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Dos and don'ts of ROI/TCO analysis

ROI expert, Scott McCready, explains why learning to stop at a child's lemonade stand will teach you the same lessons you need to understand and appreciate ROI and TCO analysis.

There are very few enduring words to live by, but "Always stop at a child's lemonade stand" is a must. Running...

a lemonade stand encourages our children to be entrepreneurial; teaches them to count; and begins to enlighten them about production constraints. However, my daughter's first foray - as a lemonade stand vendor - was greeted with one woman refusing to purchase a drink when she realized there was no ice. In addition, another would-be patron was disappointed that the girl's had no tops for the paper cups.

Now as an adult you would look aghast at this level of request and perhaps suggest that such people would be better served going to a restaurant. Even a 9-year-old can recognize when unrealistic expectations are being placed upon her, and increasingly we see the same demands being placed on Total Cost of Ownership (TCO) and Return on Investment (ROI). It seems by introducing a quantitative analysis, people unfamiliar with the workings of ROI and TCO are suddenly more interested in finding out what it does not do as opposed to appreciating what it does. So let's take a look at the dos and don'ts of ROI and TCO analysis.

ROI and TCO analysis does accomplish the following objectives:

  • Transparency: By providing a quantitative analysis with well-documented assumptions, it is easy for individuals not involved in the decision-making process to understand what went into the analysis and why a certain conclusion was made. The adoption rate of any new technology tends to accelerate dramatically if people understand what the major motivating factors are in the decision. Transparency is good in all decision-making processes, but particularly useful when the decision involves complex technology.
  • Standards: The benefits of standards are well known in the IT world. Standards in the case of ROI and TCO ensure that IT decisions can be made using a standard methodology, allowing us to easily compare the attractiveness of one IT project to another, using a level playing field. Since funds are limited for most companies, this ensures that budgets flow to those projects that will yield the highest financial return.
  • Best in class: TCO and ROI analysis often become a "best in class" methodology to extract input from across the organization, to make better decisions.
  • Documented decision-making: One of the great tragedies of corporations is that there is often no corporate memory. People come and go and over time it can be unclear why certain decisions were made. TCO and ROI analysis forces the company to document the decision based on both the quantitative and qualitative reasons. A well-known European pharmaceutical company spent millions of dollars recently trying to decide if they should get into the antibiotics marketplace, only to find shortly thereafter the same study had been done four years prior.
  • What if: Good ROI and TCO tools allow you to change your major assumptions and immediately see the impact ripple through your financial results. Therefore you might change your tax assumptions, or whether or not you want to cluster your hardware. You also might elect to partition your servers in a different way or even look at the cost of adding a SAN. It is the ability to provide single button what-if analysis that suddenly provides insight into the decision-making process that companies have never had before.
  • Hardware savings potential: ROI/TCO analysis can potentially save you millions of dollars on hardware every year. Fortune 2000 companies are collectively spending billions of dollars on hardware that they do not need. Since your hardware configuration drives your software costs, maintenance and support, IT staffing resources, and downtime, using the wrong sized boxes or the incorrect number of boxes remains the single largest IT mistake most Fortune 2000 companies make. This issue alone warrants the Fortune 2000 to use TCO and ROI analysis.

ROI and TCO analysis does not:

  • Eliminates poor assumptions: To complete an ROI and/or TCO analysis one has to make a great deal of assumptions. Some of these assumptions are empirical such as your tax rate; cost of capital, and cost of hardware. Meanwhile others require judgment. How serial is your workload? What level of average utilization can your servers run at? In other words, a good methodology is still vulnerable to poor assumptions and the old adage "Garbage In Garbage Out" still holds true.
  • Requires you to be a financial expert: 99.9% of the information required for analysis is not financial in nature. The data collection process can be an enormous amount of drudgery but it certainly does not require any financial skills. All of the financial expertise required to do an ROI analysis can be gleaned from a 10-page financial primer.
  • Eliminates risk: When a good ROI or TCO analysis has been completed, some people assume that the project risk has been ameliorated. Instead, an ROI analysis should highlight what risk factors there are and what their possible financial impact may be.

And finally, it does not make lemonade or set expectations at a realistic level. Other than that it still worth stopping for almost every time!

This was last published in September 2003

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