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Wednesday August 14 2002 Web Services Return on Investment Working out what you're Getting out of Web Services Printer-friendly
HTML version In this article, we have tried to keep a realistic, pragmatic, and balanced approach in determining the return on investment on Web Services. It is worth mentioning that, no matter how promising a new technology is, promoting and encouraging its usage through such articles and papers is not justified until there is a solid business case for its adoption. It is fundamentally important for us to warn about the pitfalls as and where we foresee them, leaving the final decision up to the readers who range from senior management (technical and business), through business analysts, and systems architects, to project managers, and software developers. Defining Return on Investment (ROI) Return on investment (ROI) is a key financial metric of the value of business investments and expenditures. It is a ratio of net benefits over costs expressed as a percentage. This formula can be expressed as: ROI = [(Monetary Benefits (Tangible and Intangible) - Cost of using Web Services Technology) / Cost of using Web Services Technology] x 100 An Example of ROI Calculation As an example, the IT group within a company determines that there is a 10 percent increase in the automation of software development following the implementation of Web Services for an organization's IT project. Other data from the IT group reveals that each one percent increase in the automation of software development is equal to increased annual revenue of $25,000. Furthermore, it is known that the Web Services implementation will cost $75,000. For this example ROI is calculated as follows: [($250,000 - $75,00) / 75,000] x 100 = 233% That's $25,000 for each one percent increase, for a total of $250,000 for a ten percent increase. This means that for every $1 invested in the Web Services implementation, the organization realized a net benefit of $2.33 in the form of increased revenue from the automation of software development. ROI Analysis There are two fundamental methodologies through which companies can conduct ROI analysis of a new technology such as Web Services. They are discounted cash flow analysis and payback period analysis. Before we look at both these methods, let's discuss some of the fundamental concepts behind them. Direct and Indirect Measures Discount Rate or Weighted Average Cost of Capital
(WACC) Net Present Value (NPV) Present Value = [Net Cash flow for Year 1 / (1 + discount rate)]+ [Net Cash Flow for Year 2 / (1 + discount rate)] * 2 +....... + [Net Cash flow for Year N / (1 + discount rate)] * N We calculate the net present value as follows: NPV = Initial Investment + Present Value For example, if Web Services technology costs $200,000 and will save (or generate return) of $50,000 per year for five years, there is a $50,000 net return on the investment. The NPV of the investment, however, is actually less than $50,000 due to time value of money. Internal Rate of Return (IRR) The IRR method of analyzing investment in a new technology or using a technology in a project allows a company to consider the time value of money. IRR enables you to find the interest rate that is equivalent to the dollar returns that are expected from the technology or project under consideration. Once a company knows the rate, it can compare it to the rates that it could earn by investing money in other technologies or projects or investments. Payback Period Discounted Cash Flow Analysis In the discounted cash flow ROI analysis methodology, the expected cash flows relating to investments for a new technology or IT-related project spanning several years are discounted using an appropriate rate to determine an NPV and/or IRR. If the NPV is positive, then the project's present value exceeds its required cash outlay, and the project should be undertaken. When a project has a positive NPV, the NPV decreases as the discount rate used increases. Similarly, if the IRR is greater than the cost of capital for the company, then the project should be undertaken. Payback Period Analysis In the payback period ROI analysis methodology, the period of time it takes for a new technology or IT-related project to yield enough returns to pay for the initial investment, or to break even, is considered. ROI Analysis Becoming a Necessity Return on investment for technology projects, both new and existing, is no longer a single-dimensional function of operational cost reduction. It has to account for multi-dimensional functions related to operational costs, changes in business activities, growth, efficiency, and productivity. ROI analysis is gradually becoming a core requirement for the kick off of any new project or use of new technology, as well as for measuring the success or failure of any existing project. A good ROI analysis can lead a new project or introduction of any technology to lower costs, improved business performance, and competitive advantage. ROI and Web Services A company should calculate the implementation and ongoing costs associated with Web Services including software, hardware, system integration, and future production support expenses. These cost estimates should be carefully examined to determine the ROI for the proposed solution. ROI Not Just About Technology Whatever the underlying technology for which ROI is being calculated, there is always a set of business and personnel factors that have a great impact on it. We cannot stress enough the fact that technology alone will not produce the quantifiable results and benefits as projected in any ROI matrix or calculation. Several business factors, such as the speed of rollout and systems adoption rate, play a critical role in determining the final numbers. Calculating ROI of Web Services How do you measure the ROI of Web Services? Well, there is a right way and a wrong way to measure ROI. The wrong way is to measure the time representatives save in reduced paper work, or in revenue the company saves by reducing the need for data entry. The right way is to measure the amount of reduction in operational and developmental costs. The ROI on Web Services comes from the increased operational efficiency and reduced costs that are achieved by streamlining and automating business processes, reduced application development cycle time, and increased reusability of applications in the form of services. Factors to be included in ROI calculation The relevance and importance of each of these factors will greatly vary from company to company, application to application, and implementation to implementation. If all these factors are considered together, however, you can get a pretty decent result from the ROI model used for Web Services. The factors we will look at are:
Costs and Expenses These factors break down into the following elements:
Technical Benefits These factors break down into the following elements:
Business Benefits These factors break down into the following elements:
There may be other direct and indirect benefits for the usage of Web Services, such as faster time to market, increased process efficiency, and increased efficiency through business process automation. These also have to be accounted for in your ROI calculation. ROI and Risk Management These factors break down into the following elements:
Applying the ROI Formula Now that we have discussed all the costs and expenses along with the technical and business benefits and risks of Web Services, it is time to apply the numbers to the ROI formula for Web Services. As presented earlier in the paper, you can either choose the discount cash flow analysis or payback period analysis. We will arrive at the numbers through a series of simple steps:
The last step is to categorize the results from Step 1 through 4 under the following headings:
Using the formula from earlier in the article, we apply the figures as follows: ROI for Web Services = (B - A - C)/ (A+C) * 100 The desired result for using Web Services will be if you get the following:
This scenario will make a business case for Web Services. It may be the case, however, that not all the factors listed above prove favorable. In this case, you will have to weigh all the options and make a decision based on the near and long-term goals. Not the Only Model Before we conclude this article, we should mention that this is not the only model that can or should be used to calculate and measure ROI. Each company or organization may use a different model to measure ROI, such as using a method that begins by identifying the desired economic results of Web Services strategy and then focuses on creating the activities necessary to achieve those results. Use the model that best fits your organization. Finally, be sure that ROI should account for phased implementation of Web Services technology. Conclusion Web Services run through industry standard protocols and offer the potential of eliminating the need for proprietary hardware, software, and network protocols. Companies will be able to lower their investment costs greatly in terms of increased ROI by implementing Web Services. There is no fixed model for calculating ROI of Web Services as of now, and the ROI in each company would greatly depend on how the technology is actually employed in solving software and business processes related tasks. Any model used for calculating ROI should take into account the risks associated with the usage of Web Services. This article is an extract from Web Services Business Strategies and Architectures. Buy the book from Amazon.com The extended PDF version of this article is available now. Return
on Investment (ROI) for Web Services by Gunjan Samtani and Dimple
Sadhwani Adobe Acrobat format (PDF) - 81K By the same authors: Keep up to date with all the new articles and features on
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