ROI Analysis: Look Before You Leap
Times have certainly changed. The days of infinite valuation for Internet companies are over. The senior executives of most companies are paying more attention to Web projects. How do you decide whether a Web project is business critical and will provide value?
An ROI analysis is the best way to demonstrate the value of a Web project. ROI framework helps recognize the ROI. It helps identify the various benefits and costs. It is also a great exercise in testing the strategic assumptions of Web projects.
ROI analysis has two important elements: cost and benefit. The difference between the two elements constitutes the return on investment for a Web project.
The first step in determining ROI is to identify the benefits of a Web project, which are tangible and intangible.
Tangible benefits are relatively easy to quantify, particularly when compared with the intangibles. Tangible benefits are a combination of increased revenues, reduced costs and reduced working capital.
Can the Web increase a company's or its business unit's total annual revenues? This can be answered by evaluating new revenues generated by the Web site. Take into account any potential cannibalization, especially if the company is a bricks-and-mortar business. Such companies may see part of their mainstream revenues cannibalized by online sales. Most dot-coms will not have to worry about cannibalization unless they are developing a new Web site that might compete with their "legacy" Web sites. New revenues can be generated by online sales and advertising. Providing new value-added products also generates new revenue streams.
Consider the Web as purely another marketing and sales channel or medium. The Web can attract new customers who ultimately buy products and services that lead to increased revenues. Existing customers can end up buying products and services from a Web site in addition to their purchases from other sales channels. This can happen because of the relative convenience of a Web site as opposed to making a trip to the retail outlets. This translates into higher per capita customer sales. Finally, a per unit price increase also leads to increased revenues. A business can increase revenues in one of the three ways mentioned above or a combination of them.
Tangible benefits also can be derived from reducing the cost of doing business. Can a Web site decrease a company's or business unit's total costs? These questions can be answered by evaluating total costs.
The Web can reduce distribution costs, cost of advertising or promotional costs. Business-to-business and extranet Web sites can reduce the cost of doing business for companies in a supply chain by decreasing transactional costs. An effective strategic analysis will help identify different techniques to reduce costs. Costs can be reduced in various ways.
A Web site potentially can reduce a company's working capital, which may be treated as a tangible benefit. A good example would be an extranet site that helps a supplier keep track of the inventory at its customers' warehouses. This inventory information will help the supplier lower inventory, therefore reducing the inventory holding costs for the customers.
Change in working capital affects cash flow and a Web project that reduces working capital can have a positive ROI. It is defined as the difference between current assets and current liabilities. Currents assets include inventory and accounts receivable. Current liabilities include accounts payable.
Usually, Web sites have one or more benefits. Often, the benefits are not easily quantifiable and are commonly referred to as the intangible benefits. The following is a list of potential intangible benefits (from "Competing in the Digital Age: How the Internet Is Transforming Corporate Strategy," Booz-Allen & Hamilton Inc.):
• Improve communication.
• Enhance customer service.
• Improve knowledge sharing across a supply chain.
• Allow businesses to enter new markets.
• Support for globalization.
• Develop new products and services.
• Foster innovation.
• Reduce time to market.
Intangible benefits are harder to quantify, especially compared with tangible benefits. Rarely do companies try to quantify intangible benefits because of the obvious difficulty. Some in the information technology industry prefer not to quantify intangibles.
Let us say that the corporate goal of company A is to increase employee morale. Employee morale is not easily quantifiable. But all of us know that better employee morale leads to higher employee productivity. Higher employee productivity eventually leads to reduced costs, because company A does not have to hire additional staff or incur overtime expenses. So one of the metrics that can be used to measure employee morale at company A is revenue per employee. An intangible benefit such as employee morale can now be translated into a tangible benefit.
The intangibles can be quantified. However, it is important that the ROI analysis remain credible by not fishing for benefits where there are none.
Web sites can be classified based on the nature of their audiences as Internet, intranet or extranet. Internet sites are universal in nature and cater to all kinds of audiences. Internet sites can be further classified as a Web portal, e-commerce site, electronic brochure or a customer relationship management site. Intranet sites cater to the internal stakeholders of a company. Intranet sites can be classified as a corporate portal, knowledge management site or a workflow/collaborative Web site. Finally, extranet sites cater to a company's external stakeholders. Extranet sites can be classified as customer, distributor, supplier or investor-based Web sites.
Table 1 will help narrow the primary and secondary benefits of a Web site. It helps focus on a Web site's key benefits and acts as a guide in identifying tangible and intangible benefits of a Web site. The next step is to focus on key intangible benefits and develop the metrics associated with these intangible benefits. The metrics depend on the type of project and business.
The top half of the ROI framework, which covers the benefits of a Web site, has been covered. The bottom half of the framework helps to identify costs involved in a Web project. It is important to capture the various costs for a Web project. There are two kinds of costs involved in a Web project: development and ongoing maintenance costs.
Development costs include connectivity, design and analysis, domain name registration, hardware, labor, localization, software, strategy and Web hosting. Ongoing maintenance and training costs include labor, software maintenance, user training and education costs, and user system adoption costs.
The driving force behind Web sites used to be time to market and gaining first-mover advantage. But the emphasis has changed to valuations. A thorough ROI analysis will help businesses understand the financial viability of a Web site. By using the framework described, companies will be able to calculate ROI more accurately, which should be completed as part of the overall strategic analysis.
• Sreekumar Rajagopalan is a senior consultant at Red Sky, New York, an interactive solutions provider. Reach him at email@example.com.