Return on investment (ROI) is the ratio of monetary benefits gained from an investment to the amount of money invested.
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ROI = (estimated benefit – initial investment) / (initial investment) |
ROI looks at how the introduction of the information system enables the usage of resources to contribute to the organization. The organization can benefit from the introduction of the new system in various ways. First, a new system can reduce the costs of current operation by increasing efficiency. For example, a business can implement a new system which stores transactional information automatically, therefore saves the labor costs of data entry. Therefore, the estimated benefit in the above equation will be the differences in labor costs. Second, a company may modify the current system to take advantage of newly developed technology. For example, a bank which offers online banking can reduce the cost of mailing monthly statements to clients. Therefore, the estimated benefit will be the differences between the cost of mailing the statements before and after the installation of the system. Finally, a new information system may also support growing business transactions. For example, a retail store may switch to an Internet ordering system from a call center to be able to serve more customers. Doing so enables the business to respond to more customers at the same time by letting customers browse products and services online and enter ordering information by themselves. The estimated benefit is the extra revenue generated from online ordering.
In all three examples, the initial investment is the cost of bringing in the technology, setting up the new business processes, training the employees, and organizing the reporting and reward structures. In other word, it is the cost of designing, building and implementing the appropriate information system (as defined above). With this information, we can compute the ROI. An information system with a positive ROI indicates that this system can enhance efficiency and/or improve effectiveness of the organization.
The advantage of using ROI is that we can explicitly quantify the costs and benefits associated with the introduction of an information system. Therefore, we can use such metric to compare different systems and see which systems can help your organization to be more efficient and/or more effective.
The disadvantage of using ROI is that it may be difficult to justify the causal link between the investment in information systems and the gained benefits. For example, the extra revenue generated from online ordering may not be due solely to the introduction of the new system. It may be because your product is in the growing phase and rapidly increasing in popularity, how can you be sure that you would not have generated the increased revenues even without the new online ordering system? As a result, the benefits of the system may over-estimated. On the other hand, some customers may browse your products online but still order through the call center; therefore, you under-estimate the benefits of the system. As you can see, it is difficult to distinguish which part of the revenue is strictly due to the introduction of the new system and this will lead to an inaccurate ROI.
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