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February 22, 2006

What Kind of ROI Do You Need?

In the table below, investment objectives (target outcomes) are laid out to identify how the organization addresses its three major functional concerns: recovery, health and growth. Growth, health and recovery are top-level categories of investment -- a portfolio-level consideration.

But the view presented in this table is meant to convey something different. It assumes that every investment is understood to be a change to the status quo on some level. Moreover, the "return" on the investment is a qualty of various outcomes that, after being balanced against each other, clearly promotes a new overall state that is preferred to the pre-investment state. This would be true whether the main issue is growth, health, or recovery, so the understanding is less circumstantial and more essential.

In this scheme, preferential outcomes pertinent to the main goal would be declared (populating the table), and the influence of the investment (which after all is a catalyst) would be directed at those targets -- making management the critical success factor of the investment.

As laid out by the table's dimensions, four quadrants identify different general modes of activity by which the investment in question can be sub-categorized. The point here is that a single investment can be influential in multiple ways. Care should be taken to identify whether the intended influence is the most likely one; meanwhile, there may be more than one significant influence concurrently.

This second general level of identification allows two important considerations. One, it offers more direct association with other organization-wide priorities already given to these different ways. And two, it invites comparing the implications of the investment in question against pre-existing or alternative mechanisms -- ones that might themselves intend to change something to the same end or by the same mode. (These might be, for example: legacy processes; organizational partners; competing proposed investments; already-active projects; etc.)

In yet more detail, the 4x4 table generates up to sixteen different opportunities for outcomes that might be identified as significant attributes of the investment's influence. Examples are easy to come by: it's not difficult to envision Standards at the lower left and Innovation at the upper right; likewise, Collaboration at the upper left and Customization at the bottom right. While those examples are not intended here to be recommendations, nor pigeon-holed, they represent a level of decription that should apply to the definition of what kind of change is likely involved in the management of the investment. That is, management should look to see how many of these sixteen issues are logically associated with the activity that the investment will catalyze, and perform some forecasting as well as compatibility and risk assessments. (Or else! We all know that the law of unintended consequences is in effect...) Knowing what the investment will support or inhibit is basic to establishing the business case fror the investment.

Overall, the table makes no assumption about how much time elapses between the present state (or start) and the target future (or recognition of the achievement goal). Not only can influences occur simultaneously on multiple target attributes, but the cycle-time from stimulus to impact can vary widely from one attribute to the next. In fact, it is again management that will both predetermine and regulate the cycle times, and management that must plan the influences for real-time accountability -- as well as reconciliation and intervention, where necessary.

Meanwhile, the table suggests one other aspect of the presumed value of an investment. For example, some investments have influence that is more on the immediate security (assurance) of the organization's economy while others weigh more on future possibilities. (The table indicates the former near the lower left, and the later near the upper right. In like fashion, other variants are indicated as well.) The table encourages us to look out for this, but in practice, it will be true only to the extent that management allows -- in exactly the same sense that a complex product will deliver its functional power only to the extent that it is allowed by its actual implementation.

The analogous idea of implementing an investment can be instrumental to understanding why the investment value should be anticipated in terms of managed change. "Implementation" is a model for controlling the influence of the investment across the various opportunities for economic impact. The picture below illustrates this idea of control, but makes it equally clear that control can be very complex and potentially very difficult.

Again, the value proposition of an investment is essentially a proposed change to the status quo. The change being pursued is a significant (beneficial) difference realized in stages (upper blue row, left-to-right) that progressively translate the difference from potential into reality. Each stage has inherent challenges to overcome, although the challenge may be great or small depending on the particular proposal and environment of stakeholders.

During that transition, issues perceived to affect the opportunity cost (associated with the investment) compete with the effectiveness of the change stages. These issues (lower blue row) may force adjustments of the change element in their respective phases, which can alter the scale, scope or logic of the initial proposal.

In general, this picture displays a principle that all value comes with risk, and that choosing value means choosing risk as well. Although not always detailed in the explanation of an investment, the built-in competition of risk factors with change progress is a predeterminant of the possible levels of return on the investment. Thus, active management is how return is generated to desired target levels.

Summarizing that active management, the four terms across the bottom of the picture, corresponding with the change phases, identify efforts in which the realization of the investment's value can break down. These terms also correspond with the four terms across the top of the picture that label the achievement objective of each change phase -- that is, what gets done without a breakdown.

In this discussion, return on investment is a phenomenon reliant on an organization's ability to take responsibility for the dynamics that create the path to deivering relevant benefits. The picture strongly reflects the experience of a manager of the investment navigating and balancing delivery opportunities and constraints. Those factors can easily be a blend of internal organizational issues and external environmental ones (markets, other stakeholders, etc.) -- which are not specified in the discussion but are not so difficult to locate in the scheme presented.

Seen as the result of a constellation of economic impacts, ROI is meaningful in the same way that the temperature of a given day or region is meaningful: it expresses a characteristic of an environment in which we might choose to operate, and it can strongly influence our choice depending on whether it inhibits our plans or not.

But the prevailing interest in ROI treats it as a specification of a building component of a protective shelter to be constructed in the environment -- and this is because we want the shelter to be the environment.

This disparity accounts for much of the confusion about whether ROI is a good measure for what should or should not be done -- because final outcomes (the reality of life in the environment) often do not match predictions. To steer clear of that confusion, the most important thing that management can do about ROI is to demonstrate what expectations about construction can logically be cost-effectively aligned with the requirements for strategically leveraging the expected environment.

This calls for managers to be the architects of return on investments -- and, well, they should be.

Posted by Malcolm Ryder at February 22, 2006 6:19 AM

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