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Sunday, January 10, 2010

Should you be measuring ROR instead of ROI?

by Ric Merrifield

Should you be measuring ROR instead of ROI?For literally decades, the notion of return on investment, or even more specifically return on invested capital (R.O.I. either way) was the gold standard for justifying a business decision. If the return exceeded the investment enough (also weighing risk, disruption, and many other factors) then it would get the green light for funding.

This was, and is, especially common in investments in enterprise software. But I predict we will see a (long overdue) rapid decline in the use of R.O.I. as the gold standard for project justification for these four reasons:

1) Smart organizations have figured out that you can justify almost anything with R.O.I. math. Someone recently said "if you do project X at a cost of $2 million and it saves you $5 million per year, then you should do it, right?" Many people would say yes, I would say there's nowhere near enough information. For large companies, a $5 million savings could be a distraction to more important activities, just to name one reason, but too often I see these sorts of projects approved.

2) The metrics are often very squishy. Organizations don't generally have great metrics to begin with, but especially when anchored to the process view (which is often very volatile, with a short half-life), and when the process changes, organizations end up comparing apples to oranges. The simple solution there is to use the business capabilities lens described in the pages of Rethink, starting with the "what" outcome you are measuring, and then looking to the "how" of process.

3) There needs to be larger context setting. What overall goals is the department, division, or enterprise setting? It isn't enough just to cover costs for a lot of projects. These days, it's about staying ahead of competition, differentiating, and knowing who your most valued customer is (see #4 below). If the $5 million in savings in #1 above doesn't connect to a key performance indicator, you need to be certain that it's not going to be too distracting or disruptive in an area in need of much more attention someplace else and the "shiny object" project selected out of context from the rest of the organization always has that risk.

4) Many organizations need to look at their R.O.R. (Return On Relationship). How much do you spend on each customer and how much do you get in return. Someplace in almost every industry, their is a vital set of relationships, sometimes it's partners, sometimes it's customers or sales channels, and sometimes it's employees and you have to know what is most valuable to your most valued relationships so that when the least valued relationships whither, you don't worry, but when you see blinking red or yellow lights in the most valuable relationships, nothing can get in your way of fixing that.

So as we enter this new decade, and hopefully start to get further out of a recession, start to measure your R.O.R., do better context setting in terms of the value of a project to the overall, be sure you have concrete metrics, and be leery of the R.O.I. math of the one-off "shiny object" projects.

Ric Merrifield is known at the "Business Scientist" at Microsoft Corporation in Redmond, WA and is the author of "Rethink". He blogs about ways to rethink through getting out of what he calls "the 'how' trap".

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Blogger Jackie Hutter, Intellectual Property and Patent Business Strategist and "Recovering Patent Lawyer" said...

ROR is a recognition of the value of intangible assets in the organization. Inter-company relationships, relationships, human capital, first mover advantage are just a few of the forms of intangible assets. You are absolutely right, this is a primary area where most organizations fail to properly measure value. Like most things in business--if you don't measure it, it can't be managed. People are waking up to this fact and, as a result, we are going to be hearing more about this in the coming year--mainly in terms of "intellectual capital management" and "intangible asset management."

5:55 AM  
Blogger Mary Adams said...

I like the addition of relationships into the discussion but I would like to echo and expand on Jackie's suggestion that it is important to take a broad view of not only the technology (and the knowledge it operationalizes) and the relationships, it's also about the people and the business model.

This four-part view of IC/IA should be used for understanding the dynamics of both investment and return. In the end, if we use a holistic view of the IC Management we will end up with greater innovation and higher returns.

3:25 PM  
Blogger Mahmoud said...

That is great approach of dealing with the direct and indirect effects of the investment decision over the long term, where such ROI ratios don’t deal with subsequent effects that could be harm/gain the business it self or the investor, for example when it is an Holding company, there might be an effects on the Holding company image from investing in certain investment, or in other way around when the image of the investor effect the investment it self (e.g. when Marlboro bought a cheese brand, they had to dump that investment…)
The consulting firms have a big hand in it, that most of their feasibility studies is copy/past, and their financial models is just anther maze set to make the client dizzy! Moreover just trying to put the least liability and accountability on them selves, taking all the assumptions from client and/or from the internet Wikipedia search… and so on! And the problem big organizations and governments are falling for this in world and specially MENA.
I don’t think decision makers will be keen in taking investment decisions like before on, just ROI numbers, since the capital become so expensive and under a lot of limitations and pressure. But in areas were no legal prosecution and supervision the decision is taken and ROI is was way back R.I.P.

And thanks for the enriching article

5:30 AM  
Anonymous Jo Jordan said...

Cool, spent all day writing similar stuff.

Off course one relationship is with the provider of capital!

9:36 AM  
Anonymous Traci Browne said...

I hear what you all are saying and it's all warm and fuzzy; but it all completely falls apart when you walk into the CFOs office. If you cannot put numbers to it it's not going to fly. and if you don't put numbers to things often enough you'll be a marketer out of a job.

Anyone that gets their C-suite to buy the ROR idea, please let us all know how you did it.

5:08 PM  

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