In the first of a three part series on ROI for Engineers, John Marchant discusses how to build a business case the Finance Director will understand and how to combat the 'credit crunch' when seeking board approval for expenditure.

Picture this: it's the monthly board meeting. There are a number of items up for discussion, including your request for approval for a new CAD/CAM system. You've costed your proposal and you've completed the internal paperwork. It's out of your hands now - or is it? How will the board decide if your proposal represents value-for-money and if it will be better for the company than say the ERP upgrade, the new conveyor system in dispatch, or the new regional office fit out? All this is quite topical, really, given the current 'credit crunch' crisis of confidence!

Increasing your chances of success

The purpose of this series of three articles is to help you increase the chances of getting the system you need, when you need it, without sacrificing such vital elements as adequate hardware, training and implementation - the usual victims of the bean-counters knife! This article explains financial return-on-investment (ROI) and how it is a vital part of any application to the board for approval to spend. Subsequent articles will show you how to structure an ROI-based business case and will present anonymised versions of the successful application of this approach. For those of you with a pressing current need, I have provided some links and resources at the end of this article.

The financial return-on-investment (ROI) business case

Research shows that the investment climate has changed. Gartner Group says, 'Increasing pressure is on technology directors to prove the link between IT investment and the company's bottom line.' Ernst & Young says, 'IT decision makers do not have much trust in the vendor supplied metrics. They need to see customised & detailed metrics for the specific solution offered.' This is where the financial return-on-investment (ROI) business case comes in. Not as a replacement for the traditional technical proposal, but as a compelling addition that gives the board the BUSINESS reasons for approving your request.

Remember the Bank Manager?

Think of the FD as the bank manager and think of your proposal as a request for a loan to finance your project. The bank manager would not necessarily be interested in your choice of hardware, software, etc. Rather, the bank would be interested in you paying the loan back in a certain time. The bank would also be interested in the value of the asset in the books, and how much money the bank will make from the transaction compared with investing the money in another opportunity. It is this that the FD will look at to assess the financial viability of your proposal. Increasingly, any proposal that does not contain trusted ROI projections is unlikely to receive approval and you may be left bidding for limited funds from your company's IT contingency budget.

What exactly is ROI?

Assume your mobile phone bills are £100 per month and a rival operator offers the same service for £70 - if there truly was no difference in the service, you'd surely change providers. However, what if the new operator charged £200 to transfer to the new service - would you consider this a good deal? The right business question is, 'Am I prepared to spend £200 now to reduce my bills by £30 per month?' This is exactly the same scenario that many businesses face when examining whether to invest in CAD solutions. They may already have solutions that work, are producing profits and seem successful - so why would they need something new that's going to cost money?

The Profit and Loss account

Traditionally, these discussions have been based around the features and the direct benefits of a solution rather than the economic impact on the company. That's because engineers understand the technical terms but may avoid quantifying the effect on the Profit & Loss account. If we can find all the REAL economic savings, then we can prove that the additional up-front investment is more than covered by the benefits that will be generated, and then everyone will be happy to move forward on the economics as well as the technical aspects of the solution being reviewed.

The language of the FD

To do this, we need to use language understood by the FD. For those of you who have an immediate need for a more comprehensive and academic explanation of the following terms, you should refer to the sources quoted at the end of the article.

Payback Period: PP

At what point in time will the economic benefits recover the original costs? In the mobile phone scenario above it is 6.7 months, being £200 up front cost divided by the £30 per month savings. The answer is a time saving. What happens after the 6.7 months period? It just gets better!

Internal Rate of Return: IRR

So how do we find the annual percentage return on the £200 just like we would be quoted an APR% on a loan? The percentage rate of return on the incremental spend, over a selected time period, arrived at by comparing all the benefits with the original cost. In effect, equivalent to the rate of interest on the loan: the higher the better and always more than your company's cost of capital.