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Calculating the ROI for Business Intelligence Projects
||Column published in DMReview.com
July 13, 2000
Individuals leading organizations are continuously evaluating the cost verses the benefit of one option over another. A typical question is: Which one will yield the greatest benefit to the organization? Understanding and quantifying the costs and benefits of each option are necessary to answer the preceding question. Increasingly, project managers are asked to evaluate the cost versus the benefit of undertaking a business intelligence (BI) project. Several financial measures can be applied such as the internal rate of return (IRR), net present value (NPV), payback period and return on investment (ROI). While each has its benefits, a commonly accepted financial measure is ROI.
Overview of ROI
The ROI provides individuals with a financial measure that quantifies the financial benefits over the costs of a BI project. The calculation evaluates the discounted projected cash flows derived from the savings generated by the BI project divided by the initial investment. With this financial measure, several assumptions have to be made that can significantly impact the analysis. These assumptions include estimating the cost of the BI project, the cost to maintain the current reporting environment and an acceptable time horizon or payback period. Quantifying these assumptions can be challenging, but the information is available from third-party organizations and internal groups within the organization.
How to Estimate the Cost of a BI Project
What is the total cost of implementing a BI application? The cost can be divided into two categories: direct and indirect. Direct costs are tangible cash outlays an organization can clearly identify with respect to the initiative and includes the purchase price of the software, maintenance or support fees, implementation expenses such as internal and external labor costs, additional hardware and software needed to support the BI application, and user training. The indirect costs are not as easy to identify or quantify. Because they usually occur after the BI application has been implemented, they are often not factored into the total cost of implementing a BI application. However, these indirect costs are a major component of the total cost. They include upgrade of client machines, upgrade of network communication, upgrade of supporting software, additional internal support for users and user training beyond the initial training. Understanding the total cost of implementation is imperative if the organization needs to stay within budget. It can also help determine the phases of implementing the BI application. Cost components of this project such as software costs, maintenance or support fees and average configuration cost can be obtained from external resources. The estimated cost of implementing a BI application will be used in the ROI calculation.
XYZ Corporation is interested in implementing a BI application to serve as its enterprise-wide, ad hoc query and reporting tool. However, the project sponsor and senior management wants to know what the ROI would be on the BI project because it will be a tremendous undertaking. XYZ Corporation's current reporting environment requires 1,200 hours/month of support. Replacing the current reporting environment with a BI application will incur the following expenses:
|Hardware || $250,000 |
|Software || $400,000 |
|Labor ||$750,000 |
|Total || $1,400,000 |
Proposed duration of the BI project is one year.
Ongoing support of the XYZ BI environment requires the following resources:
|# ||Position ||%Time |
|2 ||BI operational support ||100% |
|1 || Database administrator ||10% |
|1 ||System administrator ||10% |
|1 ||Network administrator ||5% |
|1 ||Trainer ||25% |
- BI software maintenance cost is 10 percent per year.
- The number of work hours per individual per year is 2,000.
- The average hourly labor rate is estimated at $75.
- XYZ's investment yield is 9 percent.
- Three-year time horizon for ROI calculation.
| XYZ with a BI application: || || |
| ||Year 0 ||Year 1 ||Year 2 ||Year 3 |
| Hardware || $250,000 || || || |
|Software ||$400,000 || $40,000 || $40,000 ||$40,000 |
| Labor || $750,000 || $375,000 || $375,000 || $375,000 |
| || |
| Total || $1,400,000 || $415,000 || $415,000 || $415,000 |
Figure 1: Calculations
|XYZ without a BI application: || || |
| || Year 0 ||Year 1 ||Year 2 || Year 3 |
| Labor || $1,080,000 ||$1,080,000 || $1,080,000 ||$1,080,000 |
| || || || || |
| Total || $1,080,000 ||$1,080,000 || $1,080,000 || $1,080,000 |
| || |
|Net Savings ||n/a ||$665,000 || $665,000 || $665,000 |
| || || || || |
|Discounted Net Savings at 9% ||$1,683,311 || || |
| || || || || |
|Return on Investment || || || |
| Discounted Net Savings at 9% || $1,683,311 || || |
| BI Investment || $1,400,000 || || |
| || || || || |
|Return on Investment || 120% || || |
Since the rate of return is significantly greater than 0 percent, conducting the BI project will be financially beneficial to the organization. In addition, since the ROI percentage is greater than 100 percent, the payback period for the BI project is better than the three-year time horizon used in the ROI calculation.
Performing a ROI Sensitivity Analysis
After applying the organization's financial measurements to the BI project, a sensitivity analysis can be performed. A sensitivity analysis is conducted by numerically creating scenarios for a variety of project outcomes. Each scenario is assigned a probability, and the appropriate financial measurement is applied. For a BI project, three outcomes may be a successful, partially successful and failed BI implementation. A percentage is assigned to each outcome as to the likelihood that the outcome will occur. If the percentage assigned to a successful outcome is less than 50 percent, the project should be reevaluated and the critical success factors need to be addressed because the chances of a less than successful project is great. Applying the ROI in a sensitivity analysis can help executives evaluate the risk and potential gain or loss of the BI project. For the example in Figure 2, a probability percentage as been assigned to each outcome for XYZ Corporation's BI project.
Figure 2: Probability Percentages
|Scenerio ||% Probability || Gain/(Loss) || Weighted Outcome |
| Successful || 60% || $1,683,311 ||$1,009,987 |
| Partial Success || 30% ||$ - || $ - |
| Failed ||10% ||$(1,400,000) || $(140,000) |
| || |
| Totals || 100% || || $869,987 |
Since the probability of success is greater than 50 percent and the total weighted outcome is significantly greater than $0, the potential gain to XYZ Corporation from the BI project outweighs the risk of failure.
Nonfinancial Considerations of a Business Intelligence Project
While the ROI calculation is one measure to evaluate a BI project, there are other nonfinancial considerations that should also be addressed. These nonfinancial considerations, or qualitative analysis, may include improved information dissemination, improved information access, propagation of knowledge about the organization through training and the use of the BI application. Striking a balance between the financial measurement and the qualitative analysis is crucial in both winning support and in the ultimate success of a BI project.
The quantitative and qualitative benefits of a BI project need to be evaluated before the project is undertaken. Calculating the ROI on a BI project is one means of measuring the benefit to the organization. But even more critical to the success of the BI project than the calculated costs, benefits and ROI is the extent of buy in for the project from the executive leadership and the business operations of the organization. Having support for the BI project from senior management as well as user involvement in the configuration of the application(s) is essential to its success. Without the necessary support and involvement, the ROI calculation for the BI project is meaningless.
This article was developed with the assistance of Mike Fitzgerald. Mike is a Senior Consultant at BASE Consulting Group and co-author of the Planning and Project Management of a Data Warehouse course which is offered through the University of California, Berkeley Extension - Business Intelligence and Data Warehousing Certificate program. For further information about this program, please visit: http://www.baseconsulting.com/html/data_warehousing.html.
For more information on related topics visit the following related portals...
Business Intelligence and
Jonathan Wu is a senior principal with Knightsbridge Solutions. He has extensive experience designing, developing and implementing information solutions for reporting, analysis and decision-making purposes. Serving Fortune 500 organizations, Knightsbridge delivers actionable and measurable business results that inform decision making, optimize IT efficiency and improve business performance. Focusing exclusively on the information management disciplines of data warehousing, data integration, information quality and business intelligence, Knightsbridge delivers practical solutions that reduce time, reduce cost and reduce risk. Wu may be reached at email@example.com.
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