Friday, March 27, 2009

The Real ROI

ROI. ROI. ROI. There, I've said my day's requirement of "ROIs".

ROI, or Return On Investment, is today's hot business buzz word - as it should be in the economic climate we all find ourselves in. Business meetings are ablaze with discussions of allowable and appropriate investments and their returns.

But these same discussions most often come up way short when considering the return on investment for capital purchases, or other "unsexy" subjects such as labor costs or scrap rates or the cost of production downtime. Nope, it's much more hip to talk about the return on the latest marketing campaign, commercial, or new product release.

ROI Redux

But the reason these other important ROI topics are overlooked, in addition to their unsexiness, is a basic historical misrepresentation of what capital "ROI" truly is. If you asked a hundred people what Return on Investment means to them when they're evaluating a capital purchase, most will respond with a simple, and common, answer: "ROI means how long it will take for this to pay for itself."

And therein lies the problem. While payback period is one piece of ROI, it is far from being the most important. And yet for many it is the only thing they think about. The true value and motivation in ROI shouldn't be about "When will I get my money back." It should be about "How much profit will it make me and how soon?" The payback period of an ROI will always be there - whenever you do decide to move forward. In other words, a 3 month ROI payback period will ALWAYS be a 3 month payback period. Under that perspective there's no incentive or motivation to move forward in a time of tight capital.

The Elephant in the Room

But Payback period is NOT what ROI is all about. No, ROI is all about PROFIT, and making more of it sooner. ROI is about how much it is costing me to NOT do it and how much more money I'll make the sooner I move forward. It's this simple difference in perspective that differentiates those who will make it through tough economic times and those who won't. This isn't rocket science, it's very simple math - and Business 101.

The $100 Bill Analogy

If I told you I'd give you a $100 Bill each day for the rest of your life, when would it most benefit you in 2009 to start taking my money? Today or 6 months from now? If you said 6 months from now, well, you have bigger needs than my money can solve. If you said you'd like to start today, knowing that you'll get more money in 2009 the sooner you start collecting $100 a day, then you get it. You'll make more money in 2009 the sooner you start making more money. Pretty simple logic really.

Adding a Payback Period

So, now I'll change my offer to you a bit. I'll still give you a $100 bill each day, but only after you first give me $3000 to "buy in" (no this is not a Ponzi scheme - it's just an analogy!). You're not sure you want to spend the $3000 right away because it will take 30 days for my offer to pay for itself. So maybe things will be better in 3 months and you can better afford it then. After all you think, a 30-day ROI will be a 30-day ROI in 3 months, right? Wrong! Yes, the 30-day payback period will always be 30-days - but remember that's old-school ROI thinking. By waiting 90 days to start, you will be forfeiting $9000 in real earnings in 2009 simply by waiting. A costly decision.

Putting it in Capital Terms

So, now let's look at this in the realm of real capital expenditure levels. Let's say, for the purposes of easy math, I'm looking at a capital expense of $30K that shows an ROI with a 3 month payback period. Let's also assume there are exactly 9 months left in 2009. I could push that purchase back all year based on the fact that I don't want to spend $30K right now. But if I don't spend it, my management would have every reason to fire me. Confusing? Not really.

The problem is, we're programmed to think about things the "safe" (i.e. wrong) way. But my management isn't paying me to be stupid. No, they're paying me to understand that I'm ALREADY spending $10K a month on this same activity (hence the 3 month payback of $30K), which means I have a choice to make: Spend $30K on capital, or spend another $90K this year by doing nothing. Which means: doing nothing is going to cost my business $60,000 over the remaining 9 months of 2009 - while spending $30K on capital will be the equivalent of gaining $60K in revenue.

That's an average of about $220 of revenue each day for the remainder of 2009 that I'm throwing away just by waiting. And had I made this decision in January, not the end of March, I would be making $320 each day. So every day I wait is compounding the loss of revenue. Now it makes sense why management would be justified in ushering me into the ranks of the unemployed!

The time is Now

When looking at capital purchases the common logic has been that it doesn't hurt to wait. But with items with proven ROI, that logic is flawed and quite simply incorrect. Add to that the 2009 Stimulus Plan incentives for capital expenditures and it can be well argued that putting off a capital expense with a proven ROI is practicing fiscal negligence.

Connecting the Dots

So, how does this tie in to dry ice cleaning? Obviously it does, or else I wouldn't be writing it here. In many cleaning applications, dry ice blasting has an amazing ROI with payback periods less than 3 months. And that doesn't even consider the many other environmental benefits of dry ice blast cleaning. Since adding money to your bottom line is critically important for survival in 2009, then it's important to look at dry ice blasting today.

As any good business manager would say: How much of my money are you wasting by NOT moving forward with that?

Now that's the Real ROI question.


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