Financial and project

management techniques, such as

activity-based costing, are key
components for implementing
large-scale IT projects.
Jeanette Nasem Morgan

A Roadmap of
Financial Measures
for IT Project ROI

rganizations have spent billions of dollars in implementing and subsequently

repairing, removing, or altering enterprise-wide IT systems for managing
finances, customer relationships, human resources,
manufacturing resources, and supply chains. Of all
IT systems, those for enterprise resource planning
(ERP) are among the most difficult to implement.
These products provide turnkey automated
processes while sharing common data across an
organization. Unsuccessful or grossly underestimated efforts to implement ERP tools have
resulted in massive financial failures and corporate process disarray for many organizations.
Various financial techniques can help organizations select the right projects and better manage
the implementation of enterprise systems. Figure
1 illustrates a roadmap for large-scale implementations. The roadmap describes key practices in
the fields of financial management and quantitative analysis.

PROPOSING: APPROPRIATE
METRICS AND REALISTIC COSTS
In the past,organizations often asked their CFOs
to evaluate the costs and benefits of IT proposals,
even though they had little or
no understanding of the technology.However,as IT investments began to consume a
significant portion of corpoWhy do IT Projects
rate budgets,more specialized
Fail?
experience became necessary.
This led to the emergence of

Inside

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IT Pro January February 2005

the chief technology officer (CTO) or chief information officer (CIO).The problem was,most CIOs
did not understand budgeting and financial management enough to effectively determine which IT
projects would most benefit the organization.
Numerous articles have promoted quantitative
approaches as a solid method for weighing the
costs versus benefits of IT investments (The
Examination on Return on Investment for
Information Technology in Healthcare Industry,
Michael A. Chapin, Aysegul Timur, and Donald
Forrer, Proc. 3rd Intl Conf. Management of
Healthcare & Medical Technology, Assoc. for
Healthcare Technology and Management, 2003).
However, in large-scale enterprise systems, benefits such as reduced errors in medication, wordof-mouth advertising, improved newborn life
expectancy (Small Companies, Big Returns,
Edward Cone and David F. Carr, Baseline, 1 Oct.
2003), or improved employee morale (Returns
on Investment in Information Technology: A
Research Synthesis, Bruce Dehning and Vernon
J. Richardson, J. Information Systems, Spring
2002) are not easy to quantify.
Table 1 lists benefits and some potential metrics for measuring those benefits in an ERP project. It is this sort of quantitative analysis that
makes sense to CFOs and CEOs.

SELECTING: QUANTIFIABLE
RETURNS AND ABC
Organizations receive many capital outlay proposals. The CFO or CIO recommends which
investments to pursue. To help this decision

Published by the IEEE Computer Society

1520-9202/05/$20.00 2005 IEEE

process, organizations use financial management techniques such as net present value (NPV), internal rate of
return (IRR), activity-based costing (ABC), and other
schemes involving opportunity cost and payback analysis.

Figure 1. Roadmap for large-scale

IT implementations.
Proposing

Net present value

NPV aims to show an inherent contribution of IT investment to profitability. It compares the expected annual savings, minus initial capital and expenses incurred annually,
over the investments expected life. NPV equates future
cash flows to their current value at the discount rate, a percentage rate that a company applies based on alternative
investments they forego or a desired rate of return (if they
borrow the funds).
The equation for NPV is
n

NPV =

CF

x = 1

Selecting

Executing

Monitoring

n
+CFx (1.00 + discount rate )

Assessing

where CF is cash flow, x is the year the cash flow is realized,

and n is the number of years the system will be in operation.

Table 1. ERP benefits and metrics.

Return on investment benefits

Metrics

Decreased cycle time from order receipt to order fulfillment.

Time from order to fulfillment.

Access to updated, timely, and accurate information through

a shared data store (remote access to information by
regional sales representatives);faster information transactions;
improved communications among users; and improved
information on inventory levels.

Time required to make business decisions, support personnel

hours, consultant hours required, number of shipping
errors, number of inventory stock-outs (instances of unfilled
sales orders).

Reduced inventories.

Inventory holding costs, warehouse cost per square foot,

and inventory levels.

Improved cash flow management.

Average days for collection, age of accounts receivables,

cash-to-cash cycle time (average number of days from the
time a manufacturing company purchases raw materials
until the time that the company sells the product and
collects payment).

Increased efficiency and productivity; in particular, the

just-in-time restocking of vendor-managed inventory.

Operating expenses, number of items or product lines

managed per vendor, and manufacturing time.

Increased product line profitability.

Profit margin and net profits before taxes per product.

Decreased response time to changing market patterns and

pricing models for market segmentation.

Customer satisfaction rate, quality of products and services

as measured by survey, revenue growth by market segment
and number of alterations to production to fit a new trend.

Greater operational efficiency.

Costs for transactions, overhead, infrastructure, and

maintenance; number of servers eliminated; and production
throughput.*

Flexibility in business processes.

Number of added functions and response time.

Decrease the length of procurement from the time of order

placement to material receipt.

Process costs.*

* These metrics are sometimes not routinely available and often require more extensive analysis, such as activity-based costing.

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53

PROJECT

MANAGEMENT

For example, assume that an IT project has a discount

rate of 5 percent and will return $2,000 in 10 years. This
investments NPV is $1,227.83. So if this project costs
$1,000 now (capital outlay in year 0), you would approve
the project because it has a positive NPV of $227.83.

expenses. In ABC, analysts discover activities or process

redundancies that appear to add no value to the final outputs, and recommend eliminating, streamlining, or combining activities to save costs.
IT managers can use ABC to model an IT projects
scope. Requirements gathering
can include the recording of
Internal rate of return
Combining traditional
ABC data. Most process anaAlternatively, some organifinancial management
lysts or users themselves can
zations use IRR as the gauge
complete a data entry
for evaluating projects. Such an
techniques with earned value readily
form describing activities and
organization might have a polthe time required to perform
icy that new investments must
analysis is a practice
them. Some organizations
show compound average
missing in most IT projects. track hourly tasks on employee
annual returns of 20 percent.
time cards, allocating costs to
To calculate a projects IRR,
a job unit or specific project code. So cost data might alyou discount future streams of annual returns (CFx) minus
ready be available. Reviewing activities for possible
the initial outlay and annual expenses at some rate r until
automation is one way of forecasting tangible future return
they equal zero:
on investment (ROI) for an IT investment. Comparisons
n
n
of before-and-after activity costs provide net savings data
CFX 1 + r = 0
for activities the IT project will subsume or alter. Figure 2
x = 0
suggests metrics to measure potential savings for various
ERP modules.
where CFx is the cash flow in period x, and n is the number of years the system will be in operation.

EXECUTING: REPEATED FORECASTS AND EVA

Rate r is the IRR that results when the cash flows equal
0. For example, a project with a $1 million NPV for a $100
million investment only yields an IRR of 1 percent. But a
project with a $2,000 NPV for a $20,000 investment has a
far more attractive return because the sum returned in current dollars is 10 percent. The organization risks less, but
the return is far more favorable.
CFOs often view IRR as a better measure of an IT capital investment, because it does not give preference to the
greater NPV. Rather, IRR emphasizes the percentage
annual return the profit represents over the projects life.
However, whichever technique an organization uses for
measuring an IT investments financial value, measuring
the payoffs while executing the project is still where the
management of most IT projects falls short.

Activity-based costing
At their basic level, ABC tools permit the systems analyst to capture hourly human resources, facility, and
machine cost data on all process activities that the IT system will subsume or somehow change. ABC tools collect
data on how often a particular activity takes place each
day.The tools compute the total dollar cost of performing
the activities. In ABC, an analyst identifies and measures
the flow of inputs into activities and the outputs that flow
from activities.This process captures information and metrics about the resources required to perform each activity.
In addition to the inputs, the analyst records machine,
human resources, and other costs that go into creating the
outputs, so that the analysis accounts for direct and indirect
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IT Pro January February 2005

The executing phases objective is to complete the projects requirements within the prescribed budget and schedule. Executing is the total activities that all members of the
project team conduct in creating the deliverables.The project managers role is to ensure that tasks complete on time.
When approving an IT project, an organization expects
the investment to yield forecasted results. The CEO might
demand evidence of these returns. Technologists do not
always recognize that organizations evaluate projects based
on financial impact. Most college finance textbooks cover
these concepts, but public and private enterprises do not
often apply them rigorously (Information Technologies and
Business Value: An Analytic and Empirical Investigation,
Anitesh Burua, Charles H. Kriebel, and Tridas
Mukhopadhyay, Information Systems Research, Mar. 1995).
Combining traditional financial management techniques
with earned-value analysis (EVA) is a practice missing
from most IT projects. In using EVA, the organization
assumes that the project adds some dollar value and that
the organization intends to measure this value as the project progresses. However, a roadmap that includes EVA
means you now measure the projects progress and amount
of perceived value that the project yields to the organization, as it progresses. Added costs might occur if the project is slipping in its implementation, and the earned value
or benefit to the organization might be less. By considering whether a projects initial costs and benefits are indeed
forthcoming, the organization can better manage the ROI
of large-scale IT projects using EVA techniques.
EVA compares the activities and costs that a project

Figure 2. Savings and metrics in ERP modules.

Customer
relationship
management

Finance
and
accounting

Increase in number
of orders
Reduction in returns
Increase in customer
referrals
Reduction in operating
expenses
Reduction in number
of days accounts
receivables outstanding
Increase in sales revenues

Manufacturing
resource
planning II

Human
resources

Manufacturing
resource
planning

Supply
chain
management

Faster assignment of staff

Reduction in hiring costs
Reduction in employee
turnover
Increase in quality metrics
(statistical process controls)
Reduction in idle machine
time
Reduction in warehouse costs
Increased inventory turnover
Reduced mean time to repair
Increased mean time
between repairs and failures

Reduction in hiring costs

Increase in employee satisfaction
Reduction in employee turnover
Quicker turnaround on filling
vacancies
Reduction in counseled
employees

actually expends to the planned value of work that the

project should have completed for a specific budget.These
practices should be routine; many organizations use tools
like Microsoft Project to plan tasks, resources, and costs.
When tasks become more difficult than planned, it
affects project cost and schedule. For example, if a project
has a value of $50,000, and it is only 25 percent complete
at time a but should be 50 percent complete, then an unfavorable schedule variance (SV) exists.
Calculating a number to represent SV relies on two measurable quantities: the budgeted cost-of-work scheduled
(BCWS) and the budgeted cost of work performed (BCWP)
at time a. Project managers that use this roadmaps quantitative techniques typically denote this value as
SVa = BCWPa BCWSa
A negative value of SV indicates that the project is behind
schedule and assigns a dollar amount to the schedule slip.
Second, the concept of EVA also considers actual costs
expended and the amount of budget set aside for that
work, quantified in the cost variance (CV).
The CV depends on the actual cost of work performed
(ACWP). For example, an unfavorable CV occurs if the
organization has budgeted $10,000 when the project is 25
percent complete, but actually spent $25,000. In this example ACWP = $25,000 exceeds BCWP = $10,000 at time a,

Reduction in ordering
costs
Reduction in cost of
raw materials
Increase in just-in-time
uses
Increased mean time
between repairs and
to failures

so CV = $10,000 $25,000 = $15,000 is negative, indicating that the project is over budget. This is shown as
CVa = BCWPa ACWPa
EVA also focuses on evaluating performance and revising forecasts for future work based on completed work.
Tasks for each project receive a budget based on assigned
resources and their costs. EVA forecasts the cost of the completed project and introduces the cost performance index,
a productivity measure.The cost performance index (CPI)
considers the relationship between CV and SV, applying the
current burn rate (hours expended to execute a portion of
the project) to the amount of project work remaining
CPI = BCWP ACWP
IT managers apply BCWP divided by ACWP to the original budget for the remaining work to obtain the forecast
cost to complete (FCTC).
FCTC, added to costs expended to date, gives the new
total forecast cost at completion (FCAC) for the project:
FCTC = original budget for work remaining CPI
FCAC = ACWP + FCTC
The CFO and CIO periodically reevaluate ROI by
January February 2005 IT Pro

55

PROJECT

MANAGEMENT

Why do IT Projects Fail?

Many IT projects fail because of
ill fitness for using plug-and-play commercial off-the-shelf products,
costly software customization,
unanticipated implementation
costs,
complex processes that do not fit
the organizations operating procedures,
unexpectedly long, drawn-out deployments
(Enterprise Resource Planning: Measuring
Value, Vincent A Mabert, Ashok Soni, and M A
Venkataramanan, Production and Inventory
Management J., June 2001).

reviewing the projects progress. Using these advanced

project management techniques helps ensure the correct
and accurate reporting of ROI and helps monitor the IT
project over time.
Sadly, most IT managers and even CFOs fail to track
these roadmap elements. Instead, periodic reviews of success and progress sometimes focus on soft indicators of
how development and implementation are going (such as
scorecards or verbal status reports of the projects
progress). Such reviews do not routinely include quantitative management; they ignore the use of financial analysis to gauge whether future cost savings and expenditures
are still valid. This is where the combined techniques of
NPV, IRR, and EVA come into play for monitoring IT
investments.

MONITORING: CORRECTIVE ACTION AND TCO

IT managers should consider additional information when
tracking IT project expenditures and benefits. The monitoring phases goal is to identify, avoid, and correct impending problems. Monitorings objective is to collect metrics for
the processes, costs, and savings, and then evaluate the projects efficacy. These metrics help project managers adjust
the execution plan; they also give senior management an
overview of the project. Is the project healthy? Is it yielding the expected savings? Is the project team executing it
according to the plan,and is the project providing the earned
value proposed at initial consideration? The project manager; an independent verification and validation staff; program management support staff; or contract administration
experts can handle the monitoring task.The key point is to
produce quantitative evidence that the organization properly planned the project and is executing the project in line
with the feasibility arguments made at proposal time.
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IT Pro January February 2005

A project manager must also monitor less-evident costs

of ownership, because they can turn a profitable project
into a too costly one. For IT projects, total cost of ownership (TCO) includes annual maintenance contracts
(Helping Clients Value IT Investments, Rick
Freedman, Consulting to Management, Sept.
2003). Software vendors often offer free
upgrades as long as companies pay annual
licensing fees. Expenses for training, database storage, facilities, consultants, and help
desk personnel are added costs. ERP projects in particular often underestimate the
cost of paying consultants to help facilitate
onerous implementations or reengineer business practices
to conform to the ERP system.
Failing to consider impending problem areas when computing TCO can cause financial disaster. By knowing why
similar projects have hit icebergs and sunk, a project manager can monitor the health of his current project for any
similarities. The Why do IT Projects Fail? sidebar lists
several causes of IT failures. A roadmap for large-scale
projects should never ignore the lessons learned from such
projects.
A CEO once asked his organizations IT department to
implement real-time video of the warehouse and configuration staging areas; the aim was to display the video feed
on the organizations retail Web site. The CEO felt such a
video would impress customers with the smooth processes
in action and the warehouses size.Technical staff resisted,
knowing bandwidth requirements would cripple normal
sales operations.This example illustrates what can happen
when a project lacks discernable or measurable metrics. If
you cannot measure aspects of the project, you cannot
monitor it.
These types of politically driven projects distract the
organization from the main business at hand. Organizations often mistakenly approve such IT investments without justifying costs, defining requirements, or developing a
concrete maintenance plan. Managers listen to sales
personnel, other managers and any other source of
information they have and fail to begin with a basic problem statement prior to jumping into the purchase or use
of information technology, according to Chapin.
Organizations, despite positive payback evidence, often
ignore competing projects that might improve a sales
staffs phone response time or the accuracy of inventory
and item profitability information.
In such cases, the best corrective action would be to convince executives of the financial wisdom of alternative
projects.

ASSESSING: LESSONS LEARNED,

IMPROVED ESTIMATES
The final phase, assessing, involves looking back to determine whether the organization made a good decision. By

assessing the results of each IT project, the CIO can build

information that will improve future projects. Candidly
and quantifiably evaluating whether the organization accurately applied the metrics to this project is another objective. Performing an autopsy on the living or dead project
can help find the cause for the end-condition.
IT managers typically cite unanticipated complexities as
the primary factor in the failure of large-scale IT projects
to deliver expected ROI. According to Dehning, these
managers further complain that quantifying the cost savings of IT investments is difficult.
In assessing why problems occurred during a major
deployment, organizations might find that they
lacked preparatory and organizational readiness plans,
failed to adequately understand user requirements and
business processes,
lacked quantitative management techniques to monitor
progress,
did not measure the implementations expected value
over time,
failed to sufficiently prepare users, suppliers, and customers for process changes that accompany introduction of an ERP system, and
failed to consider costs of interfaces or integration with
existing legacy systems.
In some cases, the metrics for selecting projects are difficult to determine. For example, the US Postal Service had
difficulty assigning an ROI figure for a multimillion dollar
e-business project that would automate the documentation required to verify and compare the weights and
postage for business mail. All the project stakeholders
agreed that huge cost savings would result, but they were
unable to quantify the savings.To start, no one could agree
on the specific savings in staff costs, one important means
of paying for such a huge project.
In addition, the proposed project would supposedly
detect inaccurate bulk-rate business mail postage, potentially recovering millions of dollars without the usual costly
investigations. However, the Postal Service does not typically divulge the amounts recovered from its investigations, so that indicator of quantifiable cost savings was out.
There was some available data on revenues generated
from previous random, manual checks. But that data
proved insufficient to support the high target ROI of 35
percent. Despite these limitations, the Postal Service
funded the IT project. However, a post-project assessment
would have yielded the necessary evidence of benefits and
helped in the estimates for future projects.

or the initial consideration of an IT project, organizations can use three techniquesNPV, IRR, and
ABC. Financial management techniques such as NPV
help determine whether the investment would have ade-

quate cash flow to be viable. Calculating IRR is meaningful because it describes the overall investments intrinsic
value and assumes compounding returns over the projects
life. ABC converts intangible process changes into tangible savings data for use in these financial models.
In contrast, during the project, EVA can help continually reassess changing ROI. By understanding and quantifying the productivity of an IT project in progress,
management can trust the figures and estimates that the
CIO presents.As a result, the organization will see bettermanaged projects, more realistic application of mathematical techniques, and a stronger financial case for the
real ROI.

Jeanette Nasem Morgan is an assistant professor of information systems management at Duquesne University. For the
previous 28 years, she worked for IBM Consulting,
Boeing, and the World Bank. Contact her at
morgan086@duq.edu.
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