ROI Basics You Can Utilize Today!
February 2018
Jack and Patti Phillips
ROI Institute
Once you recognize the fundamentals of the ROI Methodology, the natural chain of impact starts to make sense.
Many business owners who choose to measure return on investment for diverse projects and programs understand that determining how to do it accurately and effectively can be puzzling. How do you establish which costs to include in your calculation? Can you actually isolate the business impact of any one program? Measuring ROI doesn't have to be hard. And it is so significant a measurement that we actually developed the "ROI Methodology" to make it simpler for companies, large and small, to make that all-important calculation. Once you recognize the basics of the methodology, the natural chain of impact starts to make sense.
The use of ROI has progressed to non-traditional areas. It is no longer limited to a process that shows the value of a business's buildings and equipment. ROI is now being used to show the value of technology projects, human resources, quality, and marketing initiatives. In fact, ROI can be assessed for virtually any policy, program, project, process, or system. Let us show you how with a quick course in Phillips' ROI Methodology 101.
Envision any project that you are implementing -- it can be a new sales approach, new software for the business, a new absenteeism control procedure for your workforce, or a new leadership program. Let's think about how the project evolves and the data we will gather. The process follows a simple, rational chain of impact.
The first set of data would be reaction. People should see the project as helpful, valuable, and necessary -- possibly even essential -- to them personally. Unfavorable reaction spells disaster, and the project dies. A positive reaction often indicates that it will go even further.
Learning is the next measure. Even if it is a new plan, participants must learn what they have to do to make any project or program successful. If it is new technology, they must first understand how to use it before they can employ it. We must measure learning in a simple, relaxed way. And simply put, we have to determine if they actually know the new material. If they need more structure, which is generally the case, we give them a test with self-assessments.
The chain of impact then takes us to the next level -- application. Participants need to do something with what they have learned. We want them to apply the project, implement the policy, or use the software. This is crucial, because so many projects collapse at this level. We must appreciate that if they are following the process, there are simple continuation measures that will easily conclude whether or not the program is functioning appropriately. If it is not, then it is imperative to identify what is getting in the way.
Application involves action, and the outcome of that action is impact, the next level of evaluation. These measures can involve sales, productivity, cycle time, errors, absenteeism, employee turnover, customer satisfaction, and job satisfaction. The impact measures are highly important and exemplify the results of applying the project appropriately.
This data is exceptionally valuable. It shows the business contribution of our project. But gathering the data is never enough. There are steps that we have to take to make it credible.
Most significant to calculating a reliable ROI is isolating the effects of our project on the data. We know that numerous additional factors could have contributed to these measures. Take the simple sales example we put in a new sales plan. Sales rise, and frequently there are several factors initiating it. So, we must purposefully take a step to isolate the effects of our project on the measure. In other words, we only take credit for that part. There are countless ways to accomplish this -- far beyond what we can examine in this article. You have a complete opportunity, and we recommend that you continuously have a system in place to isolate the outcomes of the program. Otherwise, there will be no credibility.
The next step is converting the data to money. To get the ROI, we need monetary benefits, which are converted from the impact measures. This is very easy for some. For example, we use the profit margin if the business impact is in sales. We use standard cost of quality for waste and rework. We use standard data or experts in the organizations for absenteeism, turnover, and accidents. It is often easy to locate the data, and an expert in a business or industry often has already converted it to money. We look at the value add If it is something we want more of, like productivity or sales. We look at the cost savings if it is something we are trying to prevent or reduce. We decide with the money, "So how long do we consider this benefit to be?" To be moderate, we go for one year. Sometimes we increase that, contingent on the extent and nature of the project. We take the monetary benefits for one year, and then compare it to the entire cost of the project. It is important to include every direct and indirect cost so that it is credible. These two amounts come together as cost verses benefit to give us ROI.
We express ROI in two ways. First, the benefits divided by cost, which is called the benefit-cost ratio. For example, a project that cost $500,000 with the benefits costing $750,000 equals a benefit-cost ratio is $1.5. This means that for every dollar invested, we receive $1.5 in benefits. Because the financial community does not utilize benefit-cost ratio, we convert it to ROI. We take the benefits minus the cost (which is the net or the earnings on the project). Then that is divided by the cost. Simply multiply it by 100 to get the percentage. That becomes the ROI, conveyed as a percent. In the previous example, benefits of $750,000 with cost of $500,000 produces a benefit using ROI of 50%.
The rules and standards of the methodology will give you a credible ROI calculation. But it is important to remember the basics and follow the chain of impact to determine the program's value in monetary terms. Simple!
Join ATD Kentuckiana and the ROI Institute on February 27 from 11am to 5pm at Humana as we dive deep into ROI Methodology, the fastest growing metric for evaluating HR, Learning, and Talent Development!