Should You Believe the Vendor’s ROI Calculator? Maybe Not
The internet is awash with vendor ROI calculator figures.
You know this very well if you are currently shopping for costly assets. Vendors know that ROI and TCO are central in purchase decisions for large IT systems, vehicles, production machines, and lab equipment.
Vendors ROI Calculators in the Spotlight
Vendor ROI calculator figures are also center stage when they deliver customer ROI and TCO estimates along with the sales proposal. Many vendors seem to believe that sale closing will follow when they show customers attractive ROI and TCO figures.
The immediate questions for customers, of course, are these:
- Are the vendor’s ROI calculator figures trustworthy?
- Are the vendor’s TCO figures really comprehensive?
- Will we really see these results?
To answer for your own situation, look first for the source of “returns” in results from the vendor’s ROI calculator. Unfortunately, most vendor ROI figures—most “ROI calculators” for sales support—know only one kind of business “return” or business benefit. The only kind of business benefit most of these calculators know is 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 don’t expect to see them in ROI figures from most vendors.
Moreover, you should also know that not all mathematical “cost savings” even represent the value they claim to have.
The problem has to do with the most frequent kind of cost savings in vendor ROI figures, namely labor savings.
A Simple Formula for Cost Savings: The Math Always Works
Many vendor ROI tools and templates rely on a formula that turns up everywhere in business case work:
Benefits = (labor units savings) * (cost of the labor unit).
Everyone understands this formula, including vendor marketing and sales people who want you to see cost savings in their proposals. The value of such benefits 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 $80,000 per year, what is the annual value of the savings?
Some people immediately say: It’s a no-brainer! Four times eighty thousand is three hundred twenty thousand dollars! Before rushing off to sign the purchase contract, and cutting $320,000 from next year’s operating budget, however, the wise decision maker needs solid answers to two questions.
1. Do Labor Costs Even Belong in This Business Case?
This can be a show-stopping question during a business case review if the presenter has not prepared for it. “Why,” the critic asks, “count the value of employ ee labor? 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.” Labor costs for these 10 people either do or do not belong in the business case depending on the purpose of the case.
- 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), labor costs are irrelevant for the purpose. (However, HW, SW, and set up costs of the new system are relevant because those costs will be impacted by a decision to acquire).
- Some cases are built either partly or fully to address decision support questions, such as the following.
“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, labor costs may be relevant if they are impacted by a decision to acquire. Here, the case builder takes an investment view of the action, which means expected investment returns are compared to resource costs the company spends in taking action. Employee labor for specific tasks will indeed be impacted by a decision to acquire (even though the total employee headcount is not affected).
2. Do ROI Calculator Labor 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 $320,000 savings to the bank. The case builder must show that the “freed up” time produces value in another way.
- In the worst case, four full time employees simply sit idle after acquiring the new system.
- Under the best case, they will be given other work, contributing just as productively as they did before.
In the best case, therefore, the legitimacy and value of the $320,000 cost savings benefit is established. Under the worst case scenario the value of the time savings is $0. In reality, the legitimate value of the labor savings will probably fall somewhere in between.
Have you ever tried to “prove” the value of labor savings in this way? If so, you already know that the simple formula above is not always easy to present credibly. The problem is that the formula assumes that “cost of labor” is the same as “value of labor,” in order to give meaningful value to 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 labor saved is easy to measure.
- Every hour, assembly line workers build a certain number of products.
- Call center operators handle a certain number of calls.
- Automobile mechanics accomplishes a certain number of repair tasks.
The same is not true, however, for the large part of the professional work force, knowledge workers—and their managers.
To experience the problem first hand, I suggest trying the online “Vendors ROI calculators” that turn up in abundance on technology vendor web sites. You can 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 (an online ROI calculator from a major vendor who will remain nameless here) estimates “ROI” for upgrading to the latest PC operating system release. “Returns,” moreover, calculate as cost savings, using productivity gain estimates. These can be 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. Clearly the upgrade pays for itself!
It Pays for itself! Or Does it?
Will you really see those savings in terms of cold cash? Six days salary is a large figure. Remember, however, that time savings come across a year of approximately 240 work days or more. As a result, that savings is 2.5% of an 8-hour day, or 12 minutes a day.
Granting the vendor assumption that you really free up 12 extra minutes a day for 4 employees, then ask a fundamentally important question:
Are those 12 minutes are really going to translate into productive value for the organization?
As for myself, with an extra 12 minutes, I’ll probably just get an extra cup of coffee. Or, straighten my desk top once more.
When you find time savings like this, you can always assume and apply the simple formula above. But are you really confident you can take these “thousands” to the bank? Does your own business case show similar savings from the same formula and the same reasoning?
I’m not suggesting cynicism here, just healthy skepticism about vendor’s ROI calculators. The cost of labor time and the time savings themselves may be easy to measure. And they may have relevance for your business case. However, the case builder is still responsible for showing that the labor time savings will turn into productivity. And, the case builder must present solid reasoning showing how to value the extra time.
- Is the extra time worth 100% of cost?
- Is it worth 0% of cost?
- Or, is it worth some other percentage in between?
For examples and more in-depth coverage, see the ebook Business Case Essentials.
Learn and practice the premier methods for building your cases at a Building the Business Case Seminar. Learn more about business case design from our books, the Business Case Guide, or the most popular business case authority in print, Business Case Essentials.