Measuring the true impact of IoT

The decision to invest in IoT, explore the space and start a project, is necessarily based on the presence of a solid business case that would ensure a Return On Investment in a reasonable time frame.

In the traditional IT space, Return on Investment is one of the more difficult factors to accurately calculate: hat is initially a good investment may, as time progresses, dig deeper into the budget or result in unplanned indirect expenses. Plus, many factors will alter outcome over the course of a project lifecycle: an example that impacts most IT departments is software that is bound to a specific platform or has limited interoperability. If another technology proved to offer better value, would you be able to cost-effectively adopt it?

The first step to combating this is to begin every major technology initiative with a build vs. buy ROI analysis. The "buy" option should encompass consideration of both acquiring an existing solution and outsourcing the build process. There are less-than-obvious ROI implications that need to be addressed with each of these route

In the IoT world, the type of ROI is different based on the specific use case, industry segment and geographical region, however there are some universal drivers that can help break down the business case and justify the IoT investment.

Measuring impact

To measure the impact of the Digital Transformation, many industry experts use the well known metric of Return On Investment (ROI), that is defined as the ratio between the net profit and cost of investment resulting from an investment of some resource. The problem with using ROI for IoT, is mainly due to the fact that it considers almost exclusively capital expenditure (CAPEX) as matter invested, while in IoT funds are typically "risked" and expensed in the current period (operational expenditure or OPEX), and they include additional types of resources and company focus.

With this in mind, it becomes clear that while ROI is definitely a great way to evaluate the efficiency of an investment, it's way less of a good indicator of an investment's effectiveness.

More promising - as it considers operational funds risked for achieving goals - is another indicator used to asses the effectiveness of investments in marketing and PR: the Return On Marketing Investments (ROMI). ROMI measures the contribution to profit attributable to marketing (net of investment), divided by the marketing 'invested' or risked, or in other words, how much revenue a marketing campaign is generating compared to the cost of running that campaign. Marketers are driven to connect their time, energy and advertising spend with results that contribute to company growth, so this KPI answers the question, “are we recouping the time and money we spent developing and executing our marketing campaigns?”

ROMI comes also with some challenges, one being that, despite the quintessential importance of marketing ROI, it can be difficult to measure and monitor. Measuring the "investment" side of the equation is typically straightforward, you track hours spent planning and executing marketing campaigns, and dollars spent securing advertising space online and offline. But measuring returns on a marketing investment is more complicated as the are multiple types of returns you can get: a marketer might target "top of the marketing funnel" returns such as increased brand mentions online, or new website traffic. They may be interested in driving more leads through the middle of the funnel, by targeting new trial starts or new newsletter subscriptions, for example.

What drives IoT adoption

IoT has the same challenges, if not more, as marketing: impact is measured on multiple returns, mostly because IoT itself is adopted to address more than one opportunity. Let's see, then, what are the main drivers that push enterprises to adopt IoT.

Brand 

IoT, like any other Digital Transformation journeys, is an opportunity for a company to change the way they frame their mission and consequently, change the way they are perceived by their customers. IoT is also synonym for innovation, universal value for brand that need to stay ahead of the curb to be perceived as leaders (or, in the case of underdogs, better alternatives) 

New Revenue 

A key driver for IoT adoption is unlocking new opportunity to generate new revenue, using insights from monitored devices for upselling/cross-selling purposes. An example is increasing revenue from spare parts by dynamically identifying – through telemetry data and analytics – wear and tear of critical components of a connected device. 

New Business Model 

Perhaps the most renown reason to embrace IoT is its ability to support the adoption of a servitized business model: tracking device conditions and usage in real-time, manufacturers are able to stop just selling devices, but start selling, as-a-service, the usage of such devices. A famous example is Rolls Royce, who stopped selling jet engines and started selling “hours of thrust”, dramatically increasing operating margins thanks to precise and continuous usage monitoring.  

Cost Reduction 

As important as creating new business models, IoT is critical in reducing operational cost of manufacturing, using and replacing monitored equipment. Leveraging data from connected devices it becomes possible to derive useful insights that can be then used to optimize their usage, identify inefficiencies and take adequate actions (programmatically or mediated by operators) in real-time. 

Cost Control 

Being able to meet cost target is almost equally important as reducing general cost: IoT is critical in cost control as it enables to leverage historical data, elaborated with ML algorithm and augmented by other business insights to predict device-related KPIs and help create more accurate cost forecasting. 

Compliance 

In many environments, from manufacturing to healthcare, regulatory compliance is one of the most important aspects of the entire process: failing to comply often leads to disastrous outcomes. Leveraging IoT makes simple and cheap to generate, store and access compliance-related data, to map processes and help operators remain compliant. 

A new indicator for IoT: Return on IoT Adoption (ROIA)

With such diverse drivers, it's clear that a traditional ROI - or even a ROMI - model would not work for IoT. If this wasn't already complex enough, there's also the investment factor: in the majority of transformational journey, investments tend to be either based on capital expenditure (CAPEX) or operational expenditure (OPEX); in IoT we actually see more often an hybrid model, with investments that have both a CAPEX and OPEX component.

With these factors in mind we can start shaping a simple formula: the overall return, in terms of all up value, of an IoT investment for Digital Transformation is informing an index that we will be calling Return on IoT Adoption (ROIA). It looks like this:

Where:

• "Incremental value generated by IoT" is the key factor, and it's meant to be a function of the drivers of IoT adoption, one or more among the aforementioned: brand, new revenue, new business model, cost reduction, cost control and compliance;
• "Operational cost of running IoT" is the gross cost of operating the IoT deployment, including software licensing, cloud (or infrastructure)
• "Initial investment" is the main differentiator of this index: as you can see it's the only element in the function representing a point in time cost, whereas all other factors are recurring cost and/or revenue. This is meant to factor the impact of initial investment in an IoT project: if it is sufficiently low compared to cost and/or value and/or planned duration that it makes business sense

Numbers?

At this point the key is quantifying the impact of the "Initial investment": fomer IDC Vice President and IoT Analyst Joe Barkai suggested an interesting approach in a recent blog post, using a methodology well known in management, real option:

Real options method considers the initial technology inves-t-ments, such as creating a proof of concept, a prototype or a pilot project, as enabling multiple options of future growth. This investment forms a foundation to realize future benefits from subsequent deployments and redeployments of that technology or its derivatives. [...] When using real options to evaluate a technology investment, the cost of the initial investment is the “price” paid to obtain the set of future options. Each follow-on project is evaluated separately as a different option.

And this is the interesting consequence: decisions and choices made this way grant companies the greatest amount of flexibility and potential benefit in regard to possible future decisions or choices.

What I like about this is that this way the ROI calculation becomes ultimately ascribable to something is taught in every business school: quantification of risk.

Business risk include strategy definition, investment decisions, product development, marketing and competition. The formula for measuring business risks is the opportunity cost formula, which represents the value or cost of a business activity calculated in relationship to the value of a second alternative. Something that look suspiciously similar to our ROIA.

Disclaimer

What's above represents my personal opinion and not the opinion or policy of any of my previous or current employer. The facts expressed here belong to everybody, the quotes, statements and images belong to their respective authors, the opinions to me. The distinction is yours to draw.