“The main hypothesis of a traditional business case is that we can isolate the effects of an investment over time (3-5 years) to calculate its benefit contribution. But the fact is that the hypothesis is far from true. In the ‘new normal’ we need new investment management methods that eliminates ‘the X factor’ (unpredictability).”
Business case plays a pivotal role in investment management. I think we all been in the situation where we formulate a business case to get a management approval for an investment. We calculate the Return on Investment (ROI) or Net Present Value (NPV) to provide evidence of high benefits of the investment. With a positive business case, we probably get investment approval and can start the project or purchasing. But how is the business case methodology actually working? And how is business case methodology affected by increased digitalization? The key question is whether ROI or NPV is the best indication of an optimal investment.
Digitalization is revolutionizing the way we communicate, interact and consume. Changed customer behavior, fast technical evolution and new competition are changing the competitive landscape of many industries. One key affect of the increased digitalization is higher unpredictability. In fact, the level of stability is limited to 9-12 months in many industries. After that, there are too many factors (customer behavior, political regulations, economic progression, technical evolution, increased competition – to name a few) that create a chaotic and unpredictable market. Increased revenue of 10% one year might be seen as the effect of planed initiatives, but it is most probable that the increased revenue is the result of chance and fortunate turn of events. The unpredictable factor is usually called “the X-factor” and that we cannot foresee.
The main hypothesis of a business case is that we can isolate the affects of an investment over time (3-5 years). For example, an investment in new CRM system will generate 10% increase of sales over a three years period. In this case, we assume that 100% of the benefits of increased sales is directly linked to the new CRM system. But the fact is the hypothesis is far from true. It is today impossible to calculate how much an investment will contribute to planed benefits over a period of time – due to “the X factor” (unpredictability).There are so many other parameters affecting the business case that we are not aware of and cannot manage.
Traditional business cases, based on ROI or NPV methodology, give a vivid picture of the investment due to the unpredictable X-factor. Therefore, many IT organizations have problem of realizing the benefits of the business case, and the value of the current project portfolio. Some organization have even stopped measuring the real benefits of the investment (years after the investment decision) since it is either impossible to understand where the real benefits actually were. I would guess that over 50% of the IT investment (to extreme high cost) have very little affect of the company’s performance and are hence meaningless – mainly due to an unsuited business case methodology. In most cases, traditional business cases therefore meaningless.
So, what should we do? We need a method for justifying IT investment and isn’t RoI the best solution? No, not even close. The RoI gives a costly sense of false comfort. But don’t worry – you are not alone. The question is if you want to continue using a non-working business case method.
The Goodwind Company has defined three principles for business case methodology aligned to the new normal (digital business environment).
- The purpose of the business case is to identify the most valuable investments at any given time.
- The value of an investment is how well they contribute to a company’s or IT department’s strategic objectives (that might include financial benefits). The strategic objectives will change over time.
- The accumulated benefits over time will not be measured.
The question is how to describe the way an investment contributes to the strategic objectives (Return on Strategy – RoS). In fact, it requires high level of strategic planning and performance management to break down the strategic objectives and vision into key challenges, and logical and physical deliverables (investments/projects)– that will alter over time. It is important to find the link between the strategic objective and a concrete investment and project, and weighting its contribution to each objective or nod in the structure. Then to measure with KPIs to monitor that the strategic objective is achieved. Note we are not calculating the accumulate benefit over time but rather an investment’s contribution to the strategic objectives as a given time. Over time, the value of the project portfolio (contribution to strategic objectives) will vary but can be monitored and governed more precise. Today, I can state that 80% of my investments are contributing to strategic objectives! Great! The C-suite will be happy!
I have worked with a valuable tool to link strategic objectives to investments and projects, that has help me to grade individual investments to the strategic objectives. It is the tool ValueMiner and provided a completely new way to assess (including the cost/benefit dimension) the project portfolio. I recommend a presentation of the tool to understand its genius.
- Dare to question your current business case methodology based on RoI or NPV. The increasing importance of the X-factor (unpredictability) due to digitalization will turn the traditional business case into a useless piece of paper.
- Understand the link between your strategic objectives and the current investments. How does the investment and project portfolio contribute to business success?
- Book a presentation to learn more about ValueMiner tool.
- Contact The Goodwind Company to learn more about Return on Strategy (RoS) and assess your project portfolio to understand how it actually contributes to business success.
I have met a number of IT organizations complaining about their investment and project portfolio management. It is difficult to assess proposed investments and also how the project portfolio contributes with value. So, when the CEO asks them how IT investments contribute to business success – there is no answer. “Sorry but we cannot give you that information”. It is understandable because of high unpredictability and influence of the X-factor – but does the CEO know that. The result is that IT is more and more regarded as a cost driver (that need to be contained) instead of a value driver (that is trusted). And it all comes back to the business case. The question is how you are going to answer the CEO the next time he/she asks for the value contribution of IT investments? Are you prepared for that talk? If not, call me!
– Hans Gillior