OK, I confess! I am thinking like a software provider when I use the phrase ‘ROI questions’. Maybe at times it is a discussion among colleagues. It could be that one is talking to oneself regarding the potential benefits of a project. Whatever form it takes, my purpose in this blog is to illustrate how one should go about coming up with the potential benefits of a proposed project. Since my back ground is in Supply Chain, I will use examples from that world. However, I suppose this technique or process could be utilized for any type of project.
So, first question that I ask in a ROI discussion is some version of the ‘so-what’ question. As one of my mentors Jim Lucas taught me, we need to understand the pain they are trying to get rid of. If no pain is obvious, then surely there must be a perceived gain. So, a lot of the initial questioning should be around this pain/gain idea. There are many questions that get to the bottom of this. Here are a few:
- What happens in your current situation that you expect to change once you have finished the project?
- Are there bad things you are trying to avoid (pain)? What are those? Is this something that affects you, your group, your department or the entire company? How?
- Are there good things that could happen if you did this project (gain)? What are those? Is this something that affects you, your group, your department or the entire company? How?
Once all of this is discussed, you might have a list of perceived pains and gains. These might be all over the place. For example, some pain/gain might be financial, directly affecting the bottom line. Others might be softer and might deal with customer satisfaction, or internal improvements. Whatever they are, create the list and divide them into categories. For ideas, see my blog on the balanced scorecard approach here.
Next, comes the question of calculating the benefits. (For this blog, I am assuming that you know the cost picture well; it is important to note that the ROI calculation needs both returns and cost numbers.) As you do this, keep in mind that in both the benefits and the cost category, there are one-time entries and there are repeating entries. My preferred way of doing this is to create a spreadsheet where you can capture the numbers in yearly or quarterly granularity.
Hard, financial pain/gains are easier to account for. Simply plug these numbers in the different years. The soft or the intangible gains require some thinking. There is a very good resource on the subject: A book titled ‘The Dollarization Discipline’ by Jeffrey Fox and Richard Gregory. A good amount of effort should go into the dollarization. For example, say you are doing a forecasting project. Further, say that one of your theories is that if you forecast better, you will keep your customers more satisfied. Great! How does one quantify this for the ROI calculation? Let us go through some steps.
What do satisfied customers do? Well they keep coming back. Maybe they order more. Good examples of gain.
What do dissatisfied customers do? Best case, they are irritated but they stay with you. Maybe for this to happen, you have to do some expediting or take other remedial steps. There is a cost associated with that. Worst case, they go away and create a fuss on social media and take other customers with them. Talk about pain! If this happens, you have to invest sales effort and money in getting new customers.
So, you could now begin to put together the costs associated with this change. Here are some questions to ask.
- What is the lifetime value of a satisfied customer?
- What is the cost associated with acquiring a new customer?
- How many new customers will be needed to backfill the revenue gap created by the customer who goes away?
- How long does it take to acquire a new customer?
Once these numbers are in, we can create a cost profile associated with the lost customer. We can apply principles of time value of money to convert them to today’s dollars. Then we can feed this information into the ROI calculations.
We should be asking these types of questions for each perceived pain or gain. Once done, you will have a pathway to a good ROI calculation.
Obviously there are several more questions surrounding ROI, these are just some of my thoughts. Please share your ideas and comments below.