Is ROI Overrated?
Return on Investment (ROI) is probably the most popular business case measure for assessing projects and initiatives. However, it is fraught with pitfalls and is the most overrated project selection method. I am using ROI here to represent a variety of financial measures that can be determined by financial analysis. Regardless of the final measure, whether it is Net Present Value (NPV), Internal Rate of Return (IRR), Economic Value Added (EVA), or ROI, the basis of the calculations is the same. You’re looking for a forecast of revenue and costs.
I am not the only one to make negative remarks about financial measures.
"These methods are extremely popular project selection approaches. But don't be fooled: The businesses with the poorest performing portfolios rely almost exclusively on financial selection approaches, according to our research."
Winning at New Products: Accelerating Ideas from Idea to Launch,
Robert G. Cooper
Your ROI decisions are only as good as your ability to forecast!
ROI is computed using a forecast of costs and a forecast of revenue or cost savings. Thus, ROI is dependent upon the accuracy of the forecasts for the costs and revenue projections. The question that the program manager needs to ask is: "How accurate are, and what degree of confidence do you have in these forecast estimates?" This question should be followed by a review of all the ROI estimates for the past three to five years to assess the demonstrated history of individual and organizational forecasting ability.
History is proof of performance!
If the organization has a history of accurate costs and revenue forecasting, then have confidence in the ROI numbers. However, if the history of the organization’s forecast of cost and revenue numbers is poor, the program manager should discount or ignore the ROI calculations. Still, have the organization calculate the ROI so you can judge their forecasting ability in the future, but you should not include ROI as a determining factor in your analysis to identify the best projects and initiatives.
As always, judgment is a determining factor, and if there is overwhelming and compelling evidence leading you to consider ROI, despite the poor forecast history, then go ahead. The good part about going back and looking at previous ROI projections is that it will tell you the forecast accuracy of those projections.
Using history drives accountability!
I am sure that no one at your great company or organization tweaks or massages their ROI numbers to "bump them up" a little or a lot with hopes of getting a project or initiative selected, but it does happen in other companies. If your organization never goes back to critique ROI estimates and then hold the estimator accountable for those estimates, expect a lot of massaging of ROI data by those trying to increase the odds of their project gaining approval. The program manager has to assure that the project selection process uses valid data and/or understands the deficiency of the data.
When this discussion comes up in my training of program and project managers, most of them say that their organization never looks back at previous ROI estimates. Invariably a program manager will make the comment that "Circumstances have changed. There is no point in going back because the circumstances are different now." This is not a valid excuse for not going back and analyzing. It is simply another reason not to give too much credence to the use of ROI and financial measures in a dynamic environment.
Dr. James T. Brown PMP PE CSP
Adapted from The Handbook of Program Management
Copyright 2008 SEBA Solutions Inc.