How to Evaluate Investment Decisions Differently Between Your Innovation and Efficiency Estate
Most IT leaders evaluate all IT investments the same. But you should look at investments in your foundation estate differently than in your innovation-driving Digital Transformation Platform.
👋 Hi and welcome to The DX Report — all about Digital Transformation, the Digital Experience, and the Digital Enterprise. I’m industry analyst, author, and speaker Charles Araujo, and I’m all about providing insights and analysis for enterprise IT leaders as you make the big bets about your organization’s future!
If you’re like most enterprise IT leaders, you go through the same process once you’ve decided to make an investment in a new technology (or to update an existing one): you calculate the return-on-investment (ROI).
And that ROI is almost always driven by cost reduction.
In most cases, this is a mandatory and perfunctory step. You’ve already made the decision based on your requirements, its features, and your budget. There’s almost always a baked-in assumption that any investment in a new technology will reduce your costs, so the ROI calculation is pretty straightforward.
For most of IT’s existence, this process worked just fine.
The reason is because up until very recently, virtually every investment in any given technology was an investment in efficiency. That’s why I consider the legacy tech stack — all your ERPs, CRMs, and Line-of-Business (LOB) apps — the enterprise efficiency estate.
The challenge is that the investments you make in your efficiency estate are wildly different than those you need to make in building what I call your Digital Transformation Platform (DXP).
When you don’t distinguish between these two types of investments is when things go off the rails.
Your Efficiency Estate Investments
Let me also start by saying that investments in your efficiency estate are important.
It’s just that you need to distinguish those investments from the investments in your Digital Transformation Platform — and use different approaches to evaluate each of them.
The reason is that, as its name implies, investments in your efficiency state are all about efficiency. I know. Duh.
As I covered in my recent analysis, How You Can Accelerate Innovation By Building a Digital Transformation Platform, you have rightly put massive effort into creating highly structured, rigid processes that run through your efficiency estate. They exist to reduce enterprise operational costs, so your goal with any investment in this estate is to further that effort.
For these investments it’s all about reducing costs, mitigating long-term financial risk, and seeking increased operational efficiency.
Looking at those factors a traditional savings-driven ROI calculation works great.
That said, it’s important that you move beyond the assumed and baked-in efficiency calculations. While it’s difficult, truly assessing the efficiencies gained and their financial impact will help you better adjudicate these investments.
Your Innovation Estate Investments
The investments in your Digital Transformation Platform — your innovation estate — are different.
Or, more precisely, using savings-based ROI as the primary evaluation tool is insufficient.
Investments in your innovation estate should still pass the ROI smell test. Using the same form of savings-driven ROI calculations, any investment in your Digital Transformation Platform should pencil out.
But the stakes with these investments are much larger, so you’ll need to add an additional dimension to your evaluation and return calculations: value creation.
In truth, this dimension should already be part of any ROI calculation. But when it comes to technology investments, it’s generally skipped over — partially because it’s hard to quantify, and partially because it was largely unnecessary when the focus was on efficiency.
The value creation dimension is essential in evaluating investments in your Digital Transformation Platform because the objective of these investments isn’t to drive efficiency. Efficiency is merely the byproduct of investments in your innovation estate.
The objective in these investments isn’t to drive efficiency. Efficiency is merely the byproduct of investments in your innovation estate.
The true goal of these investments is to, as the name signifies, drive innovation in the form of an improved customer experience, increased differentation, and in driving top-line improvements in revenue, market share, market expansion, etc.
So, you need to add a specific dimension to your evaluation that goes beyond traditional ROI to ensure that you’re making the right bets.
The Three Elements of Value Creation ROI
When it comes to investments in your innovation estate, merely looking at savings-based ROI, won’t do the trick. Instead, you should establish a baseline savings-based ROI and use it as a gatekeeper. Any investment must demonstrate that it can deliver your baseline savings-based ROI — but that just earns it the right to complete the evaluation process.
The real evaluation should take place in this Value Creation Dimension.
Specifically, there are three elements of value creation you should examine:
Customer Experience Return
Differentiation Return
Business Outcome Return
Customer Experience Return
The first is your customer experience return. To what degree will this investment enable you to improve and transform the customer experience in some way?
This is, of course, difficult to quantify. But you should attempt to evaluate the degree to which the investment will enable you to create, change, and improve the customer experience in a way that leads to increased customer acqusition, retention, loyalty, and recommendation.
A positive customer experience return should manifest itself in improved conversion rates, decreased churn rates, increased transaction values, increased Net Promoter Score, and so on. Ideally, you should be able to estimate the improvement in one or more of these measures and then translate that into a positive return that you can include in your true ROI calculation.
Differentiation Return
If your invesment in your Digital Transformation Platform yields a Customer Experience Return, it will automatically yield a Differentiation Return. But that’s not the only way to create competitive differention using your Digital Transformation Platform.
In some cases, you will be able to leverage your DXP to create new business models, new ways to engage with clients, or other ways that create competitive differentiation and advantage for your organization.
In other cases, you will be able to leverage your DXP to harvest your organization’s data and leverage it in new ways to create differentiation. Often, this process will feed into better experiences, new business models, and new product offerings.
In whichever case, you should attempt to explicitly capture the return generated by differentation and feed it into your true ROI calculation.
Business Outcome Return
Ultimately, the goal of any investment in the innovation estate should be to generate top-line business outcomes in the form of increased revenue, increased marketshare, increased share of wallet, and market expansion (amongh others).
Both a Customer Experience Return and a Differentiation Return should result in these improved business outcomes, but it’s important to distinctly quantify the return across these various outcome dimensions.
In addition, it’s also possible that innovation investments will generate these top-line business outcomes in other ways. For instance, it may increase your ability to secure partners that help drive business outcomes, or a new application could allow you to expand into a market you couldn’t have otherwise tapped.
Whatever the situation, you need to capture all of these top-line returns in your true ROI calculation.
The Turbo-charged ROI of Investments in Your Digital Transformation Platform
Frankly, I almost feel foolish writing this particular piece. Much of what I’ve just written is not particularly novel. In fact, these sorts of top-line return elements are routinely included in ROI calculations made in most parts of the business.
But other than perhaps a gloss-over, technology projects are almost never evaluated from a top-line perspective using the value creation dimension of the ROI.
Instead, the focus is always on cost savings.
This oversight creates two problems. First, it understates the return for investments in your DXP — you’re doing yourself no favors by glossing over them.
But secondly, and much more importantly, the value creation dimension is the measure by which you should ultimately be evaluating and selecting your investments.
The value creation dimension is the measure by which you should ultimately be evaluating and selecting your investments.
As I discussed in my last analysis on how to evaluate vendor investments, focusing solely on requirements and cost savings will put you at a distinct disadvantage and lead you to make the wrong investments.
Evaluating your DXP investments primarily from the perspective of how they will enable you to create value through customer experience, differentiation, and business outcome returns will, instead, enable you to make the investments that will have the biggest top-line impact for your organization.
And that’s what your Digital Transformation Platform is all about.
So, that’s my take on how to evaluate investment decisions differently between your efficiency and innovations estates, but what do you think? Agree? Think I’m completely off? Let me know!
And don’t keep this conversation to yourself. Invite your friends and associates to weigh in!