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Your Risk/Return Profile. Objectives. Review Findings-to-date for ERDMS and Desktop Replacement Capture the initial “Risk/Return Profile” to be used to evaluate the investments. Desktop risk plots. 30%. 3. 25%. 20%. 1. Chance of a negative IRR. 15%. 2. 10%. 5%. 0%. 0%. 20%. 40%.
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Objectives • Review Findings-to-date for ERDMS and Desktop Replacement • Capture the initial “Risk/Return Profile” to be used to evaluate the investments
Desktop risk plots 30% 3 25% 20% 1 Chance of a negative IRR 15% 2 10% 5% 0% 0% 20% 40% 60% 80% 100% 7 Year Expected IRR Initial Desktop Risk/Return • 3 year replacement cycle; $29 million • 4 year replacement cycle; $11 million • Initially accelerated “catch-up” followed by 4 year replacement cycle; $49 million
Initial ERDMS Risk/Return • Full ERDMS; $67 million • Various ERDMS Light options are a negative return, but will probably have a viable risk/return position when the information value of a pilot is considered ERDMS risk plots 60% 50% 1 40% Chance of a negative IRR 30% 20% 10% 0% 0% 20% 40% 60% 80% 100% 7 Year Expected IRR
Inputs Administrative Cost Reduction 5% 10% 15% % Improvement in Customer Retention 10% 20% 30% Total Project Cost $2 million $4 million $6 million ROI -50% 0% 50% 100% Distribution-based ROI
Analyzing the Distribution ROI = 0% “Expected” ROI Risk of Negative ROI Probability of Positive ROI The “cancellation hump” -25% 0% 25% 50% 75% 100% 125% Return on Investment (ROI)
Various Risks & Returns Low Expected Return High Expected Return High Risk -100% 0% 100% 200% -100% 0% 100% 200% Low Risk -100% 0% 100% 200% -100% 0% 100% 200%
Quantifying Risk Aversion • Your level of “risk aversion” is captured in a risk/return profile chart Risk Investment Region 40% Acceptable Risk/Return Boundary 30% Probability of a negative ROI 20% 10% Return 10% 20% 30% 40% 50% 60%
Decision makers seem to “catch on” to this right away The risk/return boundaries are consistent with non-IT investors 50% Risk Boundaries for IT investments in the range of $2-3 Million (initial outlay) 40% Region of Unacceptable Investments 30% 20% Region of Acceptable Investments 10% 0% Expected IRR over 5 years 0% 50% 100% 150% 200% 250% 300% How Risk Averse are You? Example profiles from 7 actual decision makers Chance of a negative IRR
Example of Risk Effects • These are real IT investments of $2M-$3M plotted against a client’s investment boundary • The 27% ROI investment is actually preferred to the 83% ROI investment 50% Region of Unacceptable Investments 40% 30% Chance of a negative IRR 20% Region of Acceptable Investments 10% 0% 0% 50% 100% 150% 200% Expected IRR over 5 years
Defining Return • The “Objective Function” may be defined as ROI, NPV, EVA, Shareholder value or any other measure you think is relevant • The Internal Rate of Return (IRR) method for computing return is common • We need to specify the timeframe to compute this value (5 years is common)
Define Risk • The definition(s) of risk used by AIE are much closer to what actuaries mean by risk than other methods • We should define a risk as: A certain probability of a specific undesirable outcome (loss) • The exact “undesirable outcome” can be unique to the organization - the important thing is to be precise and consistent (so all investments can be compared on the same basis).
Example Risk Definitions: • “The percent chance of receiving a negative return on investment (ROI).” • “The chance of losing more than $1,000,000.” • “The chance of receiving an internal rate of return (IRR) below the ‘risk-free’ return.”