For years, companies have been using Return On Investment (ROI) to validate purchasing decisions of ERP Software, Engineering Software, CRM Software, and more. But the number you get out of this calculation is only as accurate as the numbers you put in.
In this post, I'll review the numbers that go into calculating ROI for a software purchase. For illustrative purposes, I am going to use a true cloud ERP software as my example software. (For information about the difference between hosted software and true cloud software, see my last blog post here).
How do you calculate the ROI for your software purchase?
The “By-the-Book” Answer:
ROI measures the amount of return on an investment relative to the investment's cost. The typical calculation used is the following:
Simple ROI = (Gain from Investment – Cost of Investment) / (Cost of Investment)
5-year ROI Example
Your service company does a benchmarking exercise to document its’ business processes, cost of compliance, and performance, using metrics such as ‘the cost of providing quality service/products’ and ‘use of technology’.
It produces the following hypothetical results (these are not random, but taken from hundreds of our clients’ evaluations of their business):
- You have many disparate systems for managing your business.
- Many of the processes to manage the quality, efficiency and customer facing systems are manual.
- Month end and year end closings are very time consuming and many times inaccurate.
- Many of the processes are managed through Access databases or third party software.
Cost of Software
- 1st year - $ 150,000
- 2nd – 5th year - $ 40,000 per year
5-year Estimated Cost = $ 310,000
(For help calculating this amount, see my previous post on Total Cost of Ownership)
Gain from Investment (Savings)
Items factored in to savings calculation:
|• Technology hardware savings||• Reduction of Theft / Fraud|
|• Staff time||• Inventory Write Offs|
|• Compliance||• New Markets / Customers|
|• Expedited Billing||• Repurposed software costs|
|• Billing Errors / Shortfall||• Staff Changes|
5-year Estimated Savings (Gain) = $ 500,000
($ 500,000 (Gain) - $ 310,000 (Cost)) / ($ 310,000 (Cost))
= 61.2% or 12.2% per year.
Your company now has a good idea of the savings that you can expect over the next 5 years; how it will impact the broader company and your competitive positioning. This benefit can be compared to other investments under consideration.
So, that's the "by-the-book" answer. It seems straightforward - just a simple math equation. But how do you come up with these numbers?
The Real Answer:
Calculating ROI requires you to quantify both Savings and Cost intangibles. How do you assign a dollar figure to time or productivity, increased market vision, or the value of identifying high revenue/profit drivers?
Let’s read between the lines and give real world examples to quantifying the individual components, both on the cost side and the savings side.
Cost Side Calculation Factors
(For a breakdown of how to cost software, see my previous post here)
You’ve obtained figures for the cost of the software, support, training and implementation for the first year, and you also have the cost of the subsequent years (for both software and support). Is this the entirety of the Cost calculation? No.
The largest potential cost intangible is what we call “Scope Creep”. This is defined as an increase in the work that was originally specified. This is very important to understand, and can be minimized or eliminated by understanding how it happens, both from your vendor and your staff.
As you progress through the exercise of creating a final Business Requirements Document (BRD) with your vendor, your staff and management (project team) may be tempted to add features not originally in scope, encouraged by the knowledge of what software features are available to you and the advantages these features bring. This can be avoided by doing a thorough evaluation of what departments/functions/problems you are trying to address before you get into the configuration stage of the project. A good vendor will always be willing to assist you with this exercise, and you may also solicit outside opinions from trusted and knowledgeable sources. Be sure to produce a clear Business Requirements document before you start looking at software demonstrations.
There is an adage that goes “You are better off with the wrong software and the right vendor than the reverse”. I, of course, encourage you to shoot for both, but the message that this adage is attempting to impart is very valid.
The vendors you choose to compete for your business have a decision to make. How much free time do they “donate” to this opportunity before the transition to a paid engagement? A thorough discovery done by the vendor (the expert) should allow them to provide you with an accurate proposal. On the other hand, a quick proposal, done by inexperienced personnel without proper process, and/or one done with their eye on the clock is liable to end up in project-killing “Scope Creep”. The downside of discovering this too late is that you have already expended a great deal of resources and money and it may be too late to back out. Choose your vendor wisely and embrace process over speed.
Savings Side Calculation
Technology hardware savings
Technology savings consist of the elimination of all your servers and related hardware (not related your internet access). Remember to figure both current and future needs.
Repurposed software costs
These would consist of the total that you are currently paying for software that will be replaced by your new solution.
The largest mistake we encounter is the attitude that if someone is a salaried employee and they are currently getting their work done (however painful it may be for them), that there are no savings by opening up time in their day/week. This is erroneous on several points. Your staff has been working in your industry and has learned along the way. If they are freed to contribute to efficiency, customer retention, marketing or customer experience innovation, you will experience a great savings; albeit one that is hard to quantify. Note: If you can retain or gain one customer by improving your quality (product/services or just customer experience), then that figure should be calculated as a savings.
You also greatly enhance the work experience and consequently the loyalty of your employees when they are engaged in assisting in growth or efficiency initiatives. Do not make the mistake of selling your employees short. Their previous absence in this process because of time constraints doesn’t mean they can’t assist your company in growth – who better than the people you have on the front lines to make suggestions or take on new projects?
This is by far the first benefit that is noticed by a customer who has automated through software, but may be hard to quantify. Editing and closing a work order in the field combined with proper approval workflow speeds billing up by days/weeks and yes, sometimes even months.
Billing Errors / Shortfall
Our field service clients report a significant problem with billing errors. A technician may perform a service in the field and forget to add it to the work order; money lost. Probably the biggest consequence of inaccurate billing is the time it wastes in staff investigation, correction and retransmission. This is also hard to quantify, but vitally important if you want to grow.
Inventory Write Offs - Theft - Fraud
Whether it is inventory, employee submission of job time or accounting errors, this can be a significant impact on profit figures. We have seen inventory discrepancies in the hundreds of thousands of dollars and employee job time submission errors/fraud, but don’t overlook lack of automation in accounting/finance procedures and reporting. Our recent client took a large write off for under-assigned depreciation because his system calculated this manually and had no checks in place. You can’t fix what you don’t see.
Compliance issues sometimes get sent to the bottom of the list unless your company is subjected to regular audits. Not all companies undergo regular audits for compliance: the federal government demands DCAA compliant reporting from all government vendors/integrators who do Cost Plus contracting, but a company may never get audited. Many times, a company only understands the exposure of not keeping compliant after they have been unfavorably audited. Automate your compliance.
Bottom Line Growth through Staff
Reduction in Staff Turnover
Staff turnover can be a revenue killer. Employees are your number one asset – training new employees can be a drain on productivity and morale, not to mention cost.
Do your employees have a system that:
• Automates their duties and provides data they can trust?
• Eliminates the need for multiple spreadsheets or 3rd party software in the performance of their duties, including the ability to create accurate and timely reports?
• Automates and simplifies month-end and year-end close?
• Allows them to respond to customer and vendor inquiries quickly and accurately?
• Doesn’t create frustration and anxiety in the performance of their daily, monthly and yearly tasks?
• Allows them time to make contributions/suggestions that aid in company growth or efficiency?
Staff Reduction and/or Increased Productivity
Software automation (especially cloud based or hosted) can, many times, cut staffing requirements. Although a staff reduction can be a touchy subject for some to read, cloud software can help pay for itself with the elimination of software and hardware technical personnel. The consolidation of some accounting positions is also sometimes achieved. However, the major cost benefit derived from the adoption of the right software solution is the ability to grow: to add more customers/more transactions with the same staff. You scale your business upward without the need for additional staff. This as a significant, but often overlooked, part of your ROI.
New Markets / Customers
The proper software solution can allow you to add the workflows and business process functionality to enter new markets; a great example being the addition of construction project work. Many Facilities Maintenance companies already perform such work, and Apartment Turnover and HVAC/Plumbing/Electrical companies are rapidly moving into this area.
It takes a different software solution to handle long term project work than the shorter work-order oriented applications. Many companies purchase an additional software application to handle this work and then they must find a way to integrate it to other applications. The right software solution can do both, and you can configure these business areas in phases if desired. Many software applications cannot add complex workflows or business process areas due to a narrow focus.
We believe there is no right answer now because the question is always changing; have you accounted for this in your software?
The visibility into your business that a proper software solution provides decision makers is invaluable.
Seeing things as they are happening vs. reacting well after changes in your business show up on reports is vital. Companies, large and small, are acquiring this revenue-driving capability through software. Role based software utilizing customizable dashboards with real time data is just the tip of the iceberg. The right software solution, professionally implemented, can give you decision making data that saves money and increases revenue.
We have an Apartment Turnover client whose number one customer provided them significant growth in 2014 and 2015. Our client’s Operations Director discovered that they had lost all of the Punch Out business for this customer dating back to the beginning of 2014 and had not performed any such services for 2 years. Total billings for their number one customer had increased only because the number of apartment turnovers had gone up dramatically, thereby hiding the loss of an entire service category. The territory manager had either not noticed or failed to disclose the loss. The loss of business accounted for nearly $ 50,000.00, but more importantly, jeopardized their pursuit of renovation/cap ex business. The holder of the Punch Out contract is better positioned than the paint/carpet/clean vendor to be awarded renovation/cap ex work. This example may be overly simplistic, but I can give you a thousand more.
CFO/CEO Question: Can you, from your dashboard, identify each department’s sales for a given month AND drill down to the transaction level for any transaction that derives that monthly number? Without getting out of your dashboard and opening new reports?
Once a phrase used only in the restaurant or casino industry, this phrase has never been more applicable in the service industry. The proper software solution can equip your company with the tools to provide a true customer experience, complete with positive online reviews, repeat business and upsells. These software features vary by service industry (facilities maintenance, apartment turnover, renovation/construction, HVAC, break/fix) but typically include:
- Taking payments in the field
- Providing customer order history in the field
- Providing equipment maintenance history in the field
- Displaying equipment or services information to customer in the field to include pictures
- Customer portals
- Automated job completion notification emails
- Written customer approval signatures in the field
- Automated updates to all customers announcing specials, upcoming maintenance schedules and customer appreciation communications
- Automated customer satisfaction surveys
- On-demand and periodic review of customer activity with customer
This is just the beginning of the customer facing improvements available in today’s software solutions.
As you can see, Return on Investment (ROI) is difficult to calculate but the exercise will unearth many issues that are preventing your growth. Service companies are moving to new solutions by droves, but are they choosing the right solution, or will they be repeating this exercise in a few short years? Doing your homework and choosing your vendor wisely can have a huge impact on your ROI.
Thanks for reading and please look out for my next post!
Next: Producing a clear Business Requirements document for your software purchase.