nformation technology is a risky investment. Organizations launch big IT projects with much uncertainty about benefits and costs. More than 90% of IT projects go over budget, and more than one-fifth are over by at least 100%. It's not even sure the project will be finished.
Yet IT managers don't usually consider risk in a financially meaningful way. If risk is considered, it's often with ambiguous and arbitrary "weighted scores" that mean nothing to your CFO.
It's not that better tools for risk analysis don't exist. Actuaries and investment managers certainly don't rely on ambiguous scores. These people have been analyzing risk with serious tools for decades. And their definition of risk is unambiguous. They define it as the probability of a specific, undesirable event.
Now it's time for IT to use the same tools. Here's a greatly simplified, four-step exercise to show how they might work:
- Choose the risk to be assessed. Pick a proposed development project. You can make the "undesirable event" anything you want, but it is useful and simple to define it a negative return on the investment.
- Chart your risk/return profile. Imagine a generic IT investment the size of the project you chose in step 1. Would you make that investment with, say, a 10% chance of a negative ROI if the "expected" return was 50%? What is the highest risk you would take with this expected return? You can plot that point on a graph. When you determine a few such points at various returns, draw a "risk/return boundary" (see chart, below).
- Calculate the risk. Pretend I'm willing to sell you a certificate worth $100 if the project has a negative ROI. How much of your own money would you pay? Take into account your faith in the estimates of costs and benefits, as
well as the chance of cancellation. The highest price you would pay indicates what your intuition says is the risk of a negative return. For example, paying $35 indicates a 35% risk.
- Determine the required return on investment. Compare the chance of a negative ROI from step 3 to the graph you made in step 2. What "expected" return did you say you would require to make that risk worthwhile?
Most IT managers I have surveyed say they would require an expected return well over 100% for a big investment with a 30% chance of a negative ROI. But 30% can be the chance of project cancellation alone. Even if the project isn't canceled, there is still the chance of a negative ROI.
This exercise is no substitute for a complete risk/return analysis. But it may lead you to rethink the viability of proposed projects.
Douglas W. Hubbard is director of applied information economics at
DHS and Associates in Rosemont, Ill. He can be reached by E-mail at
dhubbard@dhsassoc.com
.
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nformation technology is a risky investment. Organizations launch big IT projects with much uncertainty about benefits and costs. More than 90% of IT projects go over budget, and more than one-fifth are over by at least 100%. It's not even sure the project will be finished.
