INVESTING

WISELY FOR THE

FUTURE

Calculating the return on investment can be useful in supporting the development and implementation of an effective records management program Alan A. Andolsen, CMC, CRM

S

enior executives increasingly have realized that records and information management (RIM) is an integral part of an organization’s business plan, especially in managing an organization’s electronic records. This realization carries with it an obligation to determine the return that investing in an effective RIM program brings. However, calculating the return on investment (ROI) for records management efforts is sometimes problematic and can never be a simple financial formula. Many important elements in an effective records management program (e.g., risk management, disaster avoidance, and compliance) do not and may never produce financial gains. Thus, the use of ROI calculations to justify RIM operations must be carefully defined and focused to reflect actual results.

Methodologies

At the Core

This article ➢ examines the return on investment (ROI) for RIM programs

➢ ➢

discusses ROI methodologies and requirements

Developed in 1919 at E.I. du Pont de Nemours and Co., the classic return on investment model is the ratio or percentage calculated by dividing total assets into net income (see Table 1 below). It served as a tool to define the overall financial effectiveness of the organization’s efforts and provided a means of comparison among companies. Table 1 – DuPont ROI Profit

Sales

Sales

Net Income =

x Total Assets

= ROI Total Assets

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ROI calculations quickly became a tool for gauging the effectiveness of individual projects or investments within an organization’s activities. Calculated again as a ratio, this adapted ROI divides the total costs of an investment into the net gains produced by the investment (see Table 2 below). The net gains, of course, are calculated by subtracting the total gains by the investment costs. In this model, the result of the calculation must be greater than 1 to justify the investment. The greater the ROI is above 1, the more financial sense the investment makes. Table 2 – Adapted ROI [ Gains – Investment Costs ] = ROI

Return on Investment The classic ROI model serves the records manager well as a tool to justify specific elements of a records management program. For example, an organization moving to new offices is often looking for means to reduce the total floor space required. The records manager can usually demonstrate that the employment of compact mobile shelving will reduce the amount of floor space required for filing within the organization. A straightforward ROI calculation can be made by dividing the costs of the compact mobile shelving into the net savings of office space rental possible through the use of mobile shelving (see Table 3 below). Table 3 – Office Move ROI

Investment Costs

RS = Reduction in Office Space Cost CS = Cost of Mobile Shelving

A variety of ROI calculations have emerged to apply this tool to specific situations, including:

RS – CS = ROI CS

• Return on invested capital • Return on total assets • Return on equity • Return on net worth As a result, it is important to understand the specific definition of terms in an ROI calculation before comparisons are made about the financial returns of different projects. ROI calculations are most accurate when the gains, costs, and time frame of an investment are well-defined and easily tracked. When factors external to the actual investment costs and gains must be added to the formula (such as allocated or indirect costs), the resulting ROI may not accurately reflect the actual effect of the investment and may even render invalid the decision-making process. An extremely important element in any ROI calculation is the time frame. The same investment may produce radically different results or ROI if the time frame is shortened or lengthened. An additional consideration related to the time frame is whether to calculate the financial impact in a straightline manner or to use net-present-value calculations.

Another classic use of the ROI calculation is to justify the improvement of information management through technology. However, the ROI results will vary widely depending on the goal of the project. Take the case of an imaging system. In one approach, the imaging system is seen as an archival tool that simply replaces tons of inactive paper records. It is highly unlikely in this case that an ROI calculation will ever provide an ROI of greater than 1. The reason is that the financial gains from reduced office space costs and eliminated costs of off-site storage will not offset the personnel costs (number of staff multiplied by the time necessary to scan all the inactive documents plus the training time) and the system costs required to accomplish all the imaging (see Table 4 below). Table 4 – Archival Imaging ROI RS = Reduction in Office Storage Costs PS = Personnel + System Costs RS – PS = ROI

RIM Requirements While some elements in a records management program do not result in the types of gains calculated in classic ROI formulas, ROI calculations can, nevertheless, be a useful tool to support the efforts of RIM managers in the development and implementation of an effective records management program. Records managers must also be prepared to use alternative ROI calculations such as the risk of inaction and the risk of incarceration in addition to the traditional ROI calculation. These alternatives attempt to focus on the “preventive” components of records management that reduce risk and assure compliance. 48

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PS On the other hand, if the imaging project is focused on improving a business process by increasing throughput, reducing payment cycles, and improving customer service, the focus then shifts from storage to the management of active records with financial results that can far exceed the personnel and systems costs (see Table 5, page 49). By recognizing all the financial outcomes from the system, the ROI calculation can exceed 1 by several factors.

Table 5 – Process Improvement ROI PG = Productivity Gains IP = Increase in Cash [ Payments ] RS = Reduction in Current Office Space/Future Offsite Storage Costs PS = Personnel + System Costs [ PG + IP + RS] – PS = ROI PS

management deprives an organization of the many benefits of a good program. Calculating this ROI is extremely difficult because it depends on factors that can only be roughly estimated or projected. In essence, this type of analysis centers on risk management and an organization’s willingness to assume risk. If a valid formula could be devised to calculate this ROI, the result of the calculation would always be negative and approach infinity (see Table 6 below). Table 6 – Risk of Inaction Formula FI = Financial Loss from Inaction [ Negative Value ] CI = Lack of Investment = 0

In both cases, the classic ROI calculation provides guidance on the value of the investment. Because specific financial outcomes can be defined or predicted, a relatively reliable business decision can be made about a records management investment. However, not all records management investments provide defined or predictable financial outcomes. In these cases, the records manager may turn to two other ROIs. Risk of Inaction Another way to look at ROI is from the risk of inaction perspective. In many ways, this ROI is the most fundamental justification for a records management program. Ignoring records

-FI – CI

-FI – 0 = ∞ [ negative ROI ]

= CL

0

For example, one risk of inaction is incomplete or inaccurate information. The poor decisions that result from incomplete or inaccurate information are frequently caused by the lack of structure in the classification and maintenance of information. The dramatic, increased dependence on electronic records has only exacerbated the problem. The avalanche of digital infor-

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mation demands consistency and a process to retain only the most complete and accurate information. The malleability of digital information allows the recording of several versions of information (e.g., Excel spreadsheets) without adequate documentation identifying the most complete or official version. Lack of attention to the management of electronic records, especially those maintained on individual desktops, greatly increases the likelihood of mistaken, poor, or even disastrous, business decisions. Another common risk of inaction is the loss of important information. In some instances, this is a vital records issue – one

The main focus for ROI has o to be onn building a business case that justifies the ca investment of staff, time, and money through the returns of profits, reduced expenses, streamlined processes, increased revenues, and/or augmented productivity. that has significant potential financial implications. However, the exact cost or loss is often impossible to predict completely. One of the lessons learned from the 9/11 tragedy is the volume of information that was not included in organizations’ disaster recovery or vital records programs that proved crucial to the resumption of business. In other cases, inaction can result in a lack of compliance to statutes or regulations, leading to substantial financial penalties. In addition to financial payments, there may also be operational penalties (e.g., suspension of financial transactions for a fixed period) that will deny the organization income and profit. The focus from the perspective of risk of inaction is not on financial investment and return but instead on the management of risk within an organization and the level of tolerance that the organization chooses to accept. In these instances, records management is and remains a cost with no expected or guaranteed

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return for the money spent. No realistic ROI formula, in the classic sense, can be devised to calculate the cost of inaction. Risk of Incarceration Another ROI that has become increasingly important is the risk of incarceration. Civil (i.e., financial) penalties have been a common result of the neglect of good records management practices. Two important recent instances – one through regulation, one through statute – have radically changed the meaning of compliance for senior executives. In 1998, the U.S. Internal Revenue Service issued a new revenue procedure that listed possible criminal penalties for willful failure to maintain the proper tax-related digital information (IRS Rev Proc 98-25, Section 12). In 2002, the U.S. Congress passed the Sarbanes-Oxley Act, which stipulates that a chief executive officer or chief financial officer can be fined up to $1 million and imprisoned for up to 10 years for false certification of financial statements (Section 906). There is no formula to express this risk of incarceration ROI, nor is there a formula that adequately expresses the cost of personal imprisonment. However, the failure to implement good records management that results in such criminal penalties has an effect beyond the personal. It also affects the entire organization’s public image and employee morale. The ultimate penalty, however, is when the share price of the organization’s stock drops because of the criminal convictions of its executives. The risk of inaction and the risk of incarceration are important additional elements in the justification of investments for records management. However, the main focus for ROI has to be on building a business case that justifies the investment of staff, time, and money through the returns of profits, reduced expenses, streamlined processes, increased revenues, and/or augmented productivity.

Building the ROI Case The creation of a successful ROI case depends on careful attention to detail. Presenting the ROI formula is not sufficient. It requires context and supporting documentation to be persuasive. Although every organization should have a specific template to determine ROI for its investments, there are common elements that belong in every ROI argument: Scope A primary component of any ROI case is a statement of the scope of the argument. Scope can encompass many different factors, including: • Time frame (fiscal or calendar year[s], and start and end of data collection and analysis) • Location (single site, multiple sites, or countries) • Business units or functions affected or participating • Technology that is a part of the ROI case and that is not included in the analysis

Assumptions Every ROI case is based on assumptions. Thus, a clear statement of any factors that are given is necessary to ensure that those who review – and eventually approve – investment proposals understand what is assumed. For example, staff costs may be calculated from an average figure for all the affected personnel rather than the total of real salary and benefits costs. The speed of processing (e.g., scanning) may be calculated from performance averages provided by a manufacturer. The growth rate of information may be a number that is based on predictions of customer increases. In any case, it is essential that all assumptions are fully explained and documented.

Records m managers should not presume that those ot p evaluating their proposals will understand records management terminology and the meaning of the data used to justify a proposal.

Financial Measures The financial measures that will be used to calculate the financial impact of the investment are essential components of every ROI case. An organization may have specific financial measures that it uses in all investment decisions. In other cases, it is the responsibility of the team creating the ROI case to determine the best measures. In either instance, it is important to clearly identify the various measures and where they are used in the analysis. Among the measures frequently used are net or discounted cash flow, net present value, and internal rates of return. Other financial measures relate to the data elements that make up the analytic data. These may include the cost of an individual transaction, average salary and benefits for different classes of employees, or support expenses per day. Situation Description(s) This element provides a comprehensive description of how the

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project will create or accomplish its goals. In some cases, there are alternative scenarios that need to be examined. For example, in the acquisition of a records management application, one approach may be the organization’s staff installing, testing, and implementing the software as well as converting and importing the data. An alternative approach may assign these tasks to the software vendor. Still another approach would assign them to a systems integrator. Each of these should be fully described, incorporating the scope and assumptions defined previously. In addition, the “business-as-usual” situation should be included to provide a starting point for understanding the scenarios. Objectives A clear statement of the investment’s specific objectives provides the rationale for the project. The objectives focus in a descriptive manner on the gains that are expected from the investment and should be clearly linked to the organization’s overall business plan. The objectives should state a concrete result, not just a “high-level” goal such as “improve customer service.” In an imaging project, for example, the objectives may include improving overall customer service by reducing response time by 25 percent, increasing staff productivity by allowing processing of 30 percent more transactions in the same time period, and reducing the overall burden of paperwork through the elimination of paper files that occupy 1,000 square feet of office space. Data and Collection Methodology Those who review an investment proposal want to know where the information supporting the proposal came from and how it was collected. Some information may come from internal studies, other from research, and still other from vendors or consultants. In particular, it is important to describe the sources of information if they are not commonly known or understood. The same is true of data collection methods. For example, if sampling is used to determine workload levels, the ROI calculation should explain how the sampling was conducted and what tasks were observed and counted. Records managers should not presume that those evaluating their proposals will understand records management terminology and the meaning of the data used to justify a proposal. Costs To prepare for the ROI calculation, it is essential to have a complete listing of all the costs associated with the project. Obviously, direct purchases of hardware, software, or services need to be a part of the spreadsheet. However, other, less obvious items might include staff training time (at a standard rate), ongoing operating costs, and license and maintenance fees. The cost elements may also need to be divided into time segments – from the pilot stage through full implementation to later-stage growth and modification. In addition, the organization may require the inclusion of allocated or indirect costs in any investment proposal.

Financial Results Once the above steps are complete, it is possible to approach the gains that the investment will generate for the organization. For an ROI calculation, this focuses on the financial benefits. Some may be obvious: reduced operating costs or staff requirements, increased revenues, and shorter transaction cycle times. Others may be less obvious: ancillary features of a system, for example, that benefit the wider organization, investment tax credits, or access to a technology for smaller business units that could not justify a system alone. Each of these must be described and calculated in a manner that reflects the assumptions and scope outlined at the beginning of the ROI process. Non-financial Results Some results from investments cannot be financially quantified. There are many reasons why – from an unwillingness to place a value to the lack of sufficient information to validate a financial value. For example, implementation of an imaging system may contribute to employee morale or may even enhance the corporate image to customers. Most organizations would find it difficult to place a precise financial value on either. However, they may influence the decision to make the investment and, thus, should be included in the overall ROI presentation. Recent trends in ROI analysis have recognized the value of non-financial results as a supplement to the decision-making process.

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Risk Analysis Another important element in any ROI calculation is the definition of those risks that can alter the outcome of the investment. Each project will bring a unique set of risks that may range from a lack of equipment delivery to the inability to integrate software to the reluctant participation of staff in training. The ROI presentation must deal honestly with the risks and describe what steps are being taken to reduce or to eliminate them. The above steps will provide a structured framework for the presentation of the ROI calculation. With an ROI well above 1 (see Table 2, page 48), a strong argument for the investment can be made. However, it would be short-sighted for the records manager to try to use classic ROI in all instances. Often, there are other ROIs that must be considered – the risk of inaction and the risk of incarceration. The wise records manager knows when to choose the proper ROI.

Alan A. Andolsen CMC, CRM, is president of Naremco Services Inc., a management consulting firm founded in 1948 by Emmett Leahy that offers information and records management consulting services. He may be contacted at [email protected].