My Turn: Solid Numbers for a Solid ROI

When it comes to ROI, there is no substitute for reliable, quantifiable data. Many SCMs use ROI calculators to back up product price tags, but is the information behind the calculations trustworthy enough to take to the boardroom?

[From iSource Business, April/May 2002] Visit the Web sites of most supply chain management (SCM) solutions providers these days and you will probably find a full inventory of return on investment (ROI) calculators, white papers and customer success stories, which shouldn't come as a surprise. With the slowdown in the economy, customers are much more cautious when making purchasing decisions. They are increasingly demanding that sellers demonstrate the economic worth of their offerings, and many SCM solutions suppliers have responded by equipping their sales and account teams with customer case studies, ROI calculators and Total Cost of Ownership (TCO) models, as they are generally known. Such calculators and models are designed to show customers that an investment in the supplier's product or service will pay for itself over time by reducing costs, increasing revenue or both. 

But how effective are such tools and models? How well do they do their job? There are reasons to believe that the answer is, not very well. Building a compelling ROI- or TCO-based business case requires that SCMs demonstrate three things in particular: objectivity, replicability and relevant comparisons.

Based on the experience of both working with and talking to numerous SCM companies and reviewing their ROI work to date, the vast majority fail to perform in one or more of these dimensions. This is not to say that their efforts are totally without merit. Making broad claims or offering anecdotal evidence may be enough to pique some customers' interest, however, most SCMs, because they lack any real ROI-based marketing and sales strategy, are not realizing the more important potential benefits of shortened sales cycles, increased pricing power, stronger customer relationships and greater profitability.

Objectivity

Lack of objective and quantifiable customer data is the single greatest weakness that can be found in most ROI/TCO models and case studies. Too often, SCMs fail to conduct the necessary research to establish what their solution is really worth to customers. Instead, they tend to rely on customers' impressions or opinions about the degree to which their solution impacts efficiencies, costs or the ability to serve customers (i.e., increased revenues).

In many cases, the data that drives the ROI calculators and models hardly merits the name. Most ROI calculators generate what if scenarios. That is, the calculator produces an analysis that roughly takes this form: If your costs are X, and if our application performs as we claim, and if we charge you Y, then you will realize a savings of Z.  Thus, one can see that the persuasiveness of the analysis rests entirely on the credibility of the ifs  that is, on the credibility of the information that is entered into the calculator. Two problems loom large here.

First. In many cases the customer data is impressionistic. Consider the very common case of solutions that promise efficiency gains and cost savings by reducing the time required and investment involved in carrying out specific tasks, such as demand planning or issuing a purchase order.

Obviously, it is of paramount importance to first know how much time it takes to carry out such tasks at the present. But in what way does the SCM get the necessary information? Usually by asking a representative of the potential customer, even though very few customers have done the detailed studies necessary to provide accurate answers. So one gets responses like the following:

Oh, in general I would say the prices we're paying for many of our products are 10 to 15 percent higher than they should be because we've been unable to enforce negotiated pricing.

Well, I asked 3 or 4 of our purchasing reps how long it takes to place an order and they figured it was roughly 10 to 20 minutes per order for the typical product.

The seller dutifully enters, 10 minutes (or is it 15? 20?) in the appropriate slot in the ROI calculator.

It's pretty clear that this won't do, since impressions of this sort are notoriously unreliable. This is not to impugn the honesty of the respondents, but simply to note a psychological phenomenon with which we should all be familiar. For instance, just ask yourself, How long do I spend on the phone each day? or, How many e-mails do I send each day? Now, how accurate do you think the answers are if you don't research them before responding? 

Moreover, suppose, for the sake of the argument, that the numbers being reported are accurate. They are still not precise enough to support a true ROI. Look again at the underlined phrases. Each one qualifies the estimated time. For example, what does roughly 10 minutes mean? If that's how long it takes to order a typical product, what is considered to be a typical product? How many of these typical products were ordered? What about the atypical ones? Of course, one can attempt to resolve these issues through the use of more questions, but that just replaces general guess work with specific guess work. 

Second. The problems we have just encountered when trying to estimate customer costs arise in the context of evaluating the alleged benefits of the seller's offering. To continue with our examples above, the seller promises that its offering will deliver time savings. What is the basis for the claim? More importantly, what is the basis for the specific numbers the seller uses? Often this information is even more speculative than the customer information. 

The bottom line is that a ROI/TCO-based business case is only as good as the information that drives it. That information should be derived from rigorous measurement of actual usage situations, rather than the subjective impressions of one or a handful of people.

Suppliers that have conducted research should take a hard look at how the data was collected. It may be necessary to employ a variety of research techniques and methodologies to validate and verify customer data and benefit claims. These may include an analysis of historical data and records, mapping workflow processes, and time motion and direct observation studies.

Designing and executing such studies is difficult, but it is also essential. If such studies are not done, then the purported ROI will lack credibility.

Replicability

Regardless of how much time and effort is invested in documenting ROI and TCO and no matter how rigorous the research, prospective customers will often dismiss isolated case studies and anecdotal success stories. They will insist that their company is different, that they serve a different customer base, or that they operate with different work processes or legacy systems. These are perfectly reasonable issues for customers to raise and they have every right to question whether the ROI they will get is equal to the ROI other customers have realized. However, without the ability to demonstrate that the results are replicable, many SCMs will feel compelled to lower their prices out of fear that the customer will walk or delay their purchase decision.     

For these reasons, SCMs must conduct in-depth research with multiple enterprises that are in some way comparable to one another. Doing so will give prospective customers confidence in the purported ROI.

It has been the practice of virtually every SCM to develop single case studies for specific vertical markets (e.g., financial services, telecom). SCMs can strengthen and enhance their business case by conducting additional case studies in these markets. The optimum number of research subjects can vary from 3 to 4 up to 6 to 12 customers within a given market segment. Working with multiple customers provides a good base from which conclusions can be drawn. It also helps the SCM supplier to understand how the value delivered varies across different types of customers.

Relevant Comparisons  

Another mistake SCMs make is to shy away from comparing the value of their offering to that of their direct competitors, preferring instead to make comparisons that cast their solutions in a more favorable light (i.e., Web-based contract management vs. paper-based).  

Consider how the channel management and sell-side solutions market has developed. At one time, the early suppliers in this space, such as Click Commerce and Ironside, were correct to compare the value of their solutions to the labor-intensive and often inefficient process of supply chain management. After all, there were so few suppliers capable of offering such a solution. As more and more suppliers have entered the market, providing customers with greater choice, such a comparison becomes less relevant. At this point, enterprises evaluating the viability of sell-side solutions are now more interested in the differences between suppliers' offerings (i.e., Ironside vs. Click Commerce), and what those differences are worth.

In order to justify their price tag, SCMs must be capable of demonstrating that they deliver more value than the competing solutions providers. Yet, there are very few SCMs that have taken steps to do so. 

Conclusion

There is no denying the fact that many companies have found that their ROI calculators and sales tools have been essential in securing new business. Indeed, a recent study in Information Week indicates that more than 80 percent of companies now require a ROI analysis to justify any new IT initiative. Doesn't this show that the problems described above are overstated?

This objection is useful because it allows us to clarify how the flaws in ROI calculators adversely impact the business' sales effort. It is often rather obvious to the customer, not only that the new way is more advantageous than the old way, but also that those advantages are rather substantial. For example, it may be transparent that automating a process that formerly was very labor intensive is a wise decision. After all, businesses have been operating in that way since the Industrial Revolution. The important point is that this analysis is qualitative and conceptual, which does not imply that it is wrong. However, the ROI research and calculators add numerical ornamentation to a decision that has been arrived at on quite different grounds. It may serve as a reality check on that decision, or perhaps it is useful in meeting the needs of internal constituencies that review the purchase decision. Be that as it may, the ROI analysis depends on the qualitative/conceptual analysis for its credibility.

All goes smoothly, provided the discussion is confined to whether or not the customer is going to buy. Difficulties arise when a purchase price must be negotiated. It is then that customers will begin to express skepticism about the quality of the information, the validity of the formulas and ratios used in making calculations, and so on. This is usually done in an effort to pressure the seller to reduce the price and, if the seller lacks confidence in its ROI analysis, that will be the likely outcome. After all, in the current economic climate, no company wants to walk away from business. The crucial point is that although you can win business with a ROI analysis that suffers from the problems we have identified you will have difficulty pricing effectively.

Building a compelling ROI-based case requires hard work, but experience suggests that the rewards more than justify the time and expense invested. SCMs that can prove in an objective and data-driven fashion that they offer superior value are better positioned to shorten the sales cycle, win a larger share of strategic accounts, attract additional capital, and defend or even improve pricing and the bottom-line.

SCMs that commit to understanding, measuring and communicating value in this way will realize strategic and tactical benefits. ROI and TCO research can also inform decisions about price, product and service development, segmentation, targeting and positioning.

There is a simple proof of the foregoing. Generally the price of the offering is determined in advance of the determination of the savings the sellers' offering will yield. That is, the price is determined in advance of the return. If the ROI analysis were sound, would the business price this way, or would it set the price only after analyzing the return the customer could expect? 

Tony Kotler, is a senior consultant with Kotler Marketing Group, a consulting firm that helps companies in a number of different industries to develop a ROI/TCO-based sales capability. Tony Kotler can be reached at tkotler@kotlermarketing.com.