I am a hard-bitten chief executive officer and my staff tell me
that we must invest millions in a customer relationship management
system or an e-commerce trading exchange or a system to link the
components of the supply chain.
My reputation is that of being tough on appraising investments of
time and money. However, people do not realise that projects eat up
scarce senior management resource. I am told all is well with this
investment, because it produces a superb return on investment
(ROI).
There is one small problem - ROI is not useful in investment
decisions. I know this, as I have sat on both sides of the fence. I
spent years in an IT services company writing investment proposals,
winning capital authorisations, all with beautiful ROIs, but
knowing they were commercial nonsense.
You will probably be thinking, "Prove your case and what process is
better?"
Capital investments are a mixed bag: required for health and
safety, replacement of old systems, providing additional capacity,
allowing new products or distribution channels, reducing costs.
Some of these are not directly "productive", for example a safety
system required by law or a replacement system needed as the
current one cannot be supported. Productive investments must
therefore earn returns to cover the costs of non-productive
investments.
When we then read the investment cases with high ROIs, what do we
find? Areas of current business are at risk, so profits are
safeguarded and not lost. New distribution channels are opened, so
we have additional revenues and profits.
Here my experience or cynicism takes over. How many times have the
same revenues and profits, old or new, been counted in different
investment appraisals? What past or future costs are incurred to
create the new profits and are not included? How many proposals are
really part of a strategic initiative, but put forward separately
to escape closer scrutiny?
I have only two tests to justify an investment: is it necessary to
support my business strategy and is it fully integrated in all
current plans including financial, marketing, operational, IT,
human resource?
To gain my consent, company colleagues only need to show that all
aspects of the project are included in the current and longer-term
plans, not only financial, but operational. I want measures, such
as improved customer service levels, access to new channels, higher
conversion rates for customer prospects. All costs and benefits can
then be measured and controlled.
Even if the investment under consideration is budgeted and
accounted for, this does not mean automatic approval. The normal
commercial questioning must take place - can we do this cheaper,
what are the implications of choosing a particular technology, why
are we sure that service levels will improve, etc.
Oh dear, the proposed expenditure is not budgeted, but there are
real benefits to be had! What do we do?
We used to say no to projects not in the annual plan, as we would
lose control. However, today the world is moving too fast and we
must constantly make decisions to change - now. This is a test on
how well we can now control the business, in a very different
environment. I have two tests:
- Can we afford it? If our cash flows and debt positions are not
strong, then either we say no or other investments must be
sacrificed
- I subject the project to the normal commercial questioning, but
then recast all plans and establish whether the revised strategic,
financial, marketing and operational picture is acceptable. If it
is, then the revised plans become those to be controlled and form
the base for the next annual planning round. If not, then I say
no.
ROI is an artificial and wrong measure, but developments that are
integrated in company plans mean success.
Stuart Ruben is a partner at management consultancy KLR
& Company