Justifying a BI Initiative

7/28/2019 Justifying a BI Initiative

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Prepared by:


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Beyond ROI Justifying a Business Intelligence Initiative BI3 Solutions, Inc.

Introduction......................................................................................................................... 1ROI as Part of a Holistic Planning and Management Process for Technology Initiatives.... 1Identifying and Quantifying the Benefits of a Project ......................................................... 2Qualitative Benefits.............................................................................................................. 4Identifying the Cost for a Project......................................................................................... 4Return On Investment The Financial Foundation............................................................. 6Other Financial Metrics Commonly Used to Justify Projects ............................................... 6Sample Calculation of Common Financial Measures ........................................................... 6

Analyzing the Risk ............................................................................................................... 7


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The days when shareholders and management regarded a companys heavy investment ininformation technology as a necessity to stay competitive in the new economy withoutscrutinizing the payback potential of the investment are long gone. Today companies

have widely adopted a more prudent policy requiring a financial justification for nearlyevery IT initiative.

Industry studies have repeatedly demonstrated that Business Intelligence (BI) initiativesare amongst the information technology investments that yield the highest returns. TheIDC Study, The Financial Impact of Business Analytics (released in October 2002),reinforces and extends IDCs landmark study on Data Warehousing returns from 1996 andshows that organizations who have successfully implemented and utilized analyticapplications have realized returns ranging from 17% to more than 2000% with a medianreturn on investment (ROI) of 112%. According to the study, analytics implementationsgenerate an average five-year ROI of 431%. Over half (63%) of the companies studiedhad a payback period of two years or less.

Yet project champions find it more challenging to develop a business case for a BIinitiative than to justify other IT investments. This paper addresses these challenges andprovides guidelines for developing a solid analysis of costs and benefits to support you inidentifying, communicating and monitoring the value of a Business Intelligence initiative.

Although there is a lot of emphasis on hard ROI numbers these days, the key to asuccessful business case is not the final number resulting from an ROI study. Dontsubstitute numbers for judgment! There is no magical mathematical formula that will tell

you whether or not to approve a technology investment. ROI calculations are based onassumptions and projections that must be revisited and calibrated along the way.Measurement is the reduction of uncertainty about a quantity through observation. The

key here is the reduction of uncertainty - which is not necessarily (in fact, almost never)the elimination of uncertainty. Thus, the ROI study should be a part of a more holisticmanagement process for technology initiatives that takes business objectives, priorities,risk and technological feasibility (along with a healthy dose of business judgment) intoconsideration while fostering buy-in and accountability of business unit managers. Inother words, theprocessof getting to an ROI number is more important to the success ofthe BI initiative than the number itself.

The ROI study is not an isolated calculation that is performed by a financial analyst or by

a project manager in a vacuum. Without the necessary support and involvement of thesenior management team and the business units, the ROI calculation is meaningless. Itshould be an integral part of the Strategy & Planning phase of a BI initiative. The Strategy& Planning phase contains the following steps:

(1)Assess the Business Environment(2)Assess the IT Environment(3) Gather Business Requirements & Objectives(4) Identify & Quantify Potential Benefits


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(5) Prioritize the Requirements(6) Identify Gaps (Process, People/Skill, Technology Gaps)(7) Create High-Level Data Model & Validate Requirements(8) Define Solution Architecture(9) Develop a Phased Implementation Plan(10)Identify the Cost(11)Develop Business Justification and Calculate ROI

Steps 1 through 5 are heavily dependent on input and feedback from both the seniormanagement and the stakeholders and subject matter experts in the business units, thusproviding a balance of corporate vision and specific subject area details, which in turnresult in more realistic objectives.

As you can see, it is actually the benefits that get the attention early on in the project(Step 4) and not the costs (Step 10). The expected benefits are closely tied to thebusiness requirements, which in turn support specific business objectives.

The following figure (Figure 1) depicts this process of aligning the vision from theexecutives and the daily execution realities from operations during the requirementsgathering process to achieve a balanced view of the business objectives.

Executives

ExecutivesExecutivesExecutivesBusiness

Subject Matter

ExpertsVision

Specific Subject

Area Details

Management

Bonus

Objectives

Direction

&

Prioritization

Benefits Requirements

Realistic

Objectives

aligned w.

Corporate

Goals

Figure 1The requirements gathering process therefore also leads to quantified benefits, which canbe used to define priorities for the execution and which represent specific goals that canbecome part of the Management Bonus Objectives (MBOs).

When quantifying the expected benefits for a project, it is key to understand that theBusiness Intelligence solution itself does not provide financial returns. The ROI is derivedfrom the processes that the Business Intelligence solution supports or enables. The key toferreting out these quantified benefits from the business users is to keep asking probingquestions during the requirements gathering process.

The benefits of a Business Intelligence enabled process fall into two broad categories:


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(1) Sources of decreased costsLets examine some examples where BI initiatives can help to decrease cost.

Cost savings due to increased efficiencies due to the new process A commonexample for cost savings in this category is the closing cycle for the budgetingprocess. If the current closing cycle requires 10 days and involves several versions

of spreadsheet input being sent back and forth between departments, there is agood chance that the BI solution will reduce the time people spend working onthis process significantly. Lets assume that 20 people are involved in thebudgeting process and the total amount of time spent is 60 person days. The goalis to reduce the closing cycle time to three to five days with the help of the BIsolution, reducing the overall person days to 15. Assuming that the average personday costs the company $480, this results in a saving of $21,600 per closing cycle.

Another example of cost savings through increased process efficiencies comesfrom Marketing. By improving the granularity of customer segments as input tomarketing campaigns, the VP of Marketing believes that the cost of acquiring anew customer can be reduced by $20 each. The company acquires about 10,000new customers per year, which results in potential annual savings of $200,000.

Cost of current systems that can be eliminated Are there one or more dataextracts that are stored in databases on departmental servers and that are currentlyused for reporting purposes? Is there infrastructure from a previously failed data

warehousing initiative or unused software licenses (shelfware)? Does thecompany own licenses of an ERP module that is currently used to support a subsetof the reporting requirements? The corresponding annual software license andmaintenance fees and the current book value of the associated hardware arepossible components where cost savings can be achieved.

(2) Sources of increased revenueSuccessful BI initiatives go beyond cost savings and enable business transformation through

technology. That is the area where you will most likely find the payback for a BI initiative.Examples of sources of increased revenue are:

Estimated profit from purchases by new customers influenced by the process Staying with the previous example from Marketing, if the company can acquire10% more customers per year through better targeted campaigns as a result of theBI initiative, and we assume based on historical information about customerprofitability that those new customers would generate additional profits between$800,000 and $1,500,000, we can factor in those values as benefits into the ROIcalculation using a more conservative scenario and a second, more aggressivescenario. A Sensitivity Analysis (see Section Analyzing the Risk) will help you toassess the probability of each scenario and understand the overall risk.

Estimated profit resulting from the propensity of existing customers to purchasemore due to the process For example, as part of the specific business objectiveto increase annual sales by 20 percent, a line of business manager defines therequirement to identify opportunities to convert more one-time buyers into returncustomers, who buy multiple products through improved customer segmentationanalysis. He/she believes that having the ability to target one-time buyers with ahigh propensity to buy additional products would result in an increase in the


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conversion rate, which in turn would increase annual sales by 10 percent from$20,000,000 to $22,000,000. Given a 15 percent profit margin rate, this results inincreased profit of $300,000. This is a benefit that can be attributed to the BusinessIntelligence initiative in the ROI calculation.

Profit from sales not lost to competitors For example, a company could reducecustomer churn by 40 percent through early detection of customers with a highpropensity to switch to a competitor and targeted offerings to those customers.These customers generated annual profits of $1,500,000 from revenues of$10,000,000, which would otherwise have been lost to the competition.

There will be several benefits that will be difficult, but not always impossible, to quantify.They should be incorporated into the business case because they demonstrate additional

value for the proposed solution. Examples are:

Improved information dissemination Improved information access Improved data quality and feedback to the operational systems Improved collaboration across business units

You should make an attempt to quantify these benefits. It might be necessary to makemore assumptions, but in most cases, it is possible to identify a meaningful dollar valuethat can be attached to a potential benefit. Remember, the goal is not to find an exactamount, but to attach a meaningful and defendable value to a benefit to make it moretangible and more specific, and to enable you to track performance against it over time.Taking a conservative approach to your assumptions will help to deter challenges to youranalysis. Also, clearly state all your assumptions it will help you defend your case.

Identifying the cost components of a BI initiative is usually more straightforward thanidentifying and quantifying the benefits. The costs associated with a project aredetermined by the selected solution architecture (Step 8 in the Strategy & Planning tasklist), which identifies the hardware and software components that will be utilized, and theimplementation plan (Step 9), which includes the resource and time requirements.

The following picture (Figure 2) shows how the deliverables from the Strategy &Planning phase contribute to the identification of the cost for the project:


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Requirements PrioritiesBudget

Constraints

Current IT

Architecture

Solution

Architecture

Phased

Impl. Plan

Costs

RequirementsRequirements PrioritiesPrioritiesBudget

Constraints

Budget

Constraints

Current IT

Architecture

Solution

Architecture

Solution

Architecture

Phased

Impl. Plan

Phased

Impl. Plan

CostsCosts

Figure 2There are two types of cost components - initial costs and recurring costs. Initial cost

components include hardware, software, internal labor, external labor, and training.

Recurring cost categories are maintenance and support fees for hardware and softwareand labor costs for the operational staff dedicated to the solution.

Training costs should include not only training for the administrative staff required tooperate, maintain and expand the solution, but also initial and recurring training for thebusiness user community.

The following worksheet (Table 1) can be useful in determining the initial internal andexternal labor costs for a BI initiative:

Table 1Note that not all project roles are full-time. One person can perform multiple roles, andone role may require multiple persons.

Now that we have discussed how to identify and quantify both benefits and costs for theBI initiative based on information gathered throughout the Strategy & Planning phase, itis time to put the pieces together in order to understand the projects financial viability.The following section provides the financial foundation for the ROI calculation, whichshows you how the costs and benefits are applied to calculate ROI, NPV, IRR, and

Required Roles (initial) Hrs. Cost Rate Total Cost Hrs. Cost Rate Total Cost

Project Manager -$ -$ -$ -$

Business Analyst(s) -$ -$ -$ -$Technical Lead / Solution Architect -$ -$ -$ -$Data Modeler(s) -$ -$ -$ -$

ETL/Database Specialist(s) -$ -$ -$ -$Front-End Tool Specialist(s) -$ -$ -$ -$

Stakeholders / Biz.Subj.Matter Expert(s) -$ -$ -$ -$

IT - Network Administrator(s) -$ -$ -$ -$

IT - System / DB Administrator(s) -$ -$ -$ -$

Subtotal Labor Costs -$ -$

Total -$

Internal External


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Payback Period. It also introduces the concept of the Sensitivity Analysis, which providesa what-if analysis to understand the risk based on several outcome scenarios.

The most commonly accepted financial measure for evaluating the benefits of a project is

the calculation of theReturn On Investment(ROI). ROI allows us to assess the benefit ofa project over the initial costs. The ROI calculation evaluates theNet Present Value(NPV)of projected cash flows derived from the savings (or gains) generated by the projectdivided by the initial investment.

ROI = ((NPV of Savings) / (Initial Investment)) * 100

Now, how do we calculate the NPV of the projected gains? The NPV allows us todetermine the value of $1 one or more years from the date of the calculation consideringa discount rate or investment yield rate for the organization.

NPV = (Net Gains1 / (1+r)1) + (Net Gains2 / (1+r)

2) + (Net Gains3 / (1+r)3) + + (Net Gainsn / (1+r)

n)

Net Gainsi is the net cash flow for each year ithat the NPV is to be applied.r is the discount rate or investment yield rate for the organization at the time the NPV is being calculated.n is the total number of years for which the NPV calculation is to be applied.

In addition to ROI, some other financial metrics are commonly used to evaluateinvestments.

TheInternal Rate o f Return (IRR), for example, calculates the inherent discount rate orinvestment yield rate produced by the project. The IRR determines whether the yield ofthe investment in the project exceeds the regular investment yield rate. To calculate theIRR, the same formula as for the NPV calculation can be used. However, the NPV has to

be substituted with the initial investment, and the equation has to be iteratively resolvedfor the variable r, because in general, there is no closed-form solution for IRR. Numerousprograms and spreadsheets are available to help calculate IRR.

ThePayback Perioddetermines the number of years for the project to break even, i.e. forthe discounted projected cash flows to equal the initial investment. The formula tocalculate the Payback Period is as follows:

Payback Period = (Initial Investment) / (NPV of Gains / Total Number of Years in the Planning Horizon)

The following table (Table 2) illustrates how these financial metrics are calculated basedon an example with a time horizon of 3 years:


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Table 2The calculation of the Net Present Value of the savings or gains requires a more detaileddiscussion. To determine the net cash flow for each year, we need to understand the costand the benefits, expressed in savings or gains derived from, or influenced by, theproject.

It is recommended to do a Sensitivity Analysis which analyzes scenarios for a variety ofproject outcomes and their likelihood (successful, partially successful, failure). Applying thesensitivity analysis to ROI can help executives evaluate the risk and potential gain or loss

associated with the BI project. Following is an example based on the sample ROIcalculation in Table 2:

Table 3

The total weighted financial outcome should be significantly greater than zero for theproject to be worthwhile. The Sensitivity Analysis provides a conservative perspective onprojected gains.

Initial Year Year Year

Investment 1 2 3(a0) (a1) (a2) (a3)

Cost 500,000$ 55,000$ 55,000$ 55,000$

(b0) (b1) (b2) (b3)

Benefits -$ 450,000$ 650,000$ 800,000$

(c0)=(b0) - (a0) (c1) = (b1) - (a1) (c2) = (b2) - (a2) (c3) = (b3) - (a3)

Net Gains (500,000)$ 395,000$ 595,000$ 745,000$

Discount Rate = (r ) 7% 7% 7%

(d1) = (c1)/(1+(r )) (d2) = (c2)/(1+(r ) 2) (d3) = (c3)/(1+(r ) 3)

Discounted Net Gains 369,159$ 519,696$ 608,142$

(d) = sum((d1)..(d3))

NPV = (d) 1,496,997$

(e) = (d)/(a0)*100

ROI = (e) 299%

(f) = IRR((c0),(c1),(c2),(c3))

IRR = (f) 86%

(g) = (a0)/((d)/3)

Payback Period = (g) 1.00

Scenarios Probability Gain/(Loss) Weighted Outcome

(p0) (q0) = (d) for Best Case (o0) = (q0) * (p0)

Best Case 25% 1,496,997$ 374,249$

(p1) (q1) = (d) for Conservative Case (o1) = (q1) * (p1)

Medium Case 65% 250,000$ 162,500$

(p2) (q2) = - (a0) (o2) = (q2) * (p2)

Worst Case 10% (500,000)$ (50,000)$

Totals 100% 1,246,997$ 486,749$


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Thomas Groh is a Co-Founder and Senior Solution Architect of BI3 Solutions, Inc. He hasover fourteen years of experience in the IT professional services industry both in Europeand the United States. He utilizes his experience as a Project Manager of numerousBusiness Intelligence and Data warehousing projects to advise the Senior Management ofcompanies on Business Intelligence best practices and help them plan, design and deploysuccessful BI, Corporate Performance Management (CPM), and CRM solutions. As a SeniorSolution Architect and data management expert, he designed technologically advanced,large-scale, mission-critical business solutions for the financial services, insurance, andtelecommunication industries. As an expert in both methodology and BusinessIntelligence, Mr. Groh has authored several books in the areas of data management andBusiness Intelligence. During his tenure with IBM, he was instrumental in defining androlling out IBM's advanced Business Intelligence service offerings worldwide. Mr. Groh hastaught a variety of courses for IBM internationally and has been called upon for numerousspeaking engagements. Mr. Groh also held director-level positions at several nationalconsulting firms in the U.S. including Whittman-Hart and marchFIRST. He has a Masterof Science degree in Computer Science from the University of Technology in Vienna,Austria.

BI3 Solutions, Inc. is a full-lifecycle professional services firm focused on providing clientswith high-value solutions that meet their business and technology objectives. TheCompanys proven success rate comes from its framework that addresses business goalsand drivers first, then leverages methodologies, processes and supporting technologies inBusiness Intelligence, Data Warehousing, Corporate Performance Management, SystemsIntegration, Business Interaction, Compliance and Customer Relationship Management todeliver comprehensive business solutions. To learn more about BI3 Solutions and how theycan help your company meet its goals, please contact them at 510-521-8865 Ext. 101 orvisit them at www.bi3solutions.com.

Justifying a BI Initiative

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