Private fixed investment in software – in plain English, spending on software – has grown by a factor of 51x since 1970 to $3.4 trillion in 2020 in the United States alone.
In this study, we explore a key driver of this trend:
What Is The Return On Investment (ROI) Of Information Technology (IT) Spending?
Fundamentally, businesses are rational and calculating. The business case and ROI must be very compelling to continually spend more on information technology.
Although an important macroeconomic topic – covering over $3 trillion in capital spending – studies exploring the ROI of IT are surprisingly rare.
ROI Of IT And Software Summary
Software vendors regularly commission 3rd party IT research analyst firms to develop quantitative ROI analyses of their software products. Cloud Ratings assembled a database of 234 ROI studies (all conducted in 2020 and 2021) to conduct this meta-analysis.
Software 3-Year ROI summary findings:
- Median ROI: 278%
- Annualized IRR: 41%
- Top Quartile ROI: 390%
- Annualized IRR: 57%
- Bottom Quartile ROI: 193%
- Annualized IRR: 24%
Translating this data, the business case for IT spending is quite strong: $1.00 invested today yields $2.78 in 3 years.
How Does The ROI Of IT Compare To Non-IT Capital Expenditures?
A 2014 J.P. Morgan study examined investment hurdle rates required by S&P 500 firms:
The median S&P 500 constituent requires an 18% ROI.
In this light, the 41% annualized ROI of software spending is highly attractive and 2.4x the typical required corporate hurdle rate.
Payback Period For Software And IT Spending
Our study also examined the payback period – defined as “the time required to recoup the funds expended in an investment, or to reach the break-even point” – when investing in information technology projects:
- Median Payback: 6.0 Months
- Top Quartile Payback: 4.8 Months
- Bottom Quartile Payback: 7.0 Months
How Does ROI Vary By Software Category?
Cloud Ratings’ study also explored investment returns at the product category level:
Categories with above-average ROI profiles:
- E-Commerce
- Sales
- Data + Analytics
- Collaboration + Productivity
- Marketing
Broadly generalizing, software product categories with a clearer relationship to revenue generation tended to generate somewhat higher ROIs while software serving “cost center” functions – like HR or Finance – generated lower ROIs.
The Cloud Ratings study also examined monthly payback by category:
Given the general inverse relationship between ROI and the payback period, these results were generally in line with expectations. For example, the Sales and E-Commerce categories again scored the best.
Notable payback outperformers included the Security, Communications, and Industry Specific categories, suggesting a faster time to value (offset by less upside in later periods).
Payback underperformers included the Data + Analytics and Collaboration + Productivity categories. Their slower time to value makes intuitive sense – both categories require a heavier upfront investment and adaptation period before realizing productivity gains.
How Does ROI Vary By Customer Size?
Using the publicly available customer review mix of each software product in the 234 ROI report database, Cloud Ratings classified each product into 1 customer size. As an example, a product with a review mix of 20%/20%/60% Small Medium (SMB) / Middle Market / Enterprise would be classified as “Enterprise.” 1
Why might SMB software customers enjoy the highest ROIs? We theorize:
- “Law of Small Numbers” – a social media scheduling app that saves the sole marketer 15% of their time at an SMB actually moves the organizational productivity needle.
- “One Size Fits All Pricing” – for go-to-market (GTM) efficiency, SMB-focused SaaS vendors tend to adopt self-serve, standardized pricing. Further, these price points are set to offer a sufficiently attractive return to even the smallest customer, allowing medium and larger SMBs superior ROIs. The case of online accounting software is instructive: while a 4-employee and a 47-employee firm pay the same $30/month for Xero or Quickbooks Online, the 47-employee firm – with a far higher number of accounting transactions – is likely to generate a higher ROI.
Conversely, the greater prevalence of bespoke and value-based pricing models for Middle Market and Enterprise customers – whereby software vendors leave “less money on the table” – might explain the comparatively lower IT ROI. Furthermore, Middle Market and Enterprise customers might already be more efficiently managed than SMBs, leaving less “low-hanging fruit” for software to address.
Cloud Ratings also examined the monthly payback by customer type, with no notable exceptions from the ROI results – once again, SMBs scored most favorably:
What Software Vendors Use ROI Reports?
The ROI study database was heavily weighted toward large, category-leading software vendors:
Of the 234 studies analyzed, the product and customer size representation were in line with expectations:
- Product Category: Products with higher complexity – like Development + IT Management, Security, and Data + Analytics – were more heavily represented. Why? A more complex, innovative product will require the “math to be shown” more often than straightforward, mature software offerings.
- Customer Size: Products serving Enterprise and Middle Market were more likely to have an ROI study completed. Why? Larger deal sizes involving more deliberate organizations require a clearer articulation of business value than a self-serve purchase by an SMB organization.
Summarizing The ROI Of IT + Software
- Cloud Ratings’ meta-analysis of 234 software ROI studies highlights project returns above typical corporate investment hurdle rates
- Median 3-Year Total ROI: 278%
- Median Annualized ROI: 44%
- Median Payback: 6.0 Months
Our next post examines the underlying drivers – whether revenue lifts, labor productivity, enhanced security, employee retention, and more – of the ROI of IT.
Footnotes:
- Customer Size Definitions: Based on employee sizes: “SMB” = Less than 50 employees, “Middle Market” = 51 to 1,000 employees, and “Enterprise” = greater than 1,000 employees.