In this note I present my thoughts on the ROI measurement limitations and how to address investment decisions for BIM.
IntroductionReturn on Investment or ROI is a common evaluation metric to decide on investment projects. In certain contexts it is a back-of-envelope assessment of performance of an opportunity. It simply states the ratio between the expected returns and the required investment, and is often presented as a percentage value. (ROI = Return/Investment). The Return is the net impact of the implementation, meaning the difference between the value before and after the project is executed, or the gross return minus the investment.
A higher ROI value means that the project "pays off" more, or brings higher benefits. But rather than talking about individual benefits, ROI aggregates this granularity in a single figure. When comparing alternative options, this single figure is very useful... but it may not provide enough information for a decision. This analysis builds on my previous piece on the boundary conditions of a BIM Implementation.
While focusing on the specific mechanics of coming up with "a number", this article presents a wider reflection on the considerations of the implementation decision. I structured my analysis in four sections:
- The challenges to calculate the expected Returns
- The challenges to calculate the Investment requirements
- The shortfalls of the ROI metric for BIM implementations
- A proposal of other hard metrics to evaluate when considering a BIM implementation
Calculating the ReturnMost research confirms a sentiment or a hard-metric of tangible benefits in BIM. These benefits range from efficiencies in the delivery, automation of certain tasks, economies of scale or market expansion. When reducing these benefits to a "return" metric, several factors get in the way of establishing a consolidated figure:
- Calculating "intangible value" is the most cited challenge to measure the return on a transformation projects. Even if difficult, companies regularly assess the brand value, market potential and revenue projections. The market value (i.e. share price) of a company reflects an aggregation of these metrics. In an acquisition, this value is captured in the "good will" difference between market and book value calculations. So, if a BIM company is more "prestigious" or "valuable" than a comparable non-BIM, the difference is the return of a wider BIM transformation (sometimes distorted by what the company says they do, not by what they actually do).
- Evaluating risk is key to establish an expected return value: if a transformation could bring a return of 20 at worst and 60 at best, with 50/50 probability of outcome, the expected return should be set at 40. More complex scenarios, with multiple outcomes and probability distributions, will follow a similar calculation. External factors like market cycles and regulation play a strong role in establishing the expectation of returns and are often overlooked in implementation planning.
- Evaluating the base-line. Regardless of the BIM transformation, the company's organic growth, and an industry transformation (e.g. receiving better information because the supply chain adopted BIM), will distort the "what if" baseline. On the other hand, a competitive landscape may impose a negative cost of no-change. This means that the returns, as a delta between the scenarios "with" and "without" the implementation should acknowledge the drift to higher returns of "indirectly surfing the technology transformation" and the perils of "lagging behind" if the project is not undertaken. The base-line is also affected by external factors like cycles in the economy.
- Establishing the time-value of money is a difficulty for both the Investment and the Return. The calculation is set at a specific point in time, but the investments and more importantly the returns are spread over time. As getting the money in the future is less valuable than in the present, the value should be adjusted to reflect the interest rate or the cost of capital. This is an often overlooked aspect of the ROI calculation, but relevant for long-term transformation initiatives.
- Materializing the returns means converting the benefits of BIM into benefits to the company. For example, imagine a BIM project has a positive impact of 20% time savings on an operation. It may mean to achieve the same output levels with fewer personnel (reduce cost), increase the output with the same workforce (increase revenue) or use that 20% additional capacity to improve the personnel ability to do Business Development (business growth), Human Capital Development (training), further technology Research and Development (which amplifies but delays the attainment of the returns). How the improvement potential is materialized has a major impact on the "return" calculation.
- Establishing attribution and marginal contribution is the last consideration on my list. In practice it requires isolating the returns associated to a specific initiative. BIM transformation is often delivered as part of a culture shift, which makes it difficult to say that the expected return is tied to one project. The benefits depend on the number of initiatives, so a transformation framework will increase the success over an individual project.
Calculating the InvestmentI have fewer observations when it comes to establishing the investment calculation, although they are as difficult if not more than the returns calculation:
- Isolating the investment requirement means differentiating between a total financial requirement of the project or an explicit ask for funding. For a simple example, you can buy a house for £100 and sell it for £140; your ROI is 40% (140-100 / 100). But if you borrow £80 that you repay at sell and only invest £20 of your own funds, the ROI becomes 200% (ignoring interest rates... which I mentioned above). This means that digging in the source of funding for the project could affect the calculation dramatically.
- Establishing an opportunity cost is important to assess the level of investment. The opportunity cost is the alternative use of the resources in the project. If you have extra capacity in your system (say, for instance, the 20% time savings I mentioned before), but you are not planning to reduce your workforce (which is often the best approach to expand your top line), then you may find yourself with extra time in your hands. Allocating these resources to an innovation project will be relatively cheap (as you've already committed to an expense). If, instead, you need to hire people, the cost jumps to the salary of those resources. If you have to stop profitable projects to allocate resources to the implementation, the opportunity cost is the loss of revenue you'd earn in those projects.
- Other factors affecting the investment, like tax breaks or external funding for innovation or research which may turn the investment effort practically free. If the investment becomes close to zero, the calculation of a ratio becomes unreliable and unstable.
Other considerationsIn the introduction I mentioned that the biggest value in calculating the ROI was to be able to compare, in one metric, alternative investment opportunities. I still can point out a number of reasons why the value falls short of informative to make an investment decision:
- Strategic alignment. When comparing alternative development areas, the strategy of the company should be taken into consideration: if the company operates in a niche market and has few complex projects should focus on improvements in quality or augment variability, like computational design. When the company operates in mass markets should focus on implementations that augment production and volume, like automating drawing production. This is not saying that the company would not benefit from either initiative, but the number should be evaluated in context rather than in isolation.
- Decision factors. What alternatives are you considering? What would be a "priceless" benefit for the organization? What would be the threshold for a NO-GO decision, and why? By answering these questions you may find easier approaches to commit to the implementation project, avoiding the need to calculating the ROI. Also, unpacking these drivers and assumptions becomes insightful to understanding the variables to consider in the calculation.
- Scaling the implementation. Small and large projects have different risk and return profiles. It is not possible to calculate the ROI of a small project and multiply it across the organization, or taking a large project and expect a proportional return when implementing a fraction of it.
- Lack of benchmark. Is 400% ROI good or bad? I don't know! Unlike finance investment, it is difficult to benchmark the technology implementation expected returns.
- Source of funding. As mentioned when evaluating the investment calculation, some innovation initiatives will take advantage of spare capacity and sunk costs, making the ROI artificially large. Strategic allocation of available resources is key to decide on transformation projects.
Alternative metricsUp to this point my comment paints a gloomy picture of the ROI calculation. This section presents other financial metrics to evaluate the investment performance. It will probably make twitch my finance friends... but I tried to translate them to simplified terms.
- Sensitivity analysis. My first approach is to keep the ROI formula, but building a clear description of the underpinning assumptions, and more importantly making clear evaluations of potential scenarios. A simple clarification of the value associated to each assumption combined with best/typical/worst case scenarios goes a long way to build confidence in the calculations. A more advanced version of this approach requires probability profiles, correlation between variables and some computation heavy lifting (I am thinking of Monte Carlo simulations).
- Use of funds and/or cash-flow projections, which sets the basis for the ROI calculation but keeps the Return and Investment items as discrete items on a timeline. It gives a better idea of resource allocation and expected spend/benefit
- Break-even period calculates the point in time where the project becomes self-sufficient and repays the investment, without need for further inflow of external capital. It is helpful to establish risk profiles and implementation milestones.
- Net Present Value (NPV) sets the difference between inflows and outflows adjusted by time (interest rates), based on the cost of capital. In practice, any NPV positive project should be viable, as it increases the company's value over time. The larger the NPV, the better project opportunity. Read more on Wikipedia.
- Internal Rate of Return (IRR) reverses the calculation of NPV by considering the interest rate as the unknown. Any project with an IRR lower than the cost of capital is viable, plus the lower the IRR the better opportunity. Read more on Wikipedia.
- Return on Capital Employed (ROCE) measures the change in profitability of the company (EBIT) against the capital employed. It simplifies the calculation by focusing on the changes in "top line" (capital employed) and "bottom line" (operating income). Read more on Wikipedia.
- Return on Invested Capital (ROIC) is a similar metric to ROCE, taking into consideration the after-tax performance. As a lagging indicator of the implementation success it may be the easiest approach, but it may be difficult to identify the contribution of a specific project. Read more on Wikipedia.
When making a business case for a technology transformation you may be asked what is the ROI... I suggest you engage in a discussion to provide instead a comprehensive view on the expected benefits and expected resources required, the strategic synergies within the industry and the considerations that may arise if the project is not undertaken. If the evaluation committee still requires an ROI value, then develop a financial model of your assumptions (e.g. what parameters were used to establish the Return and the Investment), plus a sensitivity analysis where you illustrate the confidence around the variables considered.