Return on Investment (or ROI) is one of the most vital means for determining the value and impact of an IBM Garage.
There can be multiple interpretations of ROI, depending on the industry in which you are working. For our purposes, ROI is an indicator used to measure the financial gain/loss (or “value”) of a project in relation to its cost. Typically, it is used to determine whether a project will yield a positive payback and add value for the business.
ROI is a
fundamental
business metric.
Here are the primary reasons why ROI is
so important:
It quantifies project value – Perhaps the most important aspect of ROI is its ability to show dollar figures of a project’s worth to business leaders. ROI turns the subjective into the objective, which can often turn uncertainty into support.
It can build stakeholder support – Tying a dollar value to a project may help with a “go/no-go” decision. Many times, stakeholders want to see what the dollar value is to them if they are to support a particular project. Without an ROI, that is very difficult to do.
It can uncover additional benefits– The process of calculating ROI forces practitioners to investigate benefits that might not have seemed obvious at project inception.
It can lead to project prioritization
– Once the decision has been made to launch a project, ROI helps determine the project’s ranking among other priorities; usually, projects with greater ROI are ranked higher and gain resource support more quickly.
How to use ROI
The use of ROI depends on the data to which you have access and the client context in which you are operating. Some IBM Garages work with one business unit within a client; they’re responsible for enabling a transformation in retail sales operations (as is the case at the Frito-Lay Garage) or in refinery operation (as is the case for the Woodside Garage). Other Garages work on opportunities across a range of business units. As an example, the BP Garage has worked on opportunities across a number of different business units, everything from upstream refinery operations, to retail stores, to airline fuel.
Garages working with one business unit
Will likely benefit from calculating and reporting an overall ROI for their efforts
For a singular client, the sum total of the benefit they receive from every individual Garage initiative (minus the cost of the Garage itself) is an important metric.
Garages working with one business unit
Consider calculating individual ROIs for each opportunity on which they work.
In larger, complex enterprises, stakeholders are more likely to be judged by the performance of their individual business unit, and they may see less value in an ROI for the Garage as a whole.
Whichever type of situation you’re in, ROI is an important tool to use.
Every value conversation and metric calculation, every attempt to quantify difficult concepts like customer satisfaction, every effort to measure speed to value is designed to get you to a point where you can confidently show your client how and why your IBM Garage is returning value to their business.
The formula for determining ROI is:
ROI =
[(Financial value – Project cost) / Project cost] x 100
How to
Calculate ROI
In looking at the formula, there are two components we need to determine: Financial value and project cost.
Financial Value
Financial value is simply the project’s impact in terms of made or saved money. Calculating value can sometimes be complicated based on the uncertainty of assigning actual dollars to a proposed outcome. The trick is breaking down the value into presently known components and then defining those components.
When trying to quantify the value piece of the ROI formula, remember the acronym TVD ( Time, Volume, and Dollars).
If a practitioner can define the present Time, Volume and Dollars needed to complete the process, the project’s value can be derived. This acronym corresponds with a formula calculating project’s potential value from a different perspective. It forces practitioners to define what the success factors look like at the end of the project and then break down those success factors into specific numbers.
Here’s the formula
Financial Value =
TVDPresent –
TVDProject
Where
To better understand this formula, consider a few examples. The first is a project that will reduce process cycle-time of a particular product by 10 percent.
In this example, the project team calculated a single unit cost to be $2,455, based on the current values for the time it requires (13 hours), the volume or amount per time (1 unit), and dollars (wage rate of $85 per hour and $1,350 in total cost of materials). They also calculated that, based on producing 480 units per year, this will equal $1.178 million per year in cost for this product line.
They then calculated the project values by reducing the cycle time by 10 percent, from 13 hours to 11.7 hours; all other variables remained the same. The new costs are $2,344.50 per unit and $1.125 million per year for the product line.
Therefore, the project value is:
$1,178,400 – $1,125,360 = $53,040 savings per year.
The company in the first case now has customers lined up, and needs to increase capacity. They had been selling 480 units per year, at a price of $3,200 each, for a total revenue of $1.536 million. However, because the project team reduced process cycle time by 10 percent, the company can increase output by the same amount. Therefore, their annual production can go from 480 units to 528 units, for a yearly revenue of $1.689 million.
Calculating the value of this improvement project requires a change in the value formula from above. In this case, TVDPresent is subtracted from TVDProject, to find the potential for revenue growth, or $153,600.
Project Cost
The other component of an ROI calculation is the project cost. This component should be more straightforward to determine, especially in the context of an IBM Garage. The cost of the time of the members of your squad, as well as any other associated costs with running and maintaining the IBM Garage, should represent the project cost to your client of tasking your squad with pursuing a specific opportunity.
For example, if there are 8 members of your squad, billing an average of $150 an hour for the creation of a ten week MVP,then the overall project cost would be:
Therefore, the project value is:
40 hours a week * 10 weeks (400 hrs) * $150 per hour * 8 people equals $256,000.
In this instance, the ROI for the opportunity would be a comparison of whether the financial value returned to the business outweighs the project cost. An ROI of 100% in this instance would mean that the value is equal to the project cost (basically, the investment pays for itself), while an ROI of 200% means the value is twice the project cost, etc…
Important ROI
Examples
As mentioned above, non-financial KPIs can be difficult to measure, but that doesn’t mean that improving them can’t return real value to the business. The introduction of Design Thinking into the way IBM does business is an example of an instance where a large investment was made in the way IBM develops products and software based on hard to measure, non-financial practices. This report by Forrester details the total economic impact of the application of Enterprise Design Thinking on product development. Among other outcomes, Forrester found that applying design thinking to software development projects led to a 300% Return on Investment.