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Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

Introduction ......................................................................................................................... 1 ROI as Part of a Holistic Planning and Management Process for Technology Initiatives .... 1 Identifying and Quantifying the Benefits of a Project ......................................................... 2 Qualitative Benefits.............................................................................................................. 4 Identifying the Cost for a Project ......................................................................................... 4 Return On Investment The Financial Foundation............................................................. 6 Other Financial Metrics Commonly Used to Justify Projects ............................................... 6 Sample Calculation of Common Financial Measures ........................................................... 6 Analyzing the Risk ............................................................................................................... 7

Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

The days when shareholders and management regarded a companys heavy investment in information technology as a necessity to stay competitive in the new economy without scrutinizing the payback potential of the investment are long gone. Today companies have widely adopted a more prudent policy requiring a financial justification for nearly every IT initiative. Industry studies have repeatedly demonstrated that Business Intelligence (BI) initiatives are amongst the information technology investments that yield the highest returns. The IDC Study, The Financial Impact of Business Analytics (released in October 2002), reinforces and extends IDCs landmark study on Data Warehousing returns from 1996 and shows that organizations who have successfully implemented and utilized analytic applications have realized returns ranging from 17% to more than 2000% with a median return on investment (ROI) of 112%. According to the study, analytics implementations generate an average five-year ROI of 431%. Over half (63%) of the companies studied had a payback period of two years or less. Yet project champions find it more challenging to develop a business case for a BI initiative than to justify other IT investments. This paper addresses these challenges and provides guidelines for developing a solid analysis of costs and benefits to support you in identifying, communicating and monitoring the value of a Business Intelligence initiative. Although there is a lot of emphasis on hard ROI numbers these days, the key to a successful business case is not the final number resulting from an ROI study. Dont substitute numbers for judgment! There is no magical mathematical formula that will tell you whether or not to approve a technology investment. ROI calculations are based on assumptions and projections that must be revisited and calibrated along the way. Measurement is the reduction of uncertainty about a quantity through observation. The key here is the reduction of uncertainty - which is not necessarily (in fact, almost never) the elimination of uncertainty. Thus, the ROI study should be a part of a more holistic management process for technology initiatives that takes business objectives, priorities, risk and technological feasibility (along with a healthy dose of business judgment) into consideration while fostering buy-in and accountability of business unit managers. In other words, the process of getting to an ROI number is more important to the success of the BI initiative than the number itself.

The ROI study is not an isolated calculation that is performed by a financial analyst or by a project manager in a vacuum. Without the necessary support and involvement of the senior management team and the business units, the ROI calculation is meaningless. It should be an integral part of the Strategy & Planning phase of a BI initiative. The Strategy & Planning phase contains the following steps: (1) (2) (3) (4) Assess the Business Environment Assess the IT Environment Gather Business Requirements & Objectives Identify & Quantify Potential Benefits

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Beyond ROI Justifying a Business Intelligence Initiative (5) Prioritize the Requirements (6) Identify Gaps (Process, People/Skill, Technology Gaps) (7) Create High-Level Data Model & Validate Requirements (8) Define Solution Architecture (9) Develop a Phased Implementation Plan (10) Identify the Cost (11) Develop Business Justification and Calculate ROI

BI3 Solutions, Inc.

Steps 1 through 5 are heavily dependent on input and feedback from both the senior management and the stakeholders and subject matter experts in the business units, thus providing a balance of corporate vision and specific subject area details, which in turn result in more realistic objectives. As you can see, it is actually the benefits that get the attention early on in the project (Step 4) and not the costs (Step 10). The expected benefits are closely tied to the business requirements, which in turn support specific business objectives. The following figure (Figure 1) depicts this process of aligning the vision from the executives and the daily execution realities from operations during the requirements gathering process to achieve a balanced view of the business objectives.
Business Specific Subject Subject Matter Executives Area Details Experts Realistic Objectives aligned w. Executives Corporate Goals

Executives Executives

Vision

Management Bonus Objectives

Direction & Prioritization

Benefits

Requirements

Figure 1 The requirements gathering process therefore also leads to quantified benefits, which can be used to define priorities for the execution and which represent specific goals that can become part of the Management Bonus Objectives (MBOs).

When quantifying the expected benefits for a project, it is key to understand that the Business Intelligence solution itself does not provide financial returns. The ROI is derived from the processes that the Business Intelligence solution supports or enables. The key to ferreting out these quantified benefits from the business users is to keep asking probing questions during the requirements gathering process. The benefits of a Business Intelligence enabled process fall into two broad categories:

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Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

(1) Sources of decreased costs Lets examine some examples where BI initiatives can help to decrease cost. Cost savings due to increased efficiencies due to the new process A common example for cost savings in this category is the closing cycle for the budgeting process. If the current closing cycle requires 10 days and involves several versions of spreadsheet input being sent back and forth between departments, there is a good chance that the BI solution will reduce the time people spend working on this process significantly. Lets assume that 20 people are involved in the budgeting process and the total amount of time spent is 60 person days. The goal is to reduce the closing cycle time to three to five days with the help of the BI solution, reducing the overall person days to 15. Assuming that the average person day costs the company $480, this results in a saving of $21,600 per closing cycle. Another example of cost savings through increased process efficiencies comes from Marketing. By improving the granularity of customer segments as input to marketing campaigns, the VP of Marketing believes that the cost of acquiring a new customer can be reduced by $20 each. The company acquires about 10,000 new customers per year, which results in potential annual savings of $200,000. Cost of current systems that can be eliminated Are there one or more data extracts that are stored in databases on departmental servers and that are currently used for reporting purposes? Is there infrastructure from a previously failed data warehousing initiative or unused software licenses (shelfware)? Does the company own licenses of an ERP module that is currently used to support a subset of the reporting requirements? The corresponding annual software license and maintenance fees and the current book value of the associated hardware are possible components where cost savings can be achieved.

(2) Sources of increased revenue Successful BI initiatives go beyond cost savings and enable business transformation through technology. That is the area where you will most likely find the payback for a BI initiative. Examples of sources of increased revenue are: Estimated profit from purchases by new customers influenced by the process Staying with the previous example from Marketing, if the company can acquire 10% more customers per year through better targeted campaigns as a result of the BI initiative, and we assume based on historical information about customer profitability that those new customers would generate additional profits between $800,000 and $1,500,000, we can factor in those values as benefits into the ROI calculation using a more conservative scenario and a second, more aggressive scenario. A Sensitivity Analysis (see Section Analyzing the Risk) will help you to assess the probability of each scenario and understand the overall risk. Estimated profit resulting from the propensity of existing customers to purchase more due to the process For example, as part of the specific business objective to increase annual sales by 20 percent, a line of business manager defines the requirement to identify opportunities to convert more one-time buyers into return customers, who buy multiple products through improved customer segmentation analysis. He/she believes that having the ability to target one-time buyers with a high propensity to buy additional products would result in an increase in the

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Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

conversion rate, which in turn would increase annual sales by 10 percent from $20,000,000 to $22,000,000. Given a 15 percent profit margin rate, this results in increased profit of $300,000. This is a benefit that can be attributed to the Business Intelligence initiative in the ROI calculation. Profit from sales not lost to competitors For example, a company could reduce customer churn by 40 percent through early detection of customers with a high propensity to switch to a competitor and targeted offerings to those customers. These customers generated annual profits of $1,500,000 from revenues of $10,000,000, which would otherwise have been lost to the competition.

There will be several benefits that will be difficult, but not always impossible, to quantify. They should be incorporated into the business case because they demonstrate additional value for the proposed solution. Examples are: Improved Improved Improved Improved information dissemination information access data quality and feedback to the operational systems collaboration across business units

You should make an attempt to quantify these benefits. It might be necessary to make more assumptions, but in most cases, it is possible to identify a meaningful dollar value that can be attached to a potential benefit. Remember, the goal is not to find an exact amount, but to attach a meaningful and defendable value to a benefit to make it more tangible and more specific, and to enable you to track performance against it over time. Taking a conservative approach to your assumptions will help to deter challenges to your analysis. Also, clearly state all your assumptions it will help you defend your case.

Identifying the cost components of a BI initiative is usually more straightforward than identifying and quantifying the benefits. The costs associated with a project are determined by the selected solution architecture (Step 8 in the Strategy & Planning task list), which identifies the hardware and software components that will be utilized, and the implementation plan (Step 9), which includes the resource and time requirements. The following picture (Figure 2) shows how the deliverables from the Strategy & Planning phase contribute to the identification of the cost for the project:

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Beyond ROI Justifying a Business Intelligence Initiative

Budget Constraints Current IT Architecture

BI3 Solutions, Inc.

Requirements

Priorities

Solution Architecture

Phased Impl. Plan

Costs

Figure 2 There are two types of cost components - initial costs and recurring costs. Initial cost components include hardware, software, internal labor, external labor, and training. Recurring cost categories are maintenance and support fees for hardware and software and labor costs for the operational staff dedicated to the solution. Training costs should include not only training for the administrative staff required to operate, maintain and expand the solution, but also initial and recurring training for the business user community. The following worksheet (Table 1) can be useful in determining the initial internal and external labor costs for a BI initiative:
Required Roles (initial) Project Manager Business Analyst(s) Technical Lead / Solution Architect Data Modeler(s) ETL/Database Specialist(s) Front-End Tool Specialist(s) Stakeholders / Biz.Subj.Matter Expert(s) IT - Network Administrator(s) IT - System / DB Administrator(s) Subtotal Labor Costs Total Hrs. Internal Cost Rate $ $ $ $ $ $ $ $ $ Total Cost $ $ $ $ $ $ $ $ $ $ Hrs. External Cost Rate Total Cost $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ -

Table 1 Note that not all project roles are full-time. One person can perform multiple roles, and one role may require multiple persons. Now that we have discussed how to identify and quantify both benefits and costs for the BI initiative based on information gathered throughout the Strategy & Planning phase, it is time to put the pieces together in order to understand the projects financial viability. The following section provides the financial foundation for the ROI calculation, which shows you how the costs and benefits are applied to calculate ROI, NPV, IRR, and

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Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

Payback Period. It also introduces the concept of the Sensitivity Analysis, which provides a what-if analysis to understand the risk based on several outcome scenarios.

The most commonly accepted financial measure for evaluating the benefits of a project is the calculation of the Return On Investment (ROI). ROI allows us to assess the benefit of a project over the initial costs. The ROI calculation evaluates the Net Present Value (NPV) of projected cash flows derived from the savings (or gains) generated by the project divided by the initial investment.
ROI = ((NPV of Savings) / (Initial Investment)) * 100

Now, how do we calculate the NPV of the projected gains? The NPV allows us to determine the value of $1 one or more years from the date of the calculation considering a discount rate or investment yield rate for the organization.
NPV = (Net Gains1 / (1+r)1) + (Net Gains2 / (1+r)2) + (Net Gains3 / (1+r)3) + + (Net Gainsn / (1+r)n ) Net Gainsi is the net cash flow for each year i that the NPV is to be applied. r is the discount rate or investment yield rate for the organization at the time the NPV is being calculated. n is the total number of years for which the NPV calculation is to be applied.

In addition to ROI, some other financial metrics are commonly used to evaluate investments. The Internal Rate of Return (IRR), for example, calculates the inherent discount rate or investment yield rate produced by the project. The IRR determines whether the yield of the investment in the project exceeds the regular investment yield rate. To calculate the IRR, the same formula as for the NPV calculation can be used. However, the NPV has to be substituted with the initial investment, and the equation has to be iteratively resolved for the variable r, because in general, there is no closed-form solution for IRR. Numerous programs and spreadsheets are available to help calculate IRR. The Payback Period determines the number of years for the project to break even, i.e. for the discounted projected cash flows to equal the initial investment. The formula to calculate the Payback Period is as follows:
Payback Period = (Initial Investment) / (NPV of Gains / Total Number of Years in the Planning Horizon)

The following table (Table 2) illustrates how these financial metrics are calculated based on an example with a time horizon of 3 years:

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Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

Initial Investment
(a0)

Year 1
(a1)

Year 2
(a2)

Year 3
(a3)

Cost Benefits Net Gains Discount Rate

= (r )

$ $ $

500,000
(b0)

$ $ $

55,000
(b1)

$ $ $

55,000
(b2)

$ $ $

55,000
(b3)

(c0)=(b0) - (a0)

450,000
(c1) = (b1) - (a1)

650,000
(c2) = (b2) - (a2)

800,000
(c3) = (b3) - (a3)

(500,000)

395,000 7%
(d1) = (c1)/(1+(r ))

595,000 7%
(d2) = (c2)/(1+(r )^2)

745,000 7%
(d3) = (c3)/(1+(r )^3)

Discounted Net Gains

(d) = sum((d1)..(d3))

369,159

519,696

608,142

NPV = (d) ROI = (e)

1,496,997
(e) = (d)/(a0)*100

299%
(f) = IRR((c0),(c1),(c2),(c3))

IRR = (f) Payback Period

= (g)

86%
(g) = (a0)/((d)/3)

1.00

Table 2 The calculation of the Net Present Value of the savings or gains requires a more detailed discussion. To determine the net cash flow for each year, we need to understand the cost and the benefits, expressed in savings or gains derived from, or influenced by, the project.

It is recommended to do a Sensitivity Analysis which analyzes scenarios for a variety of project outcomes and their likelihood (successful, partially successful, failure). Applying the sensitivity analysis to ROI can help executives evaluate the risk and potential gain or loss associated with the BI project. Following is an example based on the sample ROI calculation in Table 2:
Scenarios Best Case
(p1)

Probability
(p0)

Gain/(Loss)
(q0) = (d) for Best Case

Weighted Outcome
(o0) = (q0) * (p0)

25% $ 65% $
(p2)

1,496,997
(q1) = (d) for Conservative Case

$ $ $ $

374,249
(o1) = (q1) * (p1)

Medium Case Worst Case Totals

250,000
(q2) = - (a0)

162,500
(o2) = (q2) * (p2)

10% $ 100% $

(500,000) 1,246,997

(50,000) 486,749

Table 3 The total weighted financial outcome should be significantly greater than zero for the project to be worthwhile. The Sensitivity Analysis provides a conservative perspective on projected gains.

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Beyond ROI Justifying a Business Intelligence Initiative

BI3 Solutions, Inc.

Thomas Groh is a Co-Founder and Senior Solution Architect of BI3 Solutions, Inc. He has over fourteen years of experience in the IT professional services industry both in Europe and the United States. He utilizes his experience as a Project Manager of numerous Business Intelligence and Data warehousing projects to advise the Senior Management of companies on Business Intelligence best practices and help them plan, design and deploy successful BI, Corporate Performance Management (CPM), and CRM solutions. As a Senior Solution Architect and data management expert, he designed technologically advanced, large-scale, mission-critical business solutions for the financial services, insurance, and telecommunication industries. As an expert in both methodology and Business Intelligence, Mr. Groh has authored several books in the areas of data management and Business Intelligence. During his tenure with IBM, he was instrumental in defining and rolling out IBM's advanced Business Intelligence service offerings worldwide. Mr. Groh has taught a variety of courses for IBM internationally and has been called upon for numerous speaking engagements. Mr. Groh also held director-level positions at several national consulting firms in the U.S. including Whittman-Hart and marchFIRST. He has a Master of Science degree in Computer Science from the University of Technology in Vienna, Austria. BI3 Solutions, Inc. is a full-lifecycle professional services firm focused on providing clients with high-value solutions that meet their business and technology objectives. The Companys proven success rate comes from its framework that addresses business goals and drivers first, then leverages methodologies, processes and supporting technologies in Business Intelligence, Data Warehousing, Corporate Performance Management, Systems Integration, Business Interaction, Compliance and Customer Relationship Management to deliver comprehensive business solutions. To learn more about BI3 Solutions and how they can help your company meet its goals, please contact them at 510-521-8865 Ext. 101 or visit them at www.bi3solutions.com.

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