The Importance of Justifying IT Projects in Financial  Terms

After several years of fighting for every dollar while being challenged to do more with less, IT executives are seeing signs of a shift in expectations for IT spending. "CIOs are approaching the coming year with marching orders to do more, and to do it more quickly," observes Gary Beach, group publisher of CIO magazine.

Those in the trenches -- such as Kevin Johnson, founder and CTO of Seamless Technologies Inc., Morristown, N.J. -- find that the push for speed and results forces CIOs to raise the bar on virtually every IT initiative. Says Johnson: "Technology executives today know they must get to positive value in less than a year."

If you'd like to achieve that kind of result, you need only look to world-class companies for inspiration. Top performers consistently demonstrate that even during lean years, if you choose your IT initiatives wisely, you'll spend less than your competitors while still gaining share in your market.

According to new research from the Hackett Group, an Atlanta-based division of the consulting firm Answerthink Inc., total IT budgets tightened by nearly 11 percent between 2002 and 2004. Yet top-performing companies spent almost 18 percent less on per-user IT costs than did their mid-tier counterparts. They also employed 37 percent fewer IT staffers.

How did they do it? Beth Hayes, the Hackett Group's IT practice leader, cites several ways that world-class performers maintain their lead, including:

However, the biggest factor in achieving world-class status is a familiar one: The need to align IT with business. It's a matter of understanding both the business goals and the IT controls that must be in place to support them, and demonstrating how new IT initiatives contribute solid business value to day-to-day operations.

Though an October 2004 CIO poll of IT executives indicates optimism that spending will grow in the coming year, financial justification continues to be paramount in getting the go-ahead from investors. Financial executives still remain reluctant to green-light IT projects without solid evidence of real business benefits.

In other words, to get your IT project funded, you must "sell" your case to the people with the checkbooks. Doing so effectively requires making sure your metrics jibe with the way financial decision-makers like to see project costs justified. While you don't need an MBA or a Ph.D. in finance to calculate costs and benefits, it does help to understand what CFOs want. Of course, even some of the most worthy IT projects ultimately won't receive funding, but framing your business case the right way may well increase your chances for success.

Components of an Effective Business Case

A well-structured business case should open with a compelling executive summary that argues for funding by presenting relevant facts about anticipated business benefits. It should also explain why the project is being proposed now, what problems it will solve, its specific financial impact on the company, and the timeline for spending and return on investment.

The rest of the business case should provide detailed validation of your argument by describing the problem, solution, project goals, and metrics. Following are tips on addressing each of those issues.

PROBLEM DESCRIPTION. What are the issues (and, if applicable, the opportunities) that this initiative will address? Clarify the compelling need for change. Highlight other organizations' best practices for addressing similar situations. Then present the gap analysis between where your company is today and where it should be.

SOLUTION DESCRIPTION. How do you propose to address the problems identified? Provide a concise overview of the technologies and business process changes involved, as well as major issues affecting other departments. Describe the resources and costs required for implementing the solution. Cite any alternatives you've considered, explaining why they were rejected. Present a project timeline, including key milestones. Finally, lay out the financial risks and their potential impact on the business.

KEY GOALS AND METRICS. What exactly do you want the project to accomplish? How will you measure its success? Define the goals and the metrics that will be used to ensure alignment between the IT solution and the business issues it is intended to address.

Different Ways to View the Financial Impact

A successful business case translates the proposed solution into the universal language of money. But make sure that your financial analysis matches the standards used by the financial executives who will sign off on your project.

Here are some of the ways in which you might paint the financial picture.

DISCOUNTED CASH FLOW ANALYSIS (DCF) evaluates the movement of cash in and out of your organization over time, taking into account the value of money over time. The two most widely used methods are net present value (NPV) and internal rate of return (IRR). NPV compares the value of money spent today against the value of benefits that will occur in the future, taking into account the firm's cost of capital (discount rate). The discount rate is calculated based on the firm's weighted average cost of capital, which varies by industry segment and financial strategies. IRR is the interest rate that equates the initial investment outlay with the present value of future cash inflows (cost savings) over a period of time, usually three to five years.

The core of a discounted cash flow-based financial decision model is the cash-flow table. A simple table that shows costs and benefits discounted to today's dollars allows financial decision makers to compare different proposed capital projects such as data center consolidation or an application upgrade.

RETURN ON INVESTMENT (ROI) is a ratio consisting of the NPV of benefits (cash inflows) minus the NPV of costs (cash outlays) over the NPV of costs (cash outlays).

TOTAL ECONOMIC IMPACT (TEI), as presented by Forrester Research Inc., of Cambridge, Mass., is a highly regarded methodology for calculating financial impact. It builds on the basics included in a discounted cash-flow analysis by including project costs and benefits. But it also factors in solution flexibility and project risk. Costs and benefits are discounted to today's dollar, the same as with ROI. Flexibility focuses on how the project will enable the deployment of future projects that will have a positive financial impact on the company. Risks require discounted costs and benefits to provide a range of less-than-optimal results. Risk-adjusted ROI adjusts all project costs higher and financial benefits lower to provide a more conservative view of the technology project's overall value.

Validate Baseline Data to Ensure the Integrity of Your Business Case

To ensure that all your calculations lead to credible results, establish a standard process to collect data scattered across the enterprise. Identify people in each department or business unit who can ferret out the necessary information. Then arm them with a carefully constructed questionnaire designed to collect the critical metrics in a uniform way that guarantees the integrity of your business-case calculations.

Also, consider benchmarking the metrics from your business units against industry standards. For instance, a number of third-party research firms -- including Forrester, Gartner Inc., and the Help Desk Institute (HDI) -- conduct technology studies spanning a range of industry segments. You can compare your in-house information against the researchers' findings to help create your own unique baseline.

Building a Case Around Reduced Headcount

Recently a leisure/travel/entertainment conglomerate hoping to reduce its overall employee headcount began considering the possibility of consolidating its service desk. Framing the financial justification for that effort was quite straightforward: Implementing the consolidated service-desk platform and single-data model would pay off quickly by reducing the need for parallel support and development staff to service multiple platforms.

But the company went one step further by seeking additional potential sources  of ROI, digging for specific metrics such as:

The company's business case, developed using Forrester's TEI model, also incorporated long-term cost-avoidance savings. Those benefits included:

While making a case for long-term ROI isn't overly difficult, it's worth noting that CIOs are under pressure to demonstrate greater returns in shorter time periods. As the entertainment conglomerate's experience indicates, today's most compelling business cases focus first on a proposed IT project's short-term returns, then with projected longer-term benefits.

The biggest challenge in building any business case is obtaining reliable and accurate baseline data. But applying a flexible financial model -- such as Forrester's TEI methodology -- can make that task easier.

In addition, using risk-adjusted ROI with both aggressive and conservative cost and benefit assumptions lets stakeholders see the range of hard-dollar costs and savings that might result from a proposed IT project's implementation.