Return on Investment (ROI) For ABC/M Projects
One of the questions managers ask when deciding on an ABC/M implementation is, what is the ROI on an ABC/M Project? In other words:
How much is this going to cost?
Does it fit in with the budget?
When are we going to see the results?
When are we going to recover the monetary and resource investment?
To answer this question, nothing better than quoting the ABC genius himself, Gary Cokins.
Estimating the Return on Investment (ROI) from ABC/M
Some organizations have strict rules to determine the acceptance of proposals to invest and spend money on equipment or projects. Sometimes the administration of these is called the capital investment justification process. Senior management may not authorize any spending unless the business proposal exceeds a certain return on investment (ROI) level – often referred to as the hurdle rate. Management wants to assure itself that any money re-invested in itself will greatly exceed the level of return that its shareholders could achieve in other investments.
Organizations that are skeptical of ABC/M regularly ask, “What is the ROI from ABC/M?” My blunt reply from what I have learned is that calculating ROI on ABC/M is not possible to do. Here is why.
What we are discussing is actually “What is the incremental benefit from having better data to make better decisions?”
My reply to this question about the ROI from ABC/m is somewhat sarcastic, but I am trying to first catch the questioner’s attention in order to make an important point about what ABC/M is and is not. I first answer with this, “The ROI from ABC/M is often 1,000%!”
However, there is some merit to this reply. As an example, after some two-day ABC/M Rapid Prototyping sessions, executives who see these early results may conclude to abandon certain losing products & service lines or to terminate (“fire”) a large but unprofitable customer. That single decision can ultimately realize a substantial amount of money in future cost avoidance that converts directly into profits. That type of financial return is a large payback from a small fraction and investment in employees’ time and the relatively minor cost of commercial ABC/M software.
That argument, however, may not be sufficiently convincing. Some managers may not believe that kind of opportunity is applicable to their organization. So I next pose this question back to the requestor: “I will answer the ROI on ABC/M relative to your estimate of the ROI you are already getting on something else. OK? What is the ROI from your general ledger accounting system?”
In short, you cannot put a measure on the benefits of better data.
What we are discussing is actually “What is the incremental benefit from having better data to make better decisions?” As discussed in this book’s outset, the general ledger is so structurally deficient that it is at best useless and at worst dysfunctional and misleading. When an organization considering implementing an ABC/M system has to think about the ROI from what they have today, ABC/M data is a multiplier of their current cost data. It is likely that the financial return from an ABC/M system is well above the ROI of 99% of the capital expenditures and investments that the questioning organization has already pursued.
In short, you cannot put a measure on the benefits of better data. An organization considering an ABC/M implementation first needs to ask itself, “Given what we see our more fierce competitors doing, how long do we want our company to perpetuate making decisions with the flawed and incomplete financial data that our users are already grumbling about?”
I am not suggesting that a company pursue an ABC/M system based on blind faith, but there is a bit of conviction required that ABC/M just makes good sense to do to provide better data. The flip side to doing ABC/M is to take no risk and keep using the same old costing method. Reluctance to act may be what is separating the stronger from the weaker economies and nations.
For example, the economy of the USA, particularly Silicon Valley, continues to boom for one reason. The people there are risk-takers. They are not waiting for consensus and 99% proof and evidence that something works. They do not keep asking about whom else is doing it because they are nervous that if they fail, they may lose face. The risk-taking people in the businesses and governments in the USA look at something, judge if it makes sense, and then go for it if it does make sense. ABC/M is a no-brainer if you can articulate the comparison of ABC/M to what an organization already has. The challenge for advocates of ABC/M is to be able to articulate this.
Excerpt from the final chapter of Gary Cokins' Activity-Based Cost Management: An Executive's Guide, John Wiley & Sons, 2001. Buy this book at Wiley.com or Amazon.com.
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