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  • The Business Case Checklist: Everything You Need to Review a Business Case, Avoid Failed Projects, and Turn Technology into ROI
    The Business Case Checklist: Everything You Need to Review a Business Case, Avoid Failed Projects, and Turn Technology into ROI
    by Business Case Pro
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IT due diligence report: Stop blowing billions

 

As technology investors, managers burn billions. Total annual IT spending exceeds the combined investment in venture capital and private equity. Around the world, corporate managers spend a trillion-and-a-half dollars a year on technology, including hardware, software, and services.

Yet 70% of projects fail to deliver any financial return, according to the Standish Group.

This pallid rate of return has plenty of support. A 2008 article in MIS Quarterly Executive, Building Better Business Cases, by John Ward, Elizabeth Daniel, and Joe Peppard, commented:

"The 'success rate' -- that is, the percentage of projects that deliver the expected benefits -- has hovered around 30% for many years."

This means technology spenders burn hundreds of billions every year. Embarrassing in good times; but shameful in a recession, with scarce capital demanding high, secure returns.

Breaking the rules of risk and return

Technology spending breaks the rules of risk and return. The largest, best-established businesses spend the most on technology, with IT typically accounting for half of total capital spending. The manager-investors of these firms have the added advantages of insider knowledge of business and project prospects along with control over results. Corporate technology projects look like low- or modest-risk investments. Instead, their investment performance resembles the portfolio of a gung-ho venture capitalist.

Stop blowing billions

To stop lost returns and wasted efforts, managers need to change their approach. They face four problems:

  1. Technology will continue to break the rules of risk and return until treated as an investment.
  2. Fixing broken business cases.
  3. Stop basing technology spending on bad finance, or what we call the low finance of high tech.
  4. The frictions and distractions of the technology industry.

Breaking the rules of risk and return:IT as an investment

Technology spending is an investment.

Why?

First, it fits the traditional definition of an investment: commit funds now against future payments, with compensation for time, inflation, and the uncertainty of future cash flows. Second, since shareholders legally own a firm, technology should -- like any corporate expenditure -- contribute to shareholder value. Buying technology means putting more capital into production processes. Like any capital investment, it requires proper justification.

The most robust measure contribution to shareholder value is discounted cash flow; the value of a business, capital project, or any proposed investment is a function of the amount, timing, and uncertainty of future cash flows. This means managers should use the risk-adjusted present value of forecasted cash flows to decide on any technology expenditure.

Not all technology expenditure is a capital investment. Remember, we are talking economics, not accounting. When project benefits and costs extend beyond one or two years, economically, it means ou have an investment, not an expense.

The broken business case

In the same way a business plan drives a business, a business case is the blueprint for deciding and executing on a technology investment. Traditional business cases have three afflictions:

  • They are underused. Fewer than half of companies use business cases for all investments. A CFO magazine survey of financial executives in 2006 found only 6% apply formal return-on-investment (ROI) analyses to most or all of their investments. And 30% have no formal approach to evaluating ROI.
  • They are unbelievable. PA Management Consultants found only 40% of survey respondents believed the business cases presented to them. Over optimism about benefits is rampant.
  • They are poorly argued. Business cases are too often couched in technical terminology, lack a unifying argument, and rely on slight evidence and suspect ROI calculations.

The low finance of high tech

Though often called "high tech," the financial techniques used in technology decisions look distinctly low end. Large, complex IT investments resemble corporate acquisitions or divestitures, but lack the financial tools. Instead, decision makers apply fuzzy finance tools such as undiscounted ROI and benefits-free total cost of ownership (TCO). These measures ignore or mismeasure time, risk, business benefits, and make no charge (or the wrong one) for the capital invested. In addition, these measures disregard shareholders as the legal owners of a firm. Technology should, like any other corporate expenditure, make a clear contribution to shareholder value.

Trouble in the channel: frictions and distractions in the technology industry

The technology industry has three frictions and two distractions. Each of them complicates and distracts from answering the fundamental questions for any technology investment. The frictions are:

  • Murky marketing, including the avalanche of white papers and vague value propositions.
  • Industry transaction costs, including the price and accessibility of technology research.
  • Generally Accepted Accounting Standards (GAAP), which can leave you with a gap in your investments.

The distractions are:

  • Inappropriate academic theories. Problems here include the widely preached, but rarely practiced, Monte Carlo simulation. Also, the financial theory of portfolio management looks stretched when applied to technology.
  • Sweeping all-purpose solutions. These are close to technical philosophies, with followers offering single, simple answers to the multiple, complex challenges of technology investment. Leading philosophical schools include: IT Does Not Matter, SaaS Will Save Us, and All Hail to the Cloud.

The first step in making better investment decisions is to avoid bad ones. Bad investment prevention comes from rigorous IT due diligence. At least five major threats undermine your business case and put your technology project investment in peril:

  1. Simplistic ROI analysis
  2. Dubious due diligence
  3. Bull
  4. Bias
  5. Amateur analysis

Learn more

Start right. Make sure you only approve high-ROI technology investments, using The Business Case Checklist. And it will help you avoid bad IT investments.