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Your Risk/Return Profile

Explore risk/return profiles for ERDMS and Desktop Replacement investments. Analyze initial profiles to evaluate potential ROI, considering factors like IRR and project costs. Learn about quantifying risk aversion and defining risk for IT investments.

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Your Risk/Return Profile

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  1. Your Risk/Return Profile

  2. Objectives • Review Findings-to-date for ERDMS and Desktop Replacement • Capture the initial “Risk/Return Profile” to be used to evaluate the investments

  3. 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

  4. 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

  5. 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

  6. 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)

  7. 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%

  8. 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%

  9. 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

  10. 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

  11. 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)

  12. 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).

  13. 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.”

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