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Lessons From the Field: Beyond ROI

March 5, 2003
By Jonathan Feldman

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Managerial Accounting 101

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	In this article
	Introduction
	Managerial Accounting 101
	Clear-Cut Challenges
	Upgrades and Fuzzy Logic
	Executive Summary
	Stupid Manager Tricks
	Epoll Results

Speaking of business credibility, one way to strengthen yours is to understand where IT fits into the corporate jigsaw puzzle from a profit-and-loss standpoint. To do so, you need to understand a couple of managerial accounting concepts. Managerial accounting is the subdiscipline of accounting that helps your business maximize profits, minimize expenses and operate more efficiently. When the decision is made to outsource your IT department, it typically comes from someone playing the MA game, so pay attention.

• Responsibility centers: From an MA standpoint, upper management judges departments based on the type of responsibility centers they are, because the type of center indicates what type of fiscal performance is expected. For example, IT is usually considered a cost center, where the manager is fiscally responsible for containing cost. The sales department typically is considered a revenue center, where the manager is responsible for total sales but not necessarily for profitability. A profit center, naturally, is responsible for making sure that revenues outstrip expenses, thus turning a profit; the manager of a consulting practice is, in effect, in charge of a profit center. Finally, an investment center is responsible not only for profitability but for making wise capital investments.

• ROI: An investment center is typically judged on its ROI: return on investment. The mathematical definition of ROI = i/c, where i is income and c is invested capital. Saying that IT generates ROI is semantically null from an MA standpoint, since IT typically isn't in the business of making investments that generate profit. To truly generate ROI for the business, IT would have to partner with an investment center. Our advice? Use the ROI moniker sparingly. Instead, concentrate on benefits and savings by working with business unit leaders.

Because ROI tends to be misused by various marketroids, it's not surprising that we heard cynicism and skepticism about ROI everywhere we went.

"I'm very jaded about ROI--every project always seems to come down to non-financial measures for justification," says a network infrastructure project manager in a large manufacturing company, whose attitude typified that of many managers we interviewed. The CEO must be convinced that there will be intangible benefits even if there aren't financial returns, he says.

"The CEO has been making that judgment for other departments anyway, like marketing. So 'if it positions the company' or 'makes things easier,' you get a green light. It has nothing to do with ROI. ROI is this idea that's come up to try to give 'measurability legitimacy' to IT," he says. "Well, no. We're not engineers the way manufacturing engineers are. ROI is some sort of MBA reaction to 'you can't manage what you can't measure.' There's all this value placed on measurables, and ROI is a stand-in for that. People say, look we've got this project, and we've got this number. Therefore I don't need to exercise judgment, I just go ahead and do it. But you've got to remember, the success of the project may not be in the numbers!"

As an IT manager, you need a practical knowledge of MA and a sprinkling of consultation with those who practice it daily. One interesting tidbit from a recent reader poll: Although 76 percent of you track the returns of a project and 39 percent do so with financial staff, many of you never consult financial staff before you start preparing a business case for a project, and when you do prepare it with them, about 30 percent of you consult them dead last. Our fieldwork indicates that those of you who do consult or partner while you're building the business case do pretty well. (If you're interested in boning up on MA, we recommend Managerial Accounting: Creating Value in a Dynamic Business Environment, by Ronald W. Hilton, McGraw-Hill/Irwin, 2001).

Show Me the Savings

Another strategy: Concentrate on cost avoidance rather than ROI. After all, revenue minus cost equals profit, and if you minimize cost, you are contributing to the bottom line in a tangible and important way.

There are some projects for which a large purchase makes sense if it will spare you from decreased quality of service and increased cost. For example, it's smart to upgrade to a new technology because the old one will cost far more over its useful life. One common example is the investment in Ethernet switches and NICs because of the high cost of maintaining aging token ring gear.

An example of a cost-avoidance strategy that might strike close to the hearts of the folks with the checkbooks is the purchase of software--for example, document imaging, or perhaps a data-conversion package--that lets a department avoid hiring temporary employees during a seasonal rush.

When you are looking at ways to save a department money, it pays to think about fixed costs versus variable costs, too. Fixed costs are those where unit volume doesn't matter--for example, a factory building or your Internet connection. Variable costs are those that increase as your unit volume goes up--software licenses and hourly labor, for instance. You're probably already pretty good at identifying ways to save money within IT--for example, switching to incident-based support where it makes sense. But as you start looking at the way departments work, think to yourself, "How could I save some money for these folks by applying IT to their problems?" Visit the departments. If you see users manually converting images to the format their database supports, clue them in to automated conversion tools.