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How Much Confidence Should You Put in an ROI?

An ROI is a analysis tool. You use it as input for your business decisions.

Think of an ROI as a speedometer on your car—it doesn’t control how you drive but gives you one measurement that will influence how you drive.

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It’s reassuring to look at the numbers and pick the answer based on what the numbers say. (“Case A says we gain 500 ducats, and case B says we gain only 450 ducats. Clearly we go with Case A.") It seems very objective. All the subjectivity seems to have been driven out.

But my experience in dealing with good businesspeople is that ROI calculations are a guide and a double check for making good business decisions—not the other way around.

I know this sounds backwards at first. But I observe that good businesspersons don’t simply follow where the numbers lead, positively or negatively. They know that the numbers are important, but they also know that there is a certain amount of subjectivity in even the most objective-looking numbers. Even if the ROI analysis says that you’ll get one hundred ducats for every ducat you invest, that’s a prediction, not a guarantee. Surprises can happen along the way to getting those one hundred ducats—predicted things might not occur, or unpredicted things might occur (war could break out, the stock market could crash, your key designer could be hit by a truck). An ROI analysis is a statement of what’s likely to happen, at a reasonable risk level. The risk cannot be eliminated completely. It might not work out the way the numbers seem to promise.

Besides the fact that predictions of the future don’t always work, ROI analyses are sometimes suspect because of the assumptions that went into calculating the numbers. Sometimes you’ll find that the expected profit of a million ducats is built on faulty assumptions that will in fact result in a profit of only a hundred ducats. Or you might find that faulty assumptions cause you to turn down a good business alternative that the ROI understates.

There are lots of pitfalls—but if you’re a successful businessperson, then you already know about these pitfalls. And you already know that making good business decisions is like making good bets at the race track. It’s important to do your homework and at least check the racing form. It’s even better, however, if you do your homework and also have a knack for picking winners.