A New Way to Look at ROI for Logistics IT Projects

Authored by Patrick Ryan, BestTransport

Attempting to measure the ROI of logistics-related IT projects seems to indicate a need for new metrics that measure more than just the cost and savings of the investment, though that's the way ROI is typically looked at. These new measures should focus on such things as how the service speeds up business processes, improves communications, increases customer satisfaction and assists in decision-making and quality control. These factors reflect performance improvements and what is important to customers, not simply short-term cost savings.

One such method is based upon measuring how current IT investments increase an organization’s options in the future. It is either called Option Valuation, or Modern Portfolio Theory, depending on your source. This method looks at the opportunities that a project creates for additional projects in the future, as an option value that should be added to the project’s other benefits.

There is another method called Real Options. Real Options is slightly different from the method just mentioned. Its emphasis is on the timing of a project launch or systems upgrade, in order to take advantage of changes in cost savings, quality improvements or market conditions.

There is yet another simple method for measuring future benefits, called Expected Value. Expected Value multiplies the size of the expected benefit of a project by the probability of its occurrence. However, this approach does not provide an estimate of the option value of a project, regarding whether or not a current project makes other future projects possible.

Value Analysis is a method that involves several steps, but is centered on the idea of using low-cost prototypes to determine a rough benefits-to-costs ratio. If the decision-maker feels that the system can provide enough benefit for the cost involved, development proceeds on a full-scale system.

Information Economics is an approach that uses organizational goals to determine which factors are included in an analysis of potential benefits. This method then assigns weights to each factor related to the achievement of the relevant goals. These factors and weights are then used to evaluate the IT alternatives.

Net Present Value (NPV) is still the most commonly used discounted cash flow (DCF) method and is considered the most accurate measurement of future value in today’s dollars. A different DCF method, the Economic Value Added (EVA) approach, takes “cash-adjusted operating profit minus the cost of capital used to produce earnings”. Both of these methods leave the measurement of intangibles mostly up to the clients.

Ultimately, old ways of measuring ROI (such as calculating the pay-back period) cannot be abandoned when attempting to determine the benefits of logistics IT. Rather, measuring cost savings is sometimes still the easiest way to measure the benefits of an IT project (and measuring the present value of the future cost savings is the most accurate way to depict those savings).