When we work with clients on their digital transformation plans, a common obstacle is the need to build a business case for the project by calculating an acceptable return on investment (ROI).
This task is especially difficult with new technologies. After all, digital transformation often means estimating potential benefits from something that’s never been done before, using relatively untried technologies.
Whether the project is a small divisional one or a companywide program, at some point ROI matters, usually to make a business case for more funding or drive a rollout.
Based on what we’ve learned from clients, case studies, and primary research, here are five key requirements for making a strong ROI estimation when starting a digital transformation project.
1. Understand where—and how—value is created.
When you start to build a business case, it’s useful to go back to basics: Ask how the business makes money, and re-examine all tangible and intangible areas. Our experience is that no one size fits all, meaning a good solution for one business may not work for another and no assumptions should be made on where the value is.
The main tangible areas are, of course, revenue and costs. There are two main drivers of sales revenue:
Volume increase. This includes any activities that increase the number of customers or the probability someone will buy from you, from building a brand reputation to satisfying existing customers.
Unit price increase. This includes any activity that makes a customer willing to pay more, from adding new features to increasing the quality of a product or sales process. For example, offering faster delivery or more product options can both enable unit price increases.
It’s critical to re-examine all the potential ways a proposed solution can create value. One of our clients implemented a social monitoring system for dealing with customer complaints. In the process, the customer identified new product features that could enhance sales and found that tracking competitors on the social monitoring system provided useful insights to improve its own customer service offering.
On the cost side, we have found it’s useful to look for two main drivers first:
Operating cost reduction. This results mainly from higher productivity techniques (more output for the same input) or increasing system efficiency by reducing delivery time, eliminating wasted effort, or improving product quality.
Customer retention/churn reduction. Serving a happy customer is always cheaper than finding new customers. Unhappy customers can also be very expensive to placate—not only in direct costs, like refunds, but also in terms of disruption to normal operations.
The key here is to understand where the main costs are and where the value is added. Often, these are not found in the same place. For example, telcos often sell mobile handsets to consumers with very large discounts and don’t recoup their investment for many months. Yet many handset vendors have poor customer service, which yields high rates of customer churn. A relatively small investment in after-sales service can therefore have a very big impact on reducing total value lost.
2. Dig out intangible benefits
Intangible benefits are those for which it is difficult to quantify cost or sales value. They are typically found in the “soft” areas of a business, such as enhancing communication or improving the work environment. Not surprisingly, they are often ignored. Yet intangible benefits can produce real returns. We know, for example, that happy employees make fewer errors and take fewer sick days. They also excel at selling and customer service.
Other intangibles are harder to tease out. For example, one of our clients found that a large proportion of its customers go online to comparison shop. Customers tended to value after-sales service highly in buying decisions. There was a hidden but strong feedback loop between customer satisfaction and new customer propensity to buy. So the company calculated that optimizing service levels not only had a cost benefit, but also had a direct impact on new product sales. As the client’s industry suffered from high churn, retaining existing customers and attracting new customers had a double impact on ROI.
3. Use the Delphi technique
The difficulty with using new methods and technologies to transform your business is transformational benefits can be hard to define or value easily. Detailed research is usually valuable but can be time consuming. Companies are often looking for a fast estimate of what’s feasible.
In this case, a modified “Delphi” technique may be useful. This involves assembling people who are familiar with the business area and asking them to estimate the costs and benefits of the proposed project. Each person ranks the costs and benefits as high, moderate, or low relative to one another. The individual feedback is then combined, and low-benefit/high-cost projects are eliminated. Even without hard numbers, the exercise is a handy way to identify the following:
- Ideal next-step projects that combine high benefit with low cost.
- High-benefit/high-cost projects that need more detailed examination.
- Low-benefit/low-cost projects. Some of these may be worth looking at, especially if they offer significant intangible benefits.
For example, one of our clients designed an ambitious companywide transformation project but was struggling how to prioritize its limited resources. Using the modified Delphi technique, it took the company about three days to sort the many possible projects by potential impact and cost and ease of execution. From this information, it estimated an ROI that was sufficiently accurate, useful, and defensible to include in an initial implementation plan.
4. Compare your project with existing models
Another approach to valuing uncertain benefits is to identify existing methods that are similar to the proposed new approach and then analyze the differences in more detail.
For example, many companies are vying to do home delivery of grocery shopping. By looking at current home delivery models, you can see that the main drivers of value are distance and time between drops, the value of the drop, and the cost of your delivery method.
If you then model home delivery scenarios on a simple spreadsheet with easy-to-get data from existing approaches, it soon becomes clear that outside of dense urban environments, home delivery can quickly become very expensive. Longer distances mean extended periods between deliveries, which reduces revenue per trip as costs rise. An inflection point is soon reached where it is cheaper to let the customer collect the goods from an existing store. This dynamic largely explains the huge current interest in drones and robot deliveries.
5. Understand the value of quick wins
We recommend starting any digital transformation project with a proof of concept. Last year, we did a major piece of research on the experiences of large multinational companies embarking on digital transformation projects. We interviewed one company that had piloted an enterprise social network in one area of the business.
The initial ROI was relatively weak, but the project was still approved, as it was relatively low-cost and low-risk. There were initial bugs, but the small team ironed those out. The new social network proved its worth by making it easier for teams to collaborate across multiple regions, languages, and time zones.
Other areas of the business then started adopting the social network. Usage rates soared. As team members became more familiar with the tool, all sorts of unexpected and valuable applications emerged, increasing the project’s ROI substantially. Now the social network is the second most popular tool in the business after email.
The project’s managers learned that by running a small-scale initial trial, they were able to test and adjust the application on the fly rather than trying to debug it after a mass rollout. As a result, they avoided getting swamped by a complicated rollout that could have failed and discredited the tool.
Finding ROI: Lessons for leaders
- Make sure you understand how your business makes money. This will ensure that proposed solutions have real ROI impact.
- Leave no stone unturned when looking for benefits. New approaches unlock new opportunities.
- Closely examine the intangible benefits.
- It’s possible to create useful ROI estimates using fairly simple estimation techniques, even when the proposed venture includes new techniques and technologies.
- Pilot! Small projects offer lower ROI requirements and less risk. They allow you to iron out bugs, suggest new opportunities, overcome opposition, and firm up the ROI model.