Should You Trust The Vendor's ROI Calculator? That Depends ......
Colin Thompson
Managing Partner Cavendish/Author/International Speaker/Mentor/Partner
The internet is awash with vendor-produced ROI calculators, as you know well if you are currently shopping online for IT systems or other costly assets such as vehicles, production machines, or lab equipment. These calculators also appear when vendors deliver projected Return on Investment (ROI) and Total Cost of Ownership (TCO) results along with the sales proposal. Many vendors seem to believe that closing a sale depends on their ability to show customers attractive ROI and TCO figures.
The immediate questions for customers, of course, are these:
Ø Should we trust the vendor's ROI figures?
Ø Will we really see these results?
To answer for your own situation, look first for the source of "returns" in the vendor's ROI figures. Unfortunately, most vendor-produced ROI figures--most sales support ROI calculators--know only one kind of business "return" or business benefit: cost savings.
In fact, investments in costly assets can bring many other kinds of business benefits besides cost savings and these can be large and real. But do not expect to see them in most vendor-produced ROI figures.
Moreover, you should also know that not all mathematically produced "cost savings" even represent the value they claim to have. (For more on business benefits besides cost savings, see `Business Benefit in the online encyclopaedia. For in-depth coverage and benefit examples, see `Business Case Essentials` - details below.
The issue/problem has to do with the most frequently found kind of cost savings in vendor-produced ROI figures, namely labour savings.
A Simple Formula for Cost Savings: The Math Always Works.
Many vendor-produced ROI tools and templates rely on a formula that is used everywhere in business case work: Benefits = (labour saved) * (the cost of labour).
The formula is understood by everyone, including vendor marketing and sales people who want you to see cost savings in their proposals. The value of benefits established this way stands on a seductive, compelling logic. Should you claim these savings as "Benefits" in your `business case`? The best answer is: Maybe, maybe not.
A software vendor claims that a new ERP system enables 6 people to do the work done now by 10. If each person costs the company £50,000 per year, what is the annual value of the savings?
Some people immediately say: It's a no-brainer! Four times fifty thousand is two hundred thousand pounds (any currency)! Before rushing off to sign the purchase contract, and cutting £200,000 from next year's operating budget, however, the wise decision maker needs solid answers to two questions.
1. Do Labour Costs Even Belong in This Business Case?
This can be a show-stopping question during an ROI or business case review if the presenter has not prepared for it. "Why," the critic asks, "count the value of employee labour? All 10 people will still work here whether we buy the ERP system or not, and all 10 will continue to draw salaries and benefits." Labour costs for these 10 people either do or do not belong in the business case depending on the purpose of the case.
Ø Some cases are built purely to answer planning questions such as, "What should we forecast as next year's operating budget? If the case is built for planning purposes, and if the employee headcount has nothing to do with the proposed action (acquire the ERP system), labour costs are irrelevant for the purpose. (However, labour costs for set up of the new system are relevant because those costs will be impacted by a decision to acquire).
Ø Some cases are built either partly or fully to address decision support questions, such as these: "Should we purchase and implement the ERP system? Is the acquisition a good investment? Or, are we better off investing the same funds elsewhere?"
In this case, labour costs may be relevant if they are impacted by a decision to acquire. Here, the analyst takes an investment view of the action, which means expected investment returns are compared to resource costs the company spends in taking action. Employee labour for specific tasks will indeed be impacted by a decision to acquire (even though the total employee headcount is not affected).
2. Do mathematically produced labour savings add real value?
Even if there's no doubt that 6 people will soon be as productive as 10 are now, it's still too early to take the $200,000 savings to the bank. The case builder must show that the "freed up" produces value in another way.
In the worst case, four full time employees simply sit idle after acquiring the new system. In the best case, they will be given other work, contributing just as productively as they did before. In that case, the legitimacy and value of the £200,000 cost savings benefit is established.
If you have ever tried to "prove" the value of labour savings in this way, however, you will not be surprised to hear that the simple formula above is not always so easy to present credibly. The problem is that the formula assumes that "cost of labour" is the same as "value of labour," in order to give meaningful value to the calculated "Savings." That assumption should always be questioned. To apply the math blindly is to risk seriously overstated benefits.
The Elusive Value of Time at Work
Sometimes the value of each hour and day of employee labour saved is easy to measure. Every hour, assembly line workers build a certain number of products, call centre operators handle a certain number of calls, and automobile mechanics accomplishes a certain number of repair tasks. The same cannot be said, however, for the large part of the professional work force that might be called as knowledge workers--and their managers.
To experience the problem first hand, I suggest you try using one or more of the online "ROI calculators" that seem to turn up in abundance on technology vendor web sites. You can easily find scores of these by searching Google for a vendor name (e.g., Microsoft, SAP, or IBM) along with the phrase "ROI Calculator." One of these tools (from a well-known vendor that will not be named here) estimates "ROI" for upgrading to the latest PC operating system release. "Returns," moreover, are estimated as cost savings, based on estimated productivity gains, which can be "...up to 6 days per user per year."
Try calculating those gains for just one user--yourself--by multiplying your daily salary by six! Or try estimating the gains for your organization by multiplying the average daily salary by six and then multiplying by the number of users. The result is no doubt many thousands of dollars, pounds, or euro (Any Currency). Clearly the upgrade pays for itself!
Or Does it?
Will you really see those savings in terms of cold cash? Six days salary is a large figure, but the time savings come across approximately 240 work days or more. On average that it is 2.5% of an 8-hour day, or 12 minutes a day.
Granting the vendor the benefit of the doubt, that you really will have save 12 extra minutes a day free if you make the upgrade, you have to ask if those 12 minutes are really going to translate into productive value for your company or organization. As for myself, given an extra 12 minutes spread throughout the work day, I'll probably get an extra cup of coffee or straighten my desk top once more.
When you find time savings like this, and when you assume that the value of labour time equals the mathematically-derived cost of labour time, you can always apply the simple formula above. But are you really confident you can take these "thousands" to the bank? What about the savings in your own business case, based on the same formula and the same reasoning?
I'm not suggesting cynicism here, just healthy scepticism. The cost of labour time and the time savings themselves may be relevant for your business case and they may be easy to measure. However, it is still up to the case builder to show, in one way or another, that the freed up time will be used productively, and then to present a reasoned argument showing why the extra time should be valued at either 100% of cost, 0% of cost, or some other percentage in between. (For examples and more in-depth coverage, see one of our books, such as `Business Case Essentials` - details below.
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About the Author Colin Thompson
Colin is a former successful Managing Director of Transactional/Document Manufacturing Plants, Document Management/Workflow Solutions companies and other organisations, former Group Chairman of the Academy for Chief Executives, Non-Executive Director, Mentor - RFU Leadership Academy, Mentor - Coventry University, Mentor - The Chartered Institute of Personnel and Development, Business Advisor NHS Deanery, author/writer Business Advice Section for IPEX, Graphic Display World, News USA, Graphic Start, plus many others globally, helping companies raise their `bottom-line` and `increase cash flow`. Plus, helping individuals to be successful in business and life in general. Author of several publications, research reports, guides, presentations, business and educational models on CD-ROM/Software/PDF and over 4000 articles/reports and 35 books published on business and educational subjects worldwide. Plus, International Speaker/Visiting University Professor.
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email: colin@cavendish-mr.org.uk
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