The e-comm ROI squeezeIT could be shouldering more than its share of e-commerce costs. Here's how to protect your budget. By Joanne Cummings
When it comes to analyzing the return on investment for e-commerce initiatives, most organizations either don't do it, or don't do it right. "In IT, especially when you're on the leading edge, there is an inherent business instinct that you have to have - a gut instinct. And sometimes, ROI just doesn't fit in," says Larry Blazevich, vice president and CIO at Sigma-Aldrich, a St. Louis manufacturer of research and specialty chemicals, and last year's recipient of Network World's E-comm Innovator of the Year Award. Sigma-Aldrich did no ROI analysis prior to its foray into e-commerce, and it's not alone. According to a summer 2000 study by research firm IDC, as many as 50% of 650 Internet executives surveyed said they did no ROI analysis on their e-commerce initiatives, compared with just 33% who did and 16% who were unsure. As more e-commerce
initiatives go belly up, however, organizations are starting to
pay more attention to the bottom line. Unfortunately, determining
e-commerce ROI is not an easy process. First of all, companies often can't pinpoint how much new revenue a site generates. Did the site earn the sale? Or did it transact a sale that would have occurred anyway, via fax or phone? "We can track Web sales, but did they cannibalize other sales? Probably," Blazevich says. Traditional accounting rules also stymie e-commerce ROI analysis. IT has historically
been classified as a general and administrative (G&A) expense, or generic
overhead, as opposed to a cost of sale, explains Tom Mangan, a partner at Arthur
Andersen in Atlanta. The cost of sale would
include factors such as the salaries of the sales force and marketing expenses.
By subtracting the cost of sale from revenue generated, a company can figure
out the profit margin for any product or service. Worse still, IT winds up saddled with inflated expenses. "When you look at industry metrics, you see the companies that are moving heavily into e-commerce look as though their IT organizations are performing poorly. That's because their costs are artificially high," Mangan says. "They aren't linked to the sales coming in." The result is a squeeze on IT. "Ex ecutives hammer the CIO
to cut costs, while at the same time they like the margins they're
seeing on these new electronic sales and want more," Mangan
says. "That creates a lot of tension for an IT organization." Few IT departments can successfully assume the costs of e-commerce projects while also trimming expenses. Something has to change, and that change usually begins with better accountability. It's up to IT to ensure the company properly accounts for the costs - and profits - associated with e-commerce before it decides which projects get the green light. Some companies, such as Sigma-Aldrich, now have IT play a key role in determining
the profitability of new e-commerce initiatives. As CIO, Blazevich
sits on a steering committee that ranks the firm's e-business
projects by the dollars they would bring in. "If an initiative
is definitely going to generate more sales, then that goes to
the top of the list," Blazevich says. "No. 2 is hard-dollar
cost savings, where we'll actually save money. No. 3 is soft
cost savings, such as an improvement in a process or time savings." Other organizations seek to sidestep such accounting issues by funding e-commerce projects entirely outside the IT budget. J.L. Hammett Co., an educational materials retailer in Braintree, Mass., pays for its e-commerce initiatives via sales of advertising and promotions. "From the marketing side, we tell our suppliers that this is new, extended exposure for them," CEO Rick Holden. says. That exposure includes additional advertising or promotions for the supplier's wares and an opportunity to interact with the supplier's ultimate customers, teachers, "and they pay us for that." Holden says the company has so far met its goal of keeping the advertising and other payments offsetting or exceeding development costs. Not only does the site eliminate paper and the costs associated with paper, but it also enables the firm to cut its reliance on temporary help used during the company's busy summer season. "With more of our customers online, we've been able to drop the temporary workforce," Holden says. That change saved the hard costs involved in paying hourly wages, and the soft costs involved in scheduling and training an ever-changing workforce that was often reluctant to learn or even show up for work. But for every J.L Hammett, there's a company that gets blindsided
by sales costs. Some diligently weigh IT costs for e-commerce
projects against the benefit of a reduced sales force or the elimination
of field sales offices, and the result is an attractive ROI. Unfortunately, in most cases those salespeople and offices never go away. The company may balk at reducing the sales force, citing customers who still require hands-on service, or decide field offices are needed for team-building or other reasons. "You're stuck paying double infrastructure costs," Arthur Andersen's Mangan says. "And those costs tend to eat up any benefits associated with the e-commerce initiative." Other
companies perform ROI analysis solely on initial development of
a Web site that simply takes orders, while neglecting ongoing
costs associated with integrating the site into the business.
These companies "realize the site won't be fully integrated with the back-end systems, order fulfillment and so on, but that is something they plan to do in Phase 2," Mangan says. As an interim measure, they hire temporary administrative staff to take the Web orders and enter them into the back-end systems. But once the costs in G&A start climbing, the IT department can no longer afford to do Phase 2. "Now it's stuck because it has this army of administrative people who become permanent employees, and all ROI goes right out the window," Mangan says. Mangan says a good way to ensure the costs of e-commerce don't outweigh the benefits is with a practice known as activities-based cost accounting. Activities-based costing directly assigns all costs associated with an initiative to the cost of the products being sold. Within e-commerce, this means IT costs now buried within G&A are broken down and assigned to the cost of the product sold via the Web on an ongoing basis. "With activities-based costing, organizations can see the true profitability of e-commerce and make an informed decision about ROI," he says. But IT people aren't accountants. "They don't need to be," Mangan says. "IT just needs to make sure the organization understands the true financial impact of bringing up this new distribution channel. A lot of companies have made a lot of money by having gut feelings, but you have to understand the impacts of the decisions. In the end, you have to make money at it." Cummings is a freelance writer in North Andover, Mass. She can be reached at jocummings@mediaone.net. Send this article to a colleague
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Prior
to e-commerce, this method made sense. But if a company keeps
e-commerce costs as part of the IT budget hidden within G&A,
the expense of e-commerce won't be reflected in a product's
operating margin. That makes products sold over the Web appear
artificially more profitable than products sold via traditional
channels. "The people in charge of those product lines don't
see the cost sitting in G&A," Mangan says. "And
they end up with a distorted view of profitability."
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