A Cautionary Note on ROI

I read a great couple of paragraphs on Fred Wilson’s blog. Fred is a Venture Capitalist who is used to making big bets on the internet and the companies that look to capitalise on it. He was writing on business sustainability and how the purpose of business is not to maximise profit but to maximise the length of time it is in business. Here’s a quote on ROI that is a refreshingly accurate and thorough alternative perspective, especially compared to social media “gurus” who ask about the “ROI of putting on your pants in the morning” or “the ROI of your telephone”.

You own a business that operates on the web. You are a leading supplier of ecommerce to a vertical market. You generate $50mm in annual revenues and make a profit of $5mm a year. You see the launch of the iPhone and Android and think that your customers are going to want to connect to your business via their mobile phones. You ask your VP Product to scope out what it would take to build a comprehensive set of mobile apps that will allow this. She tells you it will take an investment of $5mm over two years to complete this project. You gulp. That is going to reduce your profits by $2.5mm a year in each of the next two years. What do you do? You make the investment because you must invest in the long term success of the business even though that is not a profit maximizing event. It may simply get you back to the $5mm per year of profits you were making before. There may be no ROI on this investment in a positive sense. It may simply be a defensive investment. You still need to make it to ensure you will be around for the long run.

Clay Christensen talks about this kind of thing all the time. Big company executives are asked to calculate an return on investment (ROI) on the investments they want to make. If the ROI isn’t greater than some minimum hurdle, the company doesn’t make the investment. And so along comes a smaller competitor who makes the investment and they eat the big company’s lunch.

ROI is not the right framework for companies to evaluate investments. ROI is for the wall street folks. They will use it to decide if they want to invest in your company. But when you make investment decisions in your company, don’t use the tools that wall street uses. Use the tools that animals use. Survival instincts. What will it take to ensure that your company is around in ten years, fifty years, 100 years? That’s how to think if you want to stay in business.

The whole post is great reading: How to be in Business Forever

Its pretty hard to challenge an established client with stuff like this when you’re being asked to defend the ROI of a programme but you can see that organisations that try new things and disrupt their own way of doing things, do get a lot of benefit and value from them. Perhaps you can’t measure the success today but if you are investing in your future, the measurement is binary – are you still in business, or not?

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