Return On Investment

Return on investment (ROI) is a financial calculation that indicates the degree to which benefits exceed the investment for a given project or initiative. ROI is applied to initiatives that utilize capital resources because unlike expenses, capital is used to acquire assets that have a longer term impact that will either help or hinder the organization as it operates in the future. The calculation of ROI is in the form of a ratio where benefits are in the numerator (top) and investment/costs are in the denominator (bottom). By itself, ROI is just a number.

Within most organizations, capital is a limited resource; therefore projects and initiatives that require capital must compete for allocation and approval. Historically, manufacturing and facilities were the prime users of capital but increasingly, IT is moving to a very prominent level (30 percent is not unusual) and therefore must compete for limited resources. Larger corporations typically have a capital budget that identifies the potential recognized projects and then when a project is ready to start, a detailed plan and ROI analysis are submitted to actually release resources to the project. So the first hurdle for a project is to be included in the capital budget; the next step is to gain release of the actual funds, which requires the details and justification. The decision to proceed with a project is commonly handled by the most senior level of management and at certain thresholds in investment. It may require board approval.

Although the tools of ROI can provide rank order analysis, risk assessment, etc., it is still a political decision that is subject to all of the foibles of human judgment. For example, it is not uncommon for members of senior management to mentally benchmark the level of funds requested to equivalent investments that have a relatively known return; for example, a production line, warehouse space, R&D, etc. This mental benchmarking is very important because if the ROI appears weak or marginal as compared to the mental standard, it could be in trouble. Obviously the political influence of the individual backing the initiative is also important. Certainly it is possible to get approval for an initiative with little more than an emotional appeal from the right person, but is that what it is all about?

Clearly ROI is a key component of the right of passage of initiatives to get initiated. If ROI is viewed as simply a number that is placed in an approval box, it may gain access to the funds but all bets are off in terms of success. Consider this real life example. Not too many years ago, a major manufacturer rolled out an extensive CRM system based on essentially the political emotion of a senior vice president. The project alluded to an ROI but it was vague and certainly not tied to specific strategies or metrics. Though the project team attempted to do a conscientious job of implementing the system, it was never the less the impetus of the VP driving the timing and commitment. The result was all to predictable, the organization resisted the imposition of the system and the VP left the company leaving a legacy and project team with a high cost system, little organizational support, and questionable benefits. Yet more road kill on the highway to competitive advantage.

This example reinforces that it is possible to use pure emotion to get a CRM initiative through the approval process but what has been gained? In today's economic climate, all organizations are emphasizing the ROI component of the submission and to that end; many CRM vendors are offering ROI calculators. These calculators represent a positive sign in that they reflect the vendor's recognition that these applications must add economic value to the user organization. The calculators also help user organizations think about the potential for their organizations to improve performance. However, merely generating a number that meets the ROI level required as a right of passage is likely to set the stage for failure. Why is this so? In Lewis Carroll's book, Alice In Wonderland, Alice asks for direction from the Cheshire cat. When the cat inquires about Alice's destination, Alice confides that she does not know. The cat then observes that any road will take her there. To achieve success means that success must be defined and a road map used to get there.

ROI as a Road Map

ROI is just a number but a properly developed and articulated ROI is based on a set of assumptions relative to cause and effect relationships. These cause and effect relationships are tied to a set of metrics that measure performance and the degree to which the cause and effect relationships are working as predicted. The ROI road map describes how the organization is going to leverage these relationships and how the effect is going to be measured (metrics). Lastly, a senior executive signs on as the sponsor to ensure that it all happens.

In the past, most organizations have dealt with capital appropriations on a cost reduction and/or avoidance basis. What makes CRM initiatives seem peculiar or somewhat less solid is the inclusion of top line results that are hard to isolate or prove one way or another. Part of the difficulty is that most organizations go from tactic or strategy directly to top line results such as revenue and margins. Though this may have intuitive appeal it smacks as a very big leap of faith. What is missing in many cases is the use of customer performance metrics. Customer performance metrics link customer behavior to the top line financial drivers (revenue and margins). Examples of customer performance metrics include new customer acquisition cost, share of customer, customer profitability, etc. It must be realized that unless the organization improves these key metrics, it is unlikely to experience competitive improvement. The customer performance metrics become pivotal to the linkage of cause/effect relationships to the ROI. Through the creation of appropriate metrics, senior management will gain confidence that it will be able to track what is working and what is not. The size of the chasm becomes visible and the leap of faith more reasonable a business proposition.

This approach provides a clear road map and defines success. Lacking such a definition, how will you know you arrived? More importantly, lacking this definition, how committed will senior management be if problems arise (and they usually do at some level)? CRM is littered with failed and abandoned projects. One can only believe that the organizations did not adequately assess the cost and/or define (or believe) what was truly at stake. ROI is certainly no silver bullet but investing the effort to make it a road map radically improves one's probability of being on the winning side to the success statistics.

[Glen Peterson is senior vice president of One Inc.'s consulting practice. He is also the author of E-Success: A Leadership/Alignment Model, High-Impact Sales Force Automation: A Strategic Perspective, and Customer Relationship Management Systems: ROI & Results Measurements.]