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3. Determining Return On Investment (ROI) in the Public Sector

Determining Return On Investment (ROI) in the Public Sector

The following article is provided by the PMI GovSIG as part of collaboration efforts to enhance sharing of knowledge across all components.Government organizations, unlike the private sector, often do not have a choice on whether to initiate a project. Government agencies cannot assess their portfolio and promote or kill projects simply on the Return on Investment (ROI) or the value to the organization. Most public sector projects are prescribed either by law (e.g., parliament, legislature, congress, or other law-making body) or by political influence (e.g., protectionism, state vs. federal funding, or “my boss wants a better ‘so and so.’”) 

Return on Investment calculates the financial impact of the project, including its development costs, operating and maintenance costs, and financial savings.  The resulting calculation is then normalized to allow it to be compared with other project’s ROI calculations.

This is performed for two reasons:

Different agencies and authorities have widely varying appropriations. A high investment for one agency may be considered a negligible investment for another agency.

Most efforts by the public sector are not based on a commercial return.

Commercial companies develop products and services with the pri-mary intent of profit. The public sector develops products and services with the primary intent of providing specific value to its citizens - with no specific intent of profit.  Therefore it is seldom the case that the public sector receives any financial return for a product or service. 

In cases where the public sector does charge for products or services (e.g. Fishing Licenses), the charge seldom covers the cost of the product or service provided.  In point of fact, the private sector is not motivated to make a “profit” by charging its citizens for products and services.

In addition, many efforts by the public sector are funded by multiple levels of government (e.g., federal, state and local) and those funds may be contingent upon providing that product or service. In those cases a loss would occur if the product or service were eliminated, but no specific revenue (other than the Federal funding) is generated by providing the product or service.

COST/BENEFIT ANALYSIS

The cost/benefit estimate is a summary of key financial information found later in this document in the section titled Cost/Benefit Analysis. The estimate is a summary of the total cost of the project, and may include a total for individual key cost components, such as equipment, outside services and agency employee costs. It should also include measurable benefits such as reduced or avoided costs, and any revenue generated by implementing the project.

BUDGET CATEGORIES

The table that follows summarizes the financial costs and benefits of the project.  The table has four sections extracted from a series of spreadsheets that forecast costs, savings, cost avoidance, and revenue of the proposed project.  The sections include the following: Project Costs include agency and contractor labor, hardware, software, training, and other categories of direct or indirect expenditures for the project. The spreadsheet gathers detailed information about various categories of labor such as analysts, programmers, and network administrators. Only summary costs for hardware, software, and other categories are included, however. Detail schedules supporting the summary costs should be included in other project documentation.

Cost savings are defined as reductions in expenditures that will be achieved by the project. Such reductions can occur through staff reductions, consolidation of facilities, elimination of in software licenses, or other results that reduce current and foreseeable expenditures.

Cost avoidance is used to record potential expenditures or loss of revenue that will occur if the project is not successful or is not attempted. This includes costs such as fines and penalties, and loss of funding for agency programs.

Revenue generation describes additional sources of income that the application enables the organization to collect.

BUDGET SCORING

The budget is scored by a simple Return on Investment. It is calculated as the project costs minus cost savings, cost avoidance, and revenue generation . The resulting total is divided by project cost to get the Return on Investment percentage. This score is limited to +/- 150.

VALUE ANALYSIS

Without a profit motive, the public sector must identify the key values or “soft” benefits the project delivers to the agency, its customers or its citizens. Then, by scoring the values of each project, we can quantify the value the project provides. At a minimum we should be able to determine the relative value compared to other projects.

The value metrics are used to calculate a Return on Investment Value (ROIv) Score.  This score is a normalized system of evaluating a project by which:

Agency management and government leadership can assess the value of a single project

Agency management and government leadership can compare the relative values of multiple projects

Mandate lists any legislative mandates, either through statute or rule.  The mandate may be direct (e.g. legislation that specifically requires the creation of a software application) or derived (legislation that requires a program or effort, that the business case intends to fulfill through a project).

Agency Performance assesses factors of the project that enable the agency to perform its mission more effectively.  This includes ways the agency is able to deliver a mission-based service or prod- uct in a more timely fashion, enhance a mission-based product or service, offer a mission-based product of service that was not pre- viously available, simplify an existing mission-based product or  service, or eliminate an existing mission based product or service that is no longer viable.

Productivity Increase estimates factors by which the agency is able to deliver current mission based services or products with less effort, and less resources, or deliver more of the mission based services or products within the same time period.

Cross-Agency Collaboration collects information about how the project will provide the ability for multiple agencies to efficiently share the use of data or resources, eliminating duplication of effort (human or other resources) in such a manner as to better support the mission of all agencies affected.

Policies, Standards And Future Value assesses how the project abides by policies or standards in such a manner as to decrease risk, increase the likelihood of project success, product or service quality and maintainability.

Criticality evaluates how important the project is to the core mission and goals of the agency.

Value To Customer estimates the specific value the project delivers to Customers. Customers for a given project may be one or more groups of specific citizens (e.g. Medicare recipients, drivers, taxpayers), one or more groups of employees of a government agency (e.g. Accounting personnel who use the financial accounting application) or some combination of the two (e.g. State school financial auditors and school district superintendents).

VALUE SCORING

To weigh the contribution of various categories of value, the categories are scored according to the following formulas:

Mandate is scored zero or 150 where:

0 - The project has no direct or derived mandate

150 - The project is mandated

Agency Performance; Productivity Increase; Cross-Agency Collaboration; Architecture Standards and Future Value; and Criticality are scored from 0 to 10 where:

0 – The project provides no increase in value to the organization in this category or may have a negative impact to organization performance of its mission

5 – The project offers moderate increases in performance in this category

10 – The project may provide vast and obvious increases in organization performance, potentially an order of magnitude difference in organization effectiveness in the area where the project has impact

Value to Customer is scored from 0 to 5 where:

0 – The factor provides no value to the customer

5 – The factor offers substantial value to the customer

IMPACTS

Impacts are those results of the project which represent a fundamental change in existing processes, infrastructure or resource requirements for the Program area. Impacts may be positive, negative or neutral. Positive impacts are considered to be  Benefits.

The benefits of the project are the positive results of achieving the objectives.  Benefits are a direct result of completing project mile- stones or deliverables and meeting objectives.

Other Impacts are those results that are not positive results in achieving the objectives. These may include results that do not have specifically positive benefits but do represent changes in busi- ness processes or infrastructure or resource needs.  For example, the creation of a new program that provides functionality that the agency did not provide in any previous form may result in the need for additional employees to administer the program.  This does not represent a negative impact as these resources are incremental to the new services delivered by the program, however they are also not benefits, as the addition of personnel does not itself constitute a benefit.

Other impacts may also include any project results that are negative.  Negative impacts may include changes in business processes or infrastructure or resource needs that increase the cost or time to provide services and products without any specific increase in additional products, functionality or services to the agency.  An example of a negative impact may be the decision to perform a revision of a system to move to a newer architecture, resulting in the need for more administrative efforts to support that system. If the move has no other value in terms of cost savings or moving from unsupported or costly legacy infrastructure to more economical infrastructure, then the negative impacts of the effort in this example may ultimately outweigh the positive benefits of moving to the new infrastructure. Though the move to the new infra- structure may have a net positive benefit, the additional administrative efforts resulting from that move would be a negative impact.

RETURN ON INVESTMENT SCORE

Since the financial model for the public sector is not a profit based model, the calculation for return on investment has only three well defined cases and a range of less well defined cases.  The well- defined cases for Return on Investment are as follows:

SCENARIO 1 – LOW INVESTMENT AND HIGH POSITIVE RETURNS

There may be few cases where the public sector creates a product or service at a low investment cost and achieve a high return. These cases are very rare in the public sector since highly profit- able efforts would likely be considered gouging by the public sector (e.g. if the public sector charged $100 per student for citizens to take the GED examination) and in any case, excess revenues would be returned to the General Revenue stream.

Nonetheless, this case would represent a maximal positive value for Return on Investment.

SCENARIO 2 – HIGH INVESTMENT AND HIGH NEGA- TIVE RETURNS

This case might be termed a “sinkhole”, where, for example, for every dollar of investment in the effort, the public sector would lose two dollars.  This case would represent maximal negative value for Return on Investment.

SCENARIO 3 – ANY LEVEL OF INVESTMENT AND NO RETURNS

This is the most typical case for public sector projects, where the public sector invests to provide a product or service and achieves no revenue for that product or service.  This case would represent zero return on investment.

Note: Other cases of ROI will fall between these three cases, but it is likely that most cases would be no return and those cases that provide returns or have negative returns would not be at the extremes.

RISK ANALYSIS

Because we have developed a score that is based on “soft” values, we must, of course, communicate the risks associated with the project. Again, we quantify the risks that executive management should be aware of.

RISK CATEGORIES

The table that follows is extracted from a series of spreadsheets that quantify the following categories of risks

Agency Risks are those risks are due to the agency or state organizational structures or policies. For instance a project may not have adequate upper-level management support, or may not directly support core agency missions or goals.

Customer Risks are those risks due to customer characteristics such as training or education level, inability to use the application, and other factors.

Project Risks are risks inherent in executing any project, such as lack of resources, lack of planning, inappropriate monitoring, lack of scope control, and other key factors

RISK SCORING

Risks are scored on the following scale:

0 - No risk for this factor

1 - Low risk: There is some risk for this factor, but the risk has minimal impact, is well understood and easily controlled through proven, previously used remediation techniques

2 - Medium risk: There is significant risk of impacting the schedule, budget, or success of the project, but the risk is well understood and controlled through proven, previously used remediation techniques

3 - High risk: There is a high likelihood of this risk impacting schedule, budget, or success of the project and the risk cannot currently be mitigated.

The risk totals are normalized and limited so that they fall within a range of 1 to 10, from lowest to highest risk.

COMMUNICATING THE ROI

The purpose of the Business Case is to provide management with the necessary information about this project to enable them to effectively determine whether to approve it as a formal project.  This section is a concise statement of a business problem faced by the customer.  The business problem statements should be as descriptive as necessary to thoroughly describe the problems from the user’s perspective.

METHOD OF FINANCE

Of course, projects are not simply paid for out of General Revenue. The Method of Finance describes the source of funds, whether that is a specific budget object, capital item, federal funding, revenue generated, or other source. The Method of Finance also describes the terms of that source of fund; for example, how many months the funding is avail- able (Federal funds typically span multiple years, whereas agency funds may be available only within a fiscal year or biennium).

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