There's more to ROI than meets the "I"
Promises of quick payback never fail to grab management's attention. But when it comes to selling your great idea, don't underestimate the power of the "soft" returns.
Ten years ago, Sandford Grossman says, a project manager's job was much easier when it came to getting a new venture under way. In those days, he'd basically decide what equipment he'd need, run his request through a brief approval process and set the acquisition in motion. Today, however, it's a far different story. Before they get even preliminary approval, managers can expect to field a lot of questions about the project's expected payback period. And that's not just true of private corporations. Nowadays, even the federal government demands to know what sort of return on investment (ROI) each project will bring.
Take the assignment Grossman was recently handed: choosing a new warehouse management system (WMS) to replace legacy software at the Herndon, Va., distribution center run by SOC Enterprises. (SOC Enterprises, where Grossman works as a project manager, is the literature distribution arm of the government's Agency for Healthcare Research and Quality.) Besides figuring out which WMS fits best with the agency's enterprise system and material handling design, Grossman and his consultant, Ernie Schell of Marketing Systems Analysis, found they had another non-negotiable requirement to meet: the software they chose would have to pay for itself in three years (a requirement that was later trimmed to two years).
It's not that Grossman doesn't appreciate the need to make the ROI case. "When you can put the dollars and the time for a project to pay for itself in front of management, [that] takes the bite out of it," he says. Still, documenting the projected financial benefits of a new WMS hasn't been easy. What has helped, Grossman says, is that he's been able to identify all kinds of compelling "extras"—additional benefits that don't necessarily factor into the ROI equation but nonetheless bolster his case. For starters, he's been able to convince management that a new WMS will allow the facility to use its labor better and increase its through put. "It also gives us a great deal of upward mobility, such as RF, inventory control and greater operating efficiencies," says Grossman. These kinds of benefits are tough to quantify, which means they rarely make it onto the official spreadsheet. But they still can have a significant impact on a project's return.
ROI's still king
In 2005, it seems, obtaining approval to buy technology or equipment has become a numbers game. "Companies are tightening the belts on what they spend on new equipment. They're investigating their options more [thoroughly]," says David Kumle of DLK Consulting in Kirkland, Wash. "Return on investment remains the driving force of any project."
For a lucky few, it's a slam-dunk. Take, for example, a regional LTL trucking company in Wisconsin that loads 90 to 95 percent of its freight using forklifts. Several years ago, a manager noticed that the trucker's customer billing failed to reflect actual weights and recommended that the carrier invest in 20 forklift scales that would allow it to bill more accurately. Given that the projected return could be measured in days, not months (the scales paid for themselves in only 45 days), his recommendation sailed through the approval process, reports Marc Mitchell of Enterprise Information Solutions, a company that served as a consultant on the project.
But most managers don't have it so easy. Often, the more compelling case is not to be found in the "hard" (quantitative) returns, but in the "soft" (qualitative) benefits. "You have the hard economics, which are shown in a quantitative analysis, but then you have a qualitative analysis. How is this going to [improve] our customer service? Is this option going to be easier to implement?" says Dale Harmelink, a partner in Tompkins Associates, a supply chain consulting firm based in Raleigh, N.C.
Typical qualitative improvements include better labor utilization, ease of training and improved accuracy. For example, a new storage project might result in better cube utilization, a smaller footprint or easier access to product. Installation of a new transportation management system might lead to improved freight billing, better route management and denser loads—all very real improvements, albeit tough to quantify. For that reason, the soft ROI is usually a "trust me" sell to management, says Mitchell. And though he doesn't discount the soft benefits, he recommends that project managers concentrate first on those things that can be more easily quantified. "You should make your decisions on hard ROI," he says. "Then if the soft comes, that's just gravy."
Running the numbers
Questions of hard or soft returns aside, how do you go about calculating ROI? A good place to start is with the software or equipment's vendor. An experienced vendor is likely to have a good idea of what kinds of returns its customers can expect. Once you have that estimate in hand, schedule a meeting with your corporation's CFO to determine how the company analyzes costs. You'll need to find out how it calculates projected tax rates, inflation, inventory carrying costs, labor costs going forward, salvage value, borrowing costs and depreciation. Depreciation alone can have a big impact on a project's ROI. For example, a rack-supported building that is considered to be equipment can be fully depreciated in as little as seven years—a fraction of the depreciation period for a traditional structure.
The ROI calculation should include both initial investment costs and annual operating expense. Figure on spending 10 to 12 percent of the initial cost for ongoing support and maintenance, depending on whether support will be provided by the internal staff or by an outside contractor. If the project involves hardware, the calculation should also include a repair parts inventory as well as costs for storing those parts. If the project requires a software upgrade, be sure to include the cost of integrating the package into the legacy systems.
Above all, take the long view when you run the numbers. Companies whose calculations focus strictly on payback will get a distorted picture of the ROI. Instead, your calculations should reflect any savings that will continue to accumulate even after the software or equipment has paid for itself."It's not just how long it takes to recoup the investment," says Mitchell, "but how much you'll save after the investment is recouped."
Even the best idea will go nowhere if you can't provide the CFO with a clear idea of the project's payback period. But delivering a successful pitch is about more than just identifying the projected return; it's also about conducting a sound analysis and making a strong presentation. Here are some tips for getting it right from the start.
- Consider all the options. It's a rare problem that has only one solution. Make sure you consider all the alternatives. If you're looking for a new way to move products, for example, restricting your focus to conveyors could cause you to miss out on an excellent opportunity to use automatic guided vehicles. And focusing solely on a pick-to-light system to boost productivity could cause you to overlook a chance to try voice technology or an RF (radio-frequency) system. After you've weighed the advantages and disadvantages of each option, it's time to narrow the field to three or four possible solutions for more detailed investigation. Remember that your cost comparisons should include the cost of operations if they were to remain unchanged and, if applicable, the cost of outsourcing the task under review.
- Plan for the future, not for the present. "Don't box yourself into a corner. You need flexibility if your business or customer requirements change. Make sure you have the equipment and space to adjust," urges Dale Harmelink of Tompkins Associates.
- Resist the temptation to take shortcuts. Be sure your presentation includes all the various options considered in your analysis, including the expected costs of each and the payback expected. Also point out how inaction or delayed action may affect future operations.
- Have your figures at hand. Review the full installation costs and offer recommendations for when any installation work should be performed. The last thing you want to do is cripple your operations by transitioning to a new system during peak season.
- Show how each proposal affects labor needs. Is the current staff sufficient to operate new equipment? Is additional training necessary? How much ramp-up time will be required for your operation to achieve peak efficiency?
About the Author
David Maloney has been a journalist for more than 35 years and is currently the editorial director for DC Velocity and Supply Chain Quarterly magazines. In this role, he is responsible for the editorial content of both brands of Agile Business Media. Dave joined DC Velocity in April of 2004. Prior to that, he was a senior editor for Modern Materials Handling magazine. Dave also has extensive experience as a broadcast journalist. Before writing for supply chain publications, he was a journalist, television producer and director in Pittsburgh. Dave combines a background of reporting on logistics with his video production experience to bring new opportunities to DC Velocity readers, including web videos highlighting top distribution and logistics facilities, webcasts and other cross-media projects. He continues to live and work in the Pittsburgh area.
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