reach consensus on whether or not to pursue the initiative. The emphasis is on the discussion rather than a simple processing of contrived numbers.

Example two: The “continuous funding based on results” model. I have seen a few clients allocate an initial investment based on a joint case made by business and IT together — “together” being the operative word. Every 12 months, business and IT together go up to an executive oversight group, show what they have done with the “pot of money” and, based on this, get additional “grants” together. Because business and IT agree, and tangible value is demonstrated, additional funding is granted until business and IT feel that major items are achieved and only diminishing returns are left.

It may be argued that, for complex transformations, continuous funding is not possible, especially if commercial software is involved. I am not convinced. First, even with very large enterprise initiatives, I have seen the model work; second, even with commercial software purchases, the costs of such software often is a very small fraction of the overall outlay, perhaps no more than 10% to 20%.

Example three: A third model is akin to thinking about your health. If you know that your health is important in the long run, then, rather than try to quantify the benefits of investing in keeping yourself healthy, you might simply set aside a steady stream of “investments” toward the intended objective. This steady stream could be for healthy food, exercise and fresh air, periodic visits to the doctor, etc. Perhaps insurance initiatives, especially those of the “modernization” and “transformation” kind that only yield benefits over a long period, ought to be treated as you might treat your personal health. Without regular investments in health, the organization will get sick.

There are variations of those three examples of new models described that include qualitative arguments on the benefits side, with “best effort” cost estimates, fixed funding for a fixed number of years with expectations for periodic “report cards,”  etc.  But none of them are the traditional ROI approach.

How do you spend the funding for a given initiative?

How is money spent and resulting value measured along the way? All too often, regardless of how funding is appropriated, this pot of money is then handed off. “We’ve given you the money; now get us everything you promised,” is the dynamic that gets set up between those who are responsible for obtaining the money (usually the business) and those who are supposed to deliver a “set of scope” for the money (usually IT).

In reality, countless variables and problems arise that can trip initiatives up. In the worst case, you can be a dead duck before you’ve barely started. Besides disappointment and frustration, you sometimes get finger-pointing and colorful name-calling!

Here again, a different approach may be needed. Perhaps the pot of money is not handed off. Rather, joint ownership is established. A series of “micro” decisions are jointly made about what to spend the money on. Estimates of effort for smaller-scope items come from the execution side of the team. Those who will benefit from the fulfillment of that scope decide whether it is worth spending the money.

I have seen a healthy dynamic ensue from this approach. Sometimes, what was originally deemed beneficial is given up; sometimes, new benefits are identified and added. Often, when the pot of money does run out, I have seen business and IT jointly make the case for additional funding to deliver additional returns. And, more often than not, they do get the additional funding because executives who allocate capital can see the good that came from the original allocation.

A few years back, I undertook a “small scope” remodeling project at home. An architect/designer drew up the concepts and plans. A general contractor agreed to execute the plans, having provided some rough estimates. Like insurance transformation initiatives, it was “defined scope” only briefly! As the project unfolded, many changes occurred – some necessary and others as discretionary or choice items. While the architect and general contractor collaborated and provided options, my wife and I (responsible for the pot of money) had to make a series of “micro decisions” about the “return” that we might experience and the costs required. Like most IT projects, the project took longer and cost more than originally envisioned, but we were certainly happy with the results.

Reflecting on this experience, I realize that those successful teams that I have described above essentially were taking the same approach. While a home remodeling exercise is rather trivial compared to an insurance modernization or transformation initiative, to me. at least, the underlying principles seem similar.

 

While the theory of the quantitative business case may be ingrained and appealing, I have seen it offer very little practical value. A (non-quantitative) case can perhaps be made to let go of the theory and embrace more pragmatic approaches to fund, monitor and measure the returns of insurance initiatives.

Should You Quantify IT’s ROI? (Part 1)

What is a quantitative business case for an IT investment? It is a quantifiable measure of benefit, in dollars, that can be realized by making a quantified investment of resources. While resources can be capital, human, intellectual property, etc., in the end it can all be reduced to money. What money is one putting in and what return is one getting out as a result?

Making the quantitative case is a long- practiced ritual in many insurance organizations. I may be committing heresy by asserting that the quantitative case is much overrated, doesn’t serve the purpose it was intended for very well and may, in fact, be an exercise in futility. I’m not making a general statement: I’m speaking about various IT modernization or transformation initiatives in the insurance industry, which I work in and serve.

I took enough corporate accounting and finance courses to qualify as a finance major and as a result am familiar with the mechanics of discounted cash flow analysis, valuation of initiatives, calculations of NPV, IRR, payback, etc., etc. While the theory of the quantitative approach has always seemed compelling, 20 years of practice has taught me the reality and informed my views very differently.

Why, then, is the quantitative case typically so favored? There are two primary reasons. First, quantifying helps with understanding the return on investment for any individual undertaking. Second, and perhaps more important, when many initiatives vie for scarce capital, quantitative cases can allow for comparisons. And in most organizations, one of the most important responsibilities of an executive team is to allocate capital to the most beneficial initiatives.

All this sounds quite straightforward. What, then, is the problem with the quantitative case, especially for initiatives that require big capital expenditures? The problem is not with the mechanics of quantifying. Once the investment and income streams over a reasonably desired time horizon are identified, weighted average cost of capital (WACC), discounted cash flow (DCF), net present value (NPV) and internal rate of return (IRR) sorts of metrics are quite mechanical to calculate. The real problem with so-called insurance modernization or transformation initiatives is with establishing the variables of investment stream, income stream and time.

There are two ways to try to establish these three variables. First, if one can precisely establish the required investments and expected returns over a period. If I know that I have to travel 300 miles and know that I will drive 75 mph, I can mathematically say that I will complete my travel in four hours. Second, if a vast body of empirical evidence exists, then one can at least probabilistically try to establish the three variables with associated confidence levels.

But I would argue that with initiatives in the insurance industry that require large capital-expenditures, neither approach works.

With insurance industry initiatives, quantifying income returns, investments and time period with precision is extremely difficult, if not impossible. On the investments front, projecting increase in premiums and profits, cost savings through headcount reductions and other items and cost avoidance are all an exercise in sheer guesswork. Estimating the costs and timelines of large technology projects also remains elusive. No matter how diligently and hard people work to identify these, the estimates end up being wrong–often, not by some tolerable deviation but rather by orders of magnitude in overruns in costs and time.

Because the vast body of insurance initiatives suffers the same fate, there isn’t reliable empirical evidence to probabilistically establish income, investments and time period with any degree of confidence. And there are other variables that further undermine the attempts at calculations – differential in resources and execution approaches from one initiative to the other, culture of organizations, market changes, technology changes, and much more.

Despite the problems associated with the quantitative business case, most organizations still pursue it. Internal teams work on project portfolios and appropriation of funding exercises. Vendors are always at hand to help the teams develop the business case to sell it to the C-Suite and the board. Within the organization, committees and councils are established to review the “case,” “wisely adjudicate” and pick “winners” and “losers” among candidate initiatives. All these various constituents are well-intentioned and are following the rules of the game. The problem is with the current “rules of the game” and not with those who play.

Are there alternative approaches, then, both to decide whether to fund a given initiative and, once funded, to determine how best to use the funding to ensure that an initiative is yielding benefits? In several instances, I have been fortunate to witness bold leaders abandon the traditional method and take a more pragmatic approach. I’ll discuss this in Part II.