Captain’s Log, Entry 8034.3—The internet is awash with sellers asking you to believe their own ROI figures. You know this very well if you are currently shopping for costly assets. Vendors know that many customers believe ROI and TCO prove value for money in purchase decisions for large IT systems, vehicles, production machines, and lab equipment. Should you believe the vendor’s predictions? The answer is “Yes” only if you can trust them.
Vendor-produced ROI figures are also center-stage when sellers submit customer ROI and TCO figures along with the sales proposal. Many vendors seem to believe that sale closing will follow faster when they show customers the attractive ROI and TCO results they can expect.
Customers Should Ask …
Customers, of course, should immediately ask:
- Are the vendor ROI figures trustworthy?
- Are the vendor TCO figures really comprehensive?
- Will we really see these results?
You Should See Business Benefits Beyond Cost Savings
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.
Cost Savings Are Simple: 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 salespeople 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.
Question 1. Do Labor Costs Help ROI and TCO Prove Value For Money?
This can be a show-stopping question during a business case review if the presenter is not ready for it. “Why,” the critic asks, “count the value of employee labor? How can Purchase ROI and TCO prove value, when we’re going to these people on the payroll in any case? 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 exist primarily to answer planning questions such as, “What should we forecast as next year’s operating budget? If the case serves 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, a decision to acquire does indeed impact HW, SW, and set up costs of the new system, ensuring that these costs belong in the case.)
- Other cases exist primarily to address decision support questions, such as the following.
“Should we buy and install 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 belong in the case if the decision to acquire impacts these costs. 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. A decision to acquire will indeed impact employee labor for specific tasks, even though the total employee headcount does not change.
Question 2. Do the Vendor’s Calculators for ROI and TCO Value For Labor Savings?
Even if there’s no doubt that six 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 sit idle after acquiring the new system.
- Under the best case, they will take on other work, contributing just as productively as they did before.
In the best case, therefore, the new work assignments establish the legitimacy and value of the $320,000 cost savings benefit. Under the worst case scenario, the value of the time savings is $0. In reality, no doubt, the legitimate value of the labor savings probably falls somewhere 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,” to give assign value to the estimated “Savings.” That assumption should always be questioned. To apply the math blindly is to risk seriously overstated benefits.
How do ROI and TCO Prove Value for 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 given number of products.
- Call center operators handle a given number of calls.
- Automobile mechanics complete a given number of repair tasks.
The same is not true, however, for the large part of the professional workforce, knowledge workers—and their managers. In such cases, how can ROI and TCO Prove Value for the acquisition?
To experience the problem first hand, I suggest trying the online “Vendors ROI calculators” that turn up in abundance on technology vendor websites. 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, calculates as cost savings, using productivity gain estimates. These savings can be “…up to six 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! But do you believe vendor ROI predictions in such cases?
Do the ROI and TCO Prove Value For Money or Not?
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 about 240 work days or more. As a result, that savings is 2.5% of an 8-hour day, or 12 minutes a day.
Before you believe vendor ROI and TCO prove value, grant the vendor assumption that you really free up twelve extra minutes a day for four employees, then ask a fundamentally important question:
Are those twelve minutes are really going to translate into productive value for the organization?
As for myself, with an extra twelve minutes, I’ll probably just get an extra cup of coffee. Or, straighten my desktop 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 am not suggesting cynicism here, just healthy skepticism about vendor’s ROI and TCO 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, if the customer is to believe vendor claims that ROI and TCO prove value, the case builder must present solid reasoning showing how to value the extra time.
- Is the extra time worth 100% of the cost?
- Is it worth 0% of the cost?
- Or, is it worth some other percentage in between?
For examples and more in-depth coverage, see the ebook Business Case Essentials.
Where to Go From Here: Take Action!
Learn how to build confidence that ROI and TCO prove value for proposed acquisitions. For new and veteran case builders alike, see our article Business Case Analysis. Learn case design from our ebooks, the Business Case Guide or the best-selling authority in print, Business Case Essentials. Download today the premier case building books and software from The Master Analyst Shop! Learn and practice the premier case building methods at a Business Case Master Class Seminar.
To learn more on the IIBA International Institute of Business Analysis click here. For info on the IBF Institute of Business Forecasting click here. See also the Forbes Guide to GAAP Generally Accepted Accounting Principles click here. For a brief summary of Six Key Principles of Decision making click here.
By Marty Schmidt. Copyright © 2023.
Solution Matrix Limited, Publisher.