Normalizing Bias in ROI Analysis

The decision to make a capital investment in a business should be subjected to an ROI(Return On Investment) Analysis where the cost and benefit of the investment are analyzed. The objective of the analysis is to see how fast the cost of the investment will return value and recover the investment in a reasonable time frame.  This can be an effective process but it can be compromised by the presence of proposal bias and lead the company decision makers to make a less than effective and financially responsible decision.

Normal ROI Interpretation Factors

Ideally the person or group preparing the ROI is objective in their analysis and will accurately identify all the associated costs required to select, implement, operate and service the investment not just during the pay back period but during its life as well.  Too often the sponsors of the investment prepare the ROI.  Accounting can check the math and verify that the company ROI process was used but are at a disadvantage verifying assumptions and claims regarding the performance of the equipment or systems and the beneficial impact on the business as to whether proposed savings will occur.

Depending upon the circumstances the ROI may be conservative or overstated.

  • Conservative: Depending upon company practice the sponsoring manager would rather have a conservative or low hurdle to perform against so that if a post implementation/payback-period ROI analysis is performed the analysis would show that the performance of the investment was favorable and the ROI was more than met.
  • Overstated: On the other hand, a sponsoring manager knowing that post implementation/payback-period ROI analysis is rarely performed then the manager would have the latitude to overstate the performance of the investment knowing that the likelihood of being held accountable is low to non-existent.

Future accountability is even more questionable for an investment meeting its ROI when the vendor proposes ROI with their proposal.  This is a common condition for small to medium sized businesses that may not effectively do their own ROI.

ROI and Bias

The most insidious factor in a capital investment and ROI is bias.  The bias of the sponsoring organization may affect whether the “best” investment is being proposed or considered.  This may be shown in a “blind” loyalty to a brand of equipment that is consistent with what the department is comfortable with but may not be as competitive as other equipment in the marketplace.  The same is true of software systems where bias may affect the selection of the software vendor, use of internal or external resources, efficiency of the system to reduce overhead or supporting higher throughput rates.  How do you eliminate bias in a complicated investment such as expensive equipment or complicated integrated business systems?

Normalization

Using an outside opinion is a practice that can normalize bias in major investments that:

  • Will require major capital expenditures over several years,
  • Result in major changes in the methods and processes that the company conducts current or future business or,
  • Proposes major departures from previous implementation practices.

If the investment is proposed internally then an outside (one or more) consultant(s) should be engaged to not just challenge the internal plan but independently look at the needs of the business and propose an independent solution and ROI for management to consider.  This allows senior decision makers to have two views of solving the same problem that they can then use to determine the correct investment course for the company.  This method can confirm the direction of the original proposal and validate the benefit claims.  On the other hand, an alternate opinion can open a new direction that was not considered that could offer a greater reward that required less investment and implemented sooner.

If the proposal comes from a vendor, then commission one or more inside sources to propose a solution to solve the same business need.  This approach may validate the vendor solution or provide the senior decision makers with fresh ideas and direction that could be more effective due to the detail knowledge and best perspective of the business that the internal resource had over the vendor who may have been using general industry knowledge in their solution and cost/benefit analysis.

Summary

Contrasting a primary proposal with another is the best way to normalize ROI bias.  Does this extend the decision process?  Possibly!  What is the impact of not making the best decision?  Going in the wrong direction or operating short of where the business could have been far exceeds the time delay and related cost to make sure you have the best information available to invest in your company and get the best return.

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