Recently I received an email advertisement from a reputable company (which shall go unnamed). The startling claim in the headline of the email was, "How to Save Your Warehouse Over 392 Hours per Month!" and it was about an automated pick, pack and ship technologies, along with integrated credit card processing, for a specific ERP system.
The headline was backed up by this statement in the text: "Using this integrated combined solution one customer has reported to save over 392 hours a month!" [Emphasis in the original.]
Let's do the math together
A reduction of 392 hours per month calculates to be an average of 19.6 hours per day (based on 20 working-days in a typical month). Divide that 19.6 hours per day by 8 hours per day per person, and you have 2.45 person-days "saved" per day.
If the typical warehouse employee costs the company $45,000 annually (including direct wages and all direct labor overhead), that would suggest the company is saving on the order of $110,250 per year in this new operating mode.
Based on that old saw that any cost reduction falls directly to the bottom line, then the company reported should be making nearly $10,000 per month in additional profits.
Wonderful!
Yes, but…
How many of you just read the paragraphs above regarding the $110,000+ in new "profits" with a jaundiced eye and thought to yourself, "Yes, but…."?
My guess is that most of you did.
But, why?
Why do so many managers and executives seeking to buy new solutions accept "cost justifications" and "payback" figures from their technology vendors? This is especially a provoking question when faced with the reality that—in their heart of hearts—most of them know they will probably never actually see the benefit the promised "savings."
For the sake of this discussion
For the sake of this discussion, let us say that—in the example above—the estimated cost of the "integrated combined solution" just happened to be $100,000. That might be low, but let's use it for simplicity's sake.
At a cost of $100,000, and a first-year savings of $110,000, the new technology is a "shoe-in" with a payback period of under one year!
But, as you are probably thinking, there's a problem with our numbers.
Well, the numbers (we will assume) are 100 percent accurate and precise!
The costs always come to true
Here is the real problem with taking any kind of "savings" numbers at face value without further logical consideration and planning.
Unless the company hyped by the technology vendor in their advertisement laid-off two (2) full-time warehouse workers and reassigned another about half-time to some other operation, or cut back overtime by 260 hours a month (more than 60 hours a week), then no real dollar-valued "savings" occurred.
Nevertheless, if the new technologies cost the company the promised $100,000—and those promises virtually always come true, and are many times exceeded—then the payback period has become infinite ($100,000 divided by $0 in annual savings).
Increases in Throughput are key
It is possible to have "savings" that are not lay-off dependent. If the company in the advertisement is on a steep growth trajectory, then the "savings" may be accrued over time as Throughput increases, but operating expenses are held at current levels. This might lead to "savings" by not having to hire 2.5 employees to support increases in Throughput.
Our argument, in such as case, is that these matters should never be taken for granted. Instead, they should be thoroughly articulated in the justification of any improvement effort. We use an easy-to-comprehend formula to help our clients work these out.
ROI = (delta-T – delta-OE) / delta-I
where T = Throughput,
OE = Operating Expenses,
I = Investment
This formula can be read as return on investment (ROI) is equal to (the change in Throughput less the change in Operating Expenses) divided by the change in Investment.
If the company referenced in the advertisement is not going to base new Throughput (we define Throughput as revenues less only truly variable costs) on this investment and is not going to reap the labor savings in dollars through layoffs or reassignments), then their calculation would be:
ROI = ($0 - $0) / $100,000 = 0%
Not a very enticing proposition, is it.
With layoffs and / or reassignments to garner the savings in OE, it would be:
ROI ($0 – (-$110,250)) / $100,000 = 110.25%
With an estimated $200,000 increase in Throughput (first year) and no change in OE, we would state it as follows:
ROI = ($200,000 - $0) / $100,000 = 200%
Either of these options are worth considering.
Every improvement project deserves hard-dollar evaluation
We believe every improvement project deserves hard-dollar evaluations. And that those evaluations ought to be clearly articulated and understood by executives and managers before a commitment is made for the hard-dollar investment.
We help our clients make such evaluations based on the principle that "approximately right is more important than being precisely wrong."
How do you analyze your potential improvement projects to provide a greater assurance of real and effective ROI for your investment? Have you considered how you would justify an ERP project? Read 8 Sins of ERP Implementation Failure to learn more about the common mistakes that lead to ERP project failure.
