TCO versus ROI

Return on investment (ROI) metrics drove more IT project decisions in the past year than did total cost of ownership (TCO), an exclusive CIO survey finds. Which metric is used more often signals how the IT department is viewed inside your company.

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Devising ways to show the value of corporate technology has occupied CIOs for about as long as the 25-odd years the profession has existed. While measures such as internal rate of return and economic value added are applied with mixed success, ROI and TCO remain stalwarts.

An ROI calculation quantifies both the costs and the expected benefits of a specific project over a specific timeframe, usually three to five years. TCO, on the other hand, includes just costs.

“When you think TCO you don’t see IT as a business driver or an asset that can increase revenue, profit or customer value,” says Anthony Giannino, a consultant at Cornerstone Solutions, a value-added reseller in Chicago. Giannino was CIO at pharmaceutical distributor Alliance Wholesale from 2002 to 2007.

In an online survey of 225 technology managers, 59 percent said that ROI influenced whether they pursued a project in the past 12 months, compared to 41 percent who reported TCO justified the decision. In the coming 12 months, the relative difference in importance between the two measurements is more pronounced: 62 percent of respondents favored ROI compared to TCO’s 38 percent.

“ROI has to be the answer. TCO only looks at one side of the equation,” says Wayne Sadin, CIO at Loomis USA and a survey respondent who chose ROI.

TCO, Sadin says, works well for must-do infrastructure projects, such as upgrading an e-mail system. An IT leader might present options to other senior managers that compare the cost of adding one e-mail feature or another. But e-mail doesn’t typically uncover new sources of revenue or other topline growth opportunities that ROI can measure, he says.

Ken Harris, CIO at Shaklee Corp., agrees. He chose ROI in the survey, too. Although TCO has a place, extensive use of ROI signals how sophisticated a company is about IT’s strategic importance, Shaklee says. “There has been for awhile a shift going on toward more IT projects that impact topline than that are just focused on cost savings,” he says. Harris has also been a CIO at Gap Inc., Nike and Pepsico.

For example, swapping out one accounting system for another is a TCO project that while possibly important “is not going to win out over one that provides tools to my sales force,” Harris says. Shaklee markets personal and household care products such as vitamins and cleansers.

The prevalence of the ROI metric reflects the position of IT, at some companies, as a business department like any other, says Jeff O’Hare, senior vice president of IT at West Corp.

IT decisions should be less about technology and more about the business capabilities the technology makes possible, he says. Therefore, IT proposals should be measured like other business ideas, he says, for their potential to bring speed, efficiency and innovation. ROI offers a strong way to represent those ideas.

Sadin, at Loomis, explains that his projects are prioritized against proposals to, for example, open new branch offices or buy new trucks. “In every other part of the business, ROI potential drives every decision. IT can’t have its own governance model.”

Getting business units to fund IT infrastructure projects, which are frequently justified with TCO, can free up other money for technology innovation, CIO columnist Dean Meyer recently argued.

But remember: Neither ROI or TCO accounts for every cost or every financial benefit that may ripple from a project, says Erik Dorr, senior IT research director at The Hackett Group consulting firm.

Those metrics help companies choose how to spend their money. But in the decision ultimately made, “a lot of healthy business judgment is involved,” Dorr says. “You can prove anything you want with a spreadsheet but good managers have good intuition in judging how solid their assumptions are.”