 |
The
Gantry Group Building Business Through Research |
Gantry
Group Newsletter Issue No. 13, June 2002 |
|
The
Gantry Group Building Business Through Research |
Gantry
Group Newsletter Issue No. 13, June 2002 |
|
"Once upon a time......" ......vendors were able to close sales based on stated competitive differentiation, positioning and demonstrated functionality. But these are no longer the primary decision criteria used to approve a capital outlay. Instead customers are asking:
Even while a "cautious recovery" is proclaimed by economists, emphasis has shifted to identifying the specific value of e-business applications - then proving that value by quantifying it. As one IT vendor put it “I don’t think we can take [value claims] at face value any more. We have to be very precise about how to show that value and prove that value and then treat it as a true investment proposition. So competition doesn’t come so much from other IT vendors as it does from existing business propositions.” Yet as recently as November of 2001, a Morgan Stanley survey of CIOs compared projected software expenditures at the beginning of the year with actual spending in 2001. The results (depicted below) showed that CIOs ended up spending on precisely those solutions they had estimated to have the least ROI potential, while those with the most ROI potential (e.g. customer analytics software, customer relationship management solutions) were pushed to the back-burner.
Do these results indicate that ROI is not such an important component for closing big-ticket sales? To the contrary, this discrepancy brings to the forefront many aspects pertaining to the calculation and definition of ROI, which must be understood and weighed if ROI is to continue to be a valued spending guideline and a credible metric for success. Unfortunately the recent marketing hype around anything "ROI", has already cast doubt in the minds of many companies when a vendor presents them with an ROI statistic that is the equivalent of "........ and they all lived happily ever after." |
| Moving Beyond Blue Smoke & Mirror: ROI De-Mystified |
With acronyms like "ROI", "TCO" (Total Cost of Ownership), and "IRR" (Internal Rate of Return) being bandied about by budget obsessed executives - both buyer and sellers alike -- it's important for vendors who take seriously the need to develop a robust analytical approach to determine how customers value their offering and have a clear understanding of the terms.
Return on Investment is a financial term for "payback." It is a calculation of how much money comes in (or is not spent) for every dollar invested. Essentially ROI is nothing more than the sum of all the cash flows associated with a specific project or initiative:
ROI = SUM of all Savings PLUS all associated Revenues MINUS all Costs of ownership.
That said, there is nothing simple about identifying all the different ways that costs and revenues are determined. Savings can arise out of cost reductions and cost avoidance. Revenues can issue from existing customers or new business. Costs can be one-time, or on-going. And finally all of these categories have both tangible and intangible components.
After collecting data on all the various metrics that impact savings, revenues and costs, the resulting figure must be considered over some time period. An 800% ROI may be staggering for some industries if it can be achieved in 6 weeks, but unacceptable if it takes 18 months.
And finally, to be meaningful, an ROI figure must be assigned some probability or risk. A 200% ROI in one month that is a sure thing may be more appealing than a 1000% ROI in six months that is less probable, for a company with a risk averse profile. ROI with an associated time period and risk adjustment is equivalent to what some companies call their "hurdle rate", or the IRR of a project or investment. The IRR is a series of positive and negative cash flows made over fixed time periods, adjusted by risk.
The total cost of ownership, or TCO, is a vital ingredient to any rigorous ROI calculation. After all, your customer wants to know what the economic benefits are AFTER they subtract out the cost of your offering, which by the way, is not just the initial purchase price. TCO calculation requires a vendor to work closely with customers to discover underlying cost drivers that may not be apparent on the surface. A technology product for example, may require new infrastructure investments and the hiring of new skills that its operation may require. New business processes that must be put in place to accommodate a new system may require training and support. The lifetime of some technologies must be factored into TCO to reflect the replacement cost of new units when old ones fail.
In short, ROI modeling will demand a major time commitment on the part of vendors who wish to use it as a sales tool. But having such a tool is no longer an option -- particularly for high-ticket technology solution sales as demonstrated by respondents to a survey on mobility solution ROI best practices, conducted by Gantry Group in collaboration with Compaq. Of those survey respondents who track the payback of their mobile solution, most (75%) are tracking improved productivity, 54% are measuring reduced operating costs and 40% are calculating ROI or TCO (total cost of ownership).
Of those not currently satisfied with their identification of success metrics, the metrics that respondents would most like to track are improved productivity (57%), ROI (47%) and TCO (46%). Companies are least interested in measuring NPV (14%) and EVA (18%). Click here for Gantry Group Report: Searching for Wireless Signals-Enterprise Mobility ROI Study.
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Source: Gantry Group Mobility Solution ROI Study |
Study respondents included ROI in the top five important issues in their mobile solution implementation.
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Source: Gantry Group Mobility Solution ROI Study |
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Just What Do You Mean - I'll Get a 413% ROI? |
Assessing the value of your e-business solution to a prospect is not likely to be a simple calculation. But you would never know it visiting the Websites of many e-business solutions vendors, where you will find a cadre of testimonials from customers relating stupendous bottom-line increases to implementation of this or that vendor offering. Consider some of the claims rounded up by Tony Kotler for his November 2001 Line56 article, "Share the Pain, Share the Gain":
"The solution will deliver a moderate four-year return of $12,117,865 in positive cash flow and productivity."
"Our Web-based collaboration solution delivered an 884% ROI and a payback in less than 6 weeks.
"Our unique enterprise portal solution impacts so many parts of a business in so many different ways that the full ROI can be staggering."
For these and many other vendors, "ROI" is the latest marketing hype -- not a rigorous, meaningful calculation based on solid methodology. And very often, the ROI calculation is contracted out to an industry analyst who interviews customers about what they think the vendor's offering is "worth." Such data is then based on an "on-the-fly" estimation by a customer who is not basing their numbers on a systematically performed study, but rather on their current "gut feel" at the moment. In point of fact the vendor who actually has a handle on what their offering is worth to a customer is the exception not the rule.
Unfortunately, the practice of announcing hand-waving ROI figures has caused most businesses to doubt the veracity of vendors' claims about returns and payback. But that doesn't mean that the provision of accurate, meaningful, ROI calculations is not important. What this does reinforce is that utmost care should be taken to correctly define ROI and ROI metrics in the context of individual markets and industries, so that calculations are performed based on measures that are credible within those markets and industries.
Investment return will continue to be central to purchase decisions, but the definition of ROI has strayed from its original meaning as input metrics are changing to accommodate increasingly dynamic environments. One of the best ways to approach this exercise, is by letting your customers tell you what is believable or not believable to them. But what can you do when your customer has no idea how to measure ROI?
| ROI Challenges: Measuring the Immeasurable |
"The greatest danger is the 'concrete' and 'measurable' driving the significant out of the analysis." So says Eric K. Clemons, professor of Operations and Information Management at the Wharton School, adding that with business spending, the benefits are obscured when they are comprised by a combination of tangibles and intangibles.
Some e-business and other technology benefits are more easy to quantify than others. Revenue increases that can be directly attributed to an initiative, can be tracked without much difficulty. But more often than not, very real benefits such as maintaining unique competitive advantage, or increased customer satisfaction elude direct measurement. The danger, is that a narrow definition of ROI that only includes easy-to-measure inputs, may result in spending on low-risk activities with small, near-term cost-savings, but that offer no real strategic advantage. On the flip-side, a project or expenditure that could have a significant boost on sales, might be over-looked because it is too difficult to measure or because its projected ROI is considered "too soft." This could very well explain the results -- at least in part -- of the Morgan Stanley CIO survey cited earlier in this newsletter.
Understanding cause-and-effect is key to the development of an accurate ROI algorithm. According to Jupiter Media Metrix, almost 70% of retailers are misjudging the success of their Internet investments by only focusing on top-line and bottom-line metrics, admonishing brick-and-click retailers to abstain from a "laser-like focus" on the profitability of their Websites. The firm further estimates that some two-thirds of the benefits derived from online initiatives can only be discovered in improvements in offline transactions. However, Jupiter concluded that 46 percent of retailers are measuring online sales as the primary metric for Website success or failure, a factor which can be grossly misleading the assessment of true business value.
The implication that such findings have, indicate a need for development of sound methods for measuring benefits with downstream appearances. Some companies have faced this challenge by realizing the need to evaluate return on investment from a broader perspective.
Yellow Corp., a freight company committed to leveraging technology, has measured the success of its MyYellow.com portal by comparing its cost for implementation and maintenance with its impact on additional business. Aware that faster cycle times improves customer satisfaction, Yellow Corp.'s management speculated that the ultimate result would be more business. The company measured not only the cost-savings of replacing telephone queries with customer self-help, but also the increase in "customer capture rate." By understanding the "value-to-cash" flow, Yellow Corp. figured out a way to measure and quantify intangible benefits. Using customer surveys, the company discovered that customers interacting via the portal are 23% more likely to do repeat business than those who interact through traditional channels.
The importance of being able to quantify all the various ways your offering can reduce/avoid costs, create efficiencies, improve revenues and capture the real costs associated with the investment (e.g. not just the initial purchase price), cannot be emphasized too much. You will likely need to survey and interview your customers to get at hidden costs and benefits, and to discover if there are ways to quantify activities and benefits previously thought too difficult to measure. This will require the time and patience to map intangibles (costs and benefits) to quantifiable attributes in ways that your customer will consider both reasonable and insightful.
In many cases, the measure of an attribute is reflected in the cost of NOT having it. "Ease of Use" is a great example of a difficult to measure attribute that can turn out to be a major selling point. For example, one technology vendor, believing that the ease of use advantage it has over its competitors, is best translated into a lower total cost of ownership (TCO). Another firm with an innovative search technology, is conducting side-by-side usability tests of websites with, and without its technology -- again to measure the economic effect of its ease of use. Technical support staff are asked to perform a set of real use cases which are timed. In this way the company is able to quantify the increase in productivity that results from the use of its product.
| Validating the Metrics |
Developing sound ROI models that will be effective and credible in a sales situation, is not something that can be knocked off in a couple of hours. In a recent Gantry Group survey on wireless ROI best practices, the overwhelming majority of respondents said that the difficulty of collecting ROI metrics was the primary reason for not measuring it. To overcome the skepticism that some customers have already formed around ROI claims, the model must be analytical, explainable, and based on assumptions that are realistic and reasonable.
The major flaw in most ROI and TCO modeling exercises is lack of accurate, quantifiable data from the customer. Those vendors that offer ROI analysis of their product have generally done so by interviewing one or two customers for their anecdotal impressions about how a product or service offering has impacted productivity (e.g. what percent of IT services time is spent on dealing with connectivity issues of product "x"?), customer satisfaction (e.g. what is the average time to resolution of customer inquiries?), or costs (e.g. what is the average customer retention cost?).
Answers to the example parenthetical questions, are too often subjective, provided on-the-fly without actual research and analysis. ROI and TCO calculations based on a customer's relatively poor assessment of the impact a vendor offering has on their efficiencies, will not hold up to scrutiny -- customers are no longer accepting figures from back-of-the-cocktail napkin calculations, laced with a measure of secondary data complied by an industry "authority". Industry analyst reports represent data that is typically aggregated over a range of industries, enterprise sizes and existing systems, generating results that are mean-based and generalized. Customers are demanding very specific pay-back estimates that would result from an investment in your offering running in their specific environment.
Vendors who want to use compelling ROI cases must invest the time and capital resources to query, confirm, and validate their customer's needs around payback and value calculations. To do so, vendors must conduct the necessary research and develop the right survey tools (e.g. ask the right questions), to enable them to:
Yellow Corp., already mentioned above, approached its own internal ROI evaluations by having surveys conducted of its customers before and after the launch of its Web portal. The results of these surveys provided the company with quantifiable metrics that are used to monitor and track the ROI of its portal investment. Most companies are not as advanced in this regard and technology vendors should take notice of Yellow Corp.'s methodology, metrics, and its ROI algorithms as an example of what customers would consider valuable and robust.
So what do your customer's want to see in an ROI model? Ask them!
In order to develop an ROI case that your customer's will believe, there are many questions to ask such as:
| Sound ROI Methodology |
ROI modeling requires systematic application of sound methodology if it is to generate credible results. The following steps will help ensure that our ROI analysis does not produce numbers that belong in Ripley's Believe It or Not:
1. Interview a few of your closest, most representative customers to better understand cost and revenue drivers and to clearly identify goals and expectations they associate with your offering.
2. Develop a "straw-horse" of ROI metrics and methods for measuring intangibles; make sure the metrics accurately describe the business case and goals identified in Step 1.
3. Test these ROI assumptions across a statistically representative sample to validate that your ideas will be widely accepted and to debug and tune the ROI model. Are you using the right metrics? Are the business goals you identified shared by your target market? Are your cause-and-effect assumptions reasonable for quantifying intangibles?
4. Use the data collected to develop a solid modeling tool that can be used on a customer-by-customer basis to calculate tailored ROI.
5. After you've made the sale, revisit the actual ROI at the end of the implementation of your offering to measure actual performance vs. expected performance (using the same metrics developed for the pre-implementation ROI calculation.)
This methodology will ensure that your ROI claims are based on a model that:
Perhaps most importantly, remain objective. Don't use ROI inputs that come from pure guess-work. Once you gain a reputation in the market for promoting misleading numbers, it is tough to recover.
About the Gantry Group: The Gantry Group, founded in 1997 and headquartered in Concord MA, is a strategic advisory and custom marketing intelligence firm.
The Gantry Group creates business success through research, identifying and applying critical relevant data that leads to strong, actionable strategies. The Gantry Group delivers to corporate marketers the tools and predictive measurement capabilities that allow them to make informed decisions as they plan ahead and prepare for the market to come.
The Quantifying Customer Payback practice relies on customized market research and quantitative financial modeling to develop a credible payback calculator that is based on metrics that are meaningful to your customer. In addition to a re-usable payback tool, you also have solid market data to quantify your unique value proposition to your prospective customers to ultimately improve your ability to close sales.
Gantry
Group recognizes that one of the critical components to developing a compelling
and accurate payback tool is understanding how your offering impacts the very
business metrics your prospects use to judge the performance of their own
companies. To gain insight into those business metrics your customers care
about, Gantry Group surveys the target market to discover the business processes
and cost centers that are affected by the implementation of your offering. This
and other data about acceptable levels of return on investment, identifies the
drivers to the quantitative model and also provides a context for strategic
messaging that highlights the tangible, measurable economics of your offering.
The Gantry Group has been helping companies design winning strategic marketing
packages through the application of its proven ROI profiling methodology.
Contact us today to see how we can assist your firm to give your target market a
good reason to buy!
| The Gantry Group,
LLC 30 Monument Square, Suite 135 Concord MA 01742 |
Phone:
978-371-7557 Fax: 978-287-0043 Email: info@gantrygroup.com Web: http://www.gantrygroup.com/ |
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