Return on Investment (ROI) is a highly valuable metric with a variety of uses. From convincing your boss or the c-suite to invest in the next big initiative to comparing the value of process improvement options, to showcasing how amazing your team is, ROI is at the center of it all.
So… what exactly is ROI?
The equation for calculating Cost ROI is:
…. JUST KIDDING!
At its core, Return on Investment is simple. It is simply the return (value) you get for an investment (cost) you make. As long as the ROI is positive, the organization is making more value than it cost to get that value.
Unfortunately, from here things can get a little dicey. For example – what is “value” to your organization and/or team and how is it measured? Is the value time, money, retention, number of widgets produced, profit margin, etc.? And how does that value equate to costs or other values? For example, comparing one initiative that has the value of time over cost against another initiative with the value of productivity over time.
That equation above is starting to look pretty good now, isn’t it?
Luckily, there is a trick.
Normalization! In other words, turn everything into the same type of measurement so you can avoid the apples to oranges to table comparisons. This is commonly done using money, but it can be whatever makes the most sense for you (resource time, calendar days, employee satisfaction, etc.).
To calculate ROI so that you can compare options, follow these steps:
Step 1. Define the Measurement
Before calculating an ROI, start by defining how you will measure return (value) and investment (cost) across all the initiatives, process improvements, or whatever else you are comparing.
It’s easiest to choose a single measurement for both return and investment so the ROI is a single value. However, it is not a must.
For example, if you use money for return on investment then the ROI is also money.
Return = $10,000, Investment is $5,000 then…
ROI = Return – Investment = $5,000
For example if you use time to hire for return and money for investment than the ROI is money for time to hire.
Return = 3 days shorter time to hire, investment is $5,000 then…
ROI = 3 days of time to hire for $5,000
Many measurements require the ‘per’ context such as a time or item. For example, costs per year or cost per hire. If the measurement requires a ‘per’, make sure to define it and stay consistent (so you don’t end up back in the apples vs. oranges problem by comparing a cost per year with a cost per week or a one-time cost).
You may also need multiple versions of ROI depending on your audience (for example, your boss may value candidate satisfaction or recruiter time while the C-suite values budget).
Step 2: Calculate Return (value)
Start an ROI calculation with the value.
If there is little to no value, you can save a ton of time by stopping the initiative before putting in more effort to calculate costs. Why do something with no value?
Starting with value and purpose will anchor the team with momentum and energy for why they are doing the work. Whereas starting with cost may anchor the team with the burden of all the work that must be done.
Using the defined measurement from step 1, to calculate the value:
Define the current state – what is the measurement now without any changes.
Estimate the expected state – what will be the measurement after the change is done.
Value = expected state – current state
Current state of cost per hire is $1,000
Expected state of cost per hire after a change is $700
Value = $1,000 per hire - $700 per hire = $300 per hire
Step 3: Calculate Investment (cost)
Using the define measurements from step 1, calculate the cost of the change. This includes all the costs required to go from the current state to the expected state.
Make sure you are looking at total costs, not just the price tag quoted by a vendor or on an item. There are many potential sources for costs. Here are a few examples:
Technology / system costs
Resource / execution costs (the teams needed to make the change)
Adoption / training costs
Remember to keep all the costs using the same measurement so you can easily add them. For example, if you are using money, then translate time and resource costs into money (you can do this by using fully loaded salaries to convert time into money).
Technology costs = $10,000
Resource costs = 1 person for 60 hours at $60/hour = $3,600
Total costs = Technology + resources = $10,000 + $3,600 = $13,600
Step 4: calculate ROI – bonus for break-even
You have the value, you have the costs, it’s time for ROI.
ROI = Value – Costs
If the measurements are the same (with the same ‘per’ context), this is super simple. For example: $10,000 per year - $5,000 per year = $5,000 per year. If the measurements are not the same or they don’t share the ‘per’, then just keep the two numbers separate. For example: ROI has a $10,000 per year value for an investment of $25,000.
As a bonus, include “break-even”.
Break-even is that point where the value gained pays for the investment. In other words, channel those late-night infomercials “IT’S SO GOOD, IT PAYS FOR ITSELF!”
To calculate break-even, determine how many years of value are required to match the investment.
Value = $10,000 per year
Investment = $25,000
ROI = $10,000 per year with an investment of $25,000
Break-even = 2.5 years (it takes 2.5 years of value ($10,000 x 2.5) to equal the investment.
“IN 2.5 YEARS, THIS CHANGE WILL PAY FOR ITSELF!”
Bringing it all together
ROI is a powerful tool for selecting options, gaining support from management, or showing off how fantastic your team is doing. To calculate ROI, start by defining a standard measurement that your audience will care about. Then calculate the value of the change and its cost. Tie it all up with a break-even calculation and you’ll be leading your organization down the path of the most effective and profitable changes.