So you have been working with your team and possibly a few external vendors in order to get some improvements done in your supply chain planning. Perhaps, this has to do with buying software, or maybe it has to do with process improvements within your supply chain planning process. You of course want to get approval on this from management. But first, you have to get budgetary approval from management. In order to do that, you need to calculate the projected ROI. Anyone who has tried to get a project approved in a big company knows about the all-important Return on Investment (ROI) calculations. I am hoping to do a series of posts on this topic starting with this one.
Let us start with the basics first. Supply Chain Planning projects need a good ROI calculation because, in many cases, management (still!) does not see the value. While it has become easier over the years, I still run into executives where the value of supply chain planning is not understood. The same executives will readily spend millions of dollars on a robot that helps in manufacturing but would resist spending a much smaller amount on a supply chain planning project. Their reasoning is they can easily see the ROI from the robot. It is my belief that as business people, they understand the language of ROI, and as such, it remains the job of the supply chain professionals to educate them when it comes to the ROI from a supply chain planning project.
When calculating ROI, the first item you have to consider has to be your knowledge of your organization’s constraints. Typically, management teams have certain guidelines around what kind of ROI is acceptable and what is not. Most, if not all organizations have a sometimes formal but mostly informal rule stating what the minimum ROI is they are looking for prior to making an investment. One informal rule I have heard is for every dollar spent, they would like to see at least five dollars in return. The number 5 is of course not magical; I have heard a range of 3 to 10 in the various companies I have worked with. Some other companies have rules around a net payback period. I have heard a requirement of a net payback period between 6 and 12 months.
A corollary to above is to understand how the organization calculates internal costs and how it factors these internal costs in the ROI equation. Say, if the external costs are $100, and internal costs are $50, do we calculate ROI using $100 or $150 as the cost basis? Again different organizations have different rules and it helps to know what they are so you can use the right rules when calculating the ROI. Unfortunately, there is no standard way of doing this. Some companies use all internal costs in ROI calculations whereas some use no internal costs. Others will use only tangible internal costs (hardware/travel etc.) but not the costs related to personnel’s time.
Next, one thinks about the savings or the returns. It is wise to cast a wide net and then whittle it down as to what might be acceptable. Here too, it is helpful to know what your organization allows and does not allow to be counted as a return. There are two types of savings to look for: Tangible and Intangible.
Tangible returns will include anything quantifiable in dollar or money terms. Things like inventory reduction, air shipping reduction and increase in revenue are all examples of tangible savings. Beyond that, there are two types of tangible savings: One time, and repetitive.
Intangible returns are those that cannot be easily quantified. Increased operational efficiency, better time management, better labor utilization are all good things, but it is hard to put a dollar value on them. Sometimes, with some effort, some of these can be dollarized. Perhaps, I will cover this in a future post.
Once you have made a list of all your returns and have classified them as tangible or intangible, take a hard look and highlight the ones that are questionable as well as truly intangible. Then, do your ROI based on the other (‘good’) items, and list the other items as ‘possible returns’ without doing the ROI calculation. An Excel spreadsheet can be easily designed to do all this. It is also useful to establish sorting criteria based on the probability of the individual returns.
Once you have a good measure of your calculated ROI, you should absolutely do a double-take of whether it is too little or too much. Too little would obviously not get the project approved. But too much and it could have the same effect as it can become unbelievable. As the old adage goes, better to under-promise and over-deliver. So, if you have too much projected ROI, you might have some work to do around which ones to use for the ROI calculations and which ones to mention in a side list of probables.
So, there you have it. My high-level view on calculating ROIs. If interested, you can get a head start on generating an ROI with this simple ROI calculator. Upload your historical data, and you will receive an actionable forecast with an expected ROI. It’s free to download and fun to use.
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